If recent coverage of supply chain financing disclosure by The Wall Street Journal and by at least one prominent securities law blog is any indication, then the topic may be ready for its moment in the spotlight. During the past year, SEC staff have quietly asked a few companies about these arrangements via the agency’s filing review process, which includes comment letter dialogs with companies about their EDGAR filings. But, as an agenda request submitted to the Financial Accounting Standards Board last fall by the Big 4 accounting firms demonstrated, the issue of supply chain financing has been on the SEC staff’s radar since at least the early 2000s.
SEC staff raise concerns in 2003. In October of 2019, the Big 4 U.S. accounting firms of Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP, PricewaterhouseCoopers LLP submitted a letter containing an agenda request to FASB expressing concerns about the proper method for accounting for and disclosing supply chain financings. The letter noted that although such financings are known by multiple names, they can feature a combination of direct payments by a purchaser to its vendor and the use of a financial intermediary to settle these payments. Key benefits of supply chain financings include the purchaser’s ability to extend payment terms (the letter noted that previously 60-90 days was common but now 180 days to up to 364 days is common), the convenience of using a financial intermediary, and the potential for the supplier to enjoy increased liquidity from optional early (although discounted) payments from the financial intermediary (i.e., payment arrives earlier than if it came directly from the purchaser).
The Big 4’s letter suggested that SEC guidance from the early 2000s emphasized the facts and circumstances of a structured transaction. One of the SEC speeches referenced by the Big 4’s letter, but not quoted at length in the letter, might be worth a closer look in order to better grasp the origins of the supply chain financing issue as at least one SEC staffer saw it in 2003.
Robert Comerford, then-Professional Accounting Fellow for Current Accounting Projects in the SEC's Office of the Chief Accountant, told an audience at the Thirty-First AICPA National Conference on Current SEC Developments that the SEC was concerned that supply chain financing arrangements could be designed to evade disclosure requirements contained in Article V of Regulation S-X. Comerford described two such financing arrangements:
- "The arrangements we've recently become aware of involve the use of a structured arrangement in which an intermediary, typically a financial institution or one of its affiliates, pays trade payables on behalf of the purchaser in order to take advantage of discounts for early payment that the purchaser would not otherwise avail itself of. The purchaser then pays the lender either the full amount of the trade payable at a future date beyond the payable's normal terms, or an amount less than the full amount of the trade payable but on the trade payable's normal due date. Thus, the arrangement between the lender and the purchaser often results in the purchaser securing financing at lower cost of funds than is inherent in the vendor's invoice. In this transaction, the vendor is often not aware of the arrangement between the purchaser and the lender."
- Another possibility involves a tri-party arrangement: "Specifically, the intermediary accepts an IOU from the purchaser and presents a separate IOU to the vendor. The lender provides the purchaser with incentives similar to those provided in the first transaction and provides the vendor with the ability to present its IOU to the lender for accelerated payment at an appropriately discounted amount."
Moreover, the Big 4’s letter suggested that accounting for supply chain financings may involve changes to the presentation of a company’s cash flows. Specifically, companies should consider SEC guidance on structured transactions applicable to recharacterizations of trade payables as debt. That guidance was in the form of a speech by Joel Levine, then-Associate Chief Accountant in the SEC's Division of Corporation Finance, to the Thirty-Third AICPA National Conference on Current SEC and PCAOB Developments, in which Levine walked through an example involving automobile floor plan financing.
According to the Big 4’s letter, U.S. GAAP currently contains little guidance on the question of how to account for trade payable arrangements. The Big 4, thus, called upon FASB to issue guidance via the Emerging Issues Task Force (EITF).
SEC staff comments. SEC staff have engaged in some comment letter dialogs with companies regarding supply chain financing. The theme of these dialogs is that SEC staff saw something unusual in the company’s filings, the company replies that the supply chain issue is nonmaterial, and the SEC accepts the companies’ promises of additional disclosure in future filings. The supply chain financing issue does potentially relate to the COVID-19 pandemic as supply chains are stressed under severe economic circumstances resulting from the national and global response to the pandemic. However, but the supply chain issue appears to pre-date COVID-19 because the SEC began asking companies about the issue in mid-2019, although COVID-19, among other factors, could accelerate concerns about supply chain financing going forward.
The Big 4’s letter to FASB suggested four common terms for supply chain financing programs: (1) structured trade payables; (2) reverse factoring; (3) vendor payable programs; and (4) supply-chain financing. A search of the Wolters Kluwer Cheetah platform’s SEC Staff Comment Letters database and of the SEC EDGAR database revealed SEC staff comment letter dialogs with five companies: Masco Corporation; Boeing Company; Coca Cola Company; Graphic Packaging Holding Company; and Procter & Gamble Co. A sixth dialog with Federated Project and Trade Finance Tender Fund, focused on that fund’s business of investing in supply chain financings (not discussed here).
—Masco comments (April to July 2019). With respect to Masco, which provided the SEC staff with one of the most detailed responses, the SEC staff took two lines of inquiry. First, much as the Big 4's letter had suggested, companies may be extending their payable days for more days than in the past. SEC staff noted that during the last 10 years, Masco had a low of 47 days in 2009 but by the end of 2018 had extended its payable days to 71. The SEC staff wanted to know if Masco was using supply chain financings or reverse factoring. Second, SEC staff inquired about the characterization of the company’s payables program: "Provide us an analysis to support your conclusion that amounts settled under your supply chain finance program are accounts payable rather than bank financing. Your analysis should also address the classification of your payments made to the participating financial institutions as well as related disclosure of non-cash financing activities required by ASC 230-10-50-3."
Masco initially replied that it had used strategic programs to extend payment terms since 2009, that it began using a financial intermediary in 2012, that relatively few suppliers participated in the voluntary program, and that executive pay was at least partly incentivized by seeking increases in accounts payable days.
With respect to ASC 230-10-50-3, Masco said: "When considering all the factors above in their totality, we have concluded that the economic substance of our payment obligations in the program remain that of accounts payable, given that the economic terms between us and our suppliers that participate in the program are substantially the same as the economic terms between us and our suppliers that do not participate in the program. Further, the characteristics of our payables have not significantly changed as a result of our establishment of this program, for the reasons described in the table above. We consider all payments made under the program to be a reduction to our cash flows from operations and reported within our increase (decrease) in accounts payable and accrued liabilities, net line within our consolidated statements of cash flows. Accordingly, these transactions are not considered financing activities and the related disclosures of non-cash financing activities required by ASC 230-10-50-3 is not applicable."
Masco later indicated that it would include additional disclosure in an accounting policy footnote to its financials. Those disclosure would include the following disclosure: "We account for all payments made under the program as a reduction to our cash flows from operations and reported within our increase (decrease) in accounts payable and accrued liabilities, net line within our consolidated statements of cash flows."
See: SEC comments (April 25, 2019; May 10, 2019; July 9, 2019); Masco responses (May 8, 2019; June 10, 2019; July 8, 2019).
—P&G comments (September 2019 to January 2020). SEC staff inquired about P&G’s supply chain finance program as described on the company’s website and suggested the company mull additional liquidity disclosures regarding trends and uncertainties pertaining to extended payment terms for suppliers. P&G said it would provide more disclosure in its future filings about the program and that the supply chain program is voluntary for vendors who have discretion regarding which invoices to submit to the program. P&G also said that although it does not directly benefit from the program, the program may achieve "improved cash flow and resulting value creation." P&G said the main benefit of the program is that vendors can utilize P&G’s credit rating. In a later update to its response, P&G detailed the items it would include in disclosures contained in future filings.
See: SEC comments (September 24, 2019; January 10, 2020); P&G responses (October 1, 2010; January 7, 2020).
—Graphic Packaging Holding Company (March 2020). In more recent SEC staff comment letters, the staff has focused on a bulleted list of questions that varies slightly for each company receiving comments. Here, the staff asked about: (1) the impact these arrangements have on your operating cash flows; (2) the material and relevant terms of the arrangements; (3) the general risk and benefits of the arrangements; (4) any guarantees provided by subsidiaries and/or the parent; (5) any plans to further extend terms to suppliers; (6) any factors that may limit your ability to continue using similar arrangements to further improve operating cash flows; and (7) trends and uncertainties related to the extension of payment terms under the arrangements.
The company replied that its SEC filings noted the company’s participation in "revolving account receivable sale programs" with financial intermediaries (sales of accounts receivable) and "various factoring and supply chain financing arrangements" of customers in which the company participates. "We have determined that both types of arrangements qualify for sale accounting in accordance with the Transfers and Servicing topic of the FASB Codification," said the company. The company also said it would clarify these arrangements in its future filings. Moreover, the company said it has, since 2016, sought to extend payment terms or "days payable outstanding" with vendors, but that it had no material, voluntary supply chain financing arrangements with its vendors, although the company will monitor these arrangements for possible future disclosures should it related activities become material.
See: SEC comments (March 6, 2020; March 25, 2020); Graphic Packaging Holding Company responses (March 12, 2020).
—Boeing (June 2020). The SEC staff’s letter to Boeing asked seven questions: (1) the impact these arrangements have on your operating cash flows in all periods presented; (2) the intraperiod variability in accounts payable balances attributed to the programs; (3) the material and relevant terms of the arrangements, including the risks along with general benefits; (4) any guarantees provided by subsidiaries and/or the parent; (5) any plans to further extend terms to suppliers; (6) any factors that may limit your ability to continue using similar arrangements to further improve operating cash flows; and (7) trends and uncertainties related to the extension of payment terms under the arrangements.
Boeing replied that supply chain financing was not material to the company’s liquidity, even though its access to supply chain financing might be curbed if its credit ratings were further downgraded. Boeing explained: "We have concluded that supply chain finance arrangements have not historically been material to our liquidity and are not reasonably likely to materially impact our liquidity in future periods. In response to your comment, we will disclose in future filings the amounts included in accounts payable attributable to supply chain programs as well as the impact on operating cash flows in each period. This will provide users of our financial statements with information to help them understand how our supply chain financing programs affect our balance sheet and cash flow statement." Boeing also said it would provide updates in its future filings.
See: SEC comments (June 2, 2020; June 8, 2020); Boeing responses (June 15, 2020).
—Coca Cola (June to July 2020). As with other recent comments on the issue, the SEC staff asked Coca Cola about: (1) the impact the arrangements have on operating cash flows; (2) the material and relevant terms of the arrangements; (3) the general risks and benefits of the arrangements; (4) any guarantees provided by subsidiaries and/or the parent; (5) any plans to further extend terms to suppliers; (6) any factors that may limit your ability to continue using similar arrangements to further improve operating cash flows; and (7) trends and uncertainties related to the extension of payment terms under the arrangements.
Coca Cola replied that it had sought to extend payment terms with its suppliers between 2014 and 2019, with most of these arrangements being completed by 2019. The company also said it had established a voluntary supply chain finance program in 2014; that program, much like P&G’s program, allows vendors to leverage the company’s credit rating. Coca Cola also provided some metrics on its program: "Based on information provided to us by the two participating financial institutions upon our request in response to your comment letter, approximately 21 percent of our outstanding accounts payable balance as of December 31, 2019 and March 27, 2020 was sold by suppliers to the financial institutions as a result of the SCF program. This represents less than 3 percent of the balance of our current liabilities as of each of these dates. The Company did not disclose the SCF program in our prior SEC filings as we concluded the SCF program had not materially affected our liquidity in the periods presented and was not reasonably likely to materially affect our liquidity in future periods."
A later Coca Cola response contained the text of proposed further disclosure, including that its payment terms with suppliers generally are 120 days and how the company accounts for the SCF program: "Accordingly, amounts due to our suppliers that elected to participate in the SCF program are included in line item accounts payable and accrued expenses on our consolidated balance sheets. All activity related to amounts due to suppliers that elected to participate in the SCF program are reflected in cash flows from operating activities on our consolidated statements of cash flows."
See: SEC comments (June 2, 2020; July 10, 2020); Coca Cola responses (June 15, 2020; July 10, 2020).
Regulation S-K amendments. The Commission recently adopted amendments to several Items within Regulation S-K. Although much of the focus was on changes to environmental, human capital, and risk factor disclosures, the adopting release contained a little-noticed mention of supply chain financing.
With respect to supply chains, the adopting release noted that the Commission staff had reviewed EDGAR filings and noted that many companies had discussed the COVID-19 pandemic’s affect on their liquidity, including on supply chains. Overall, the Regulation S-K amendments focus on the materiality of potential items to be disclosed. As a result, the adopting release observed: "Nevertheless, under the proposed principles-based approach, registrants would have to if they are material to an understanding of the business and not otherwise disclosed. For example, if supply chain finance arrangements used by a registrant are a significant part of its working capital practices, they may be material to understanding the nature of its commercial relationships."
In June 2020, the SEC’s Division of Corporation Finance issued CF Disclosure Guidance: Topic No. 9A, titled "Coronavirus (COVID-19)—Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources," which, among other things, directed companies’ attention to supply chain financing issues that may arise in the context of the COVID-19 pandemic (taken verbatim from the guidance):
- Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow?
- Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity and if so, how?
- What are the material terms of the arrangements?
- Did you or any of your subsidiaries provide guarantees related to these programs?
- Do you face a material risk if a party to the arrangement terminates it?
- What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for you?