As more companies adopt supply chain finance (SCF) programs, and even look to such programs to bolster the bottom line, concerns are growing that third-party arrangements could trigger accounting problems.
In some SCF programs, an intermediary pays a “marketing fee” to the company for information about its payables and then approaches the company’s suppliers to offer them early payment in return for a discount.
“As a matter of course, we can offer solutions like this, but we strongly caution our clients to seek clear guidance and approval from their auditors,” says Rick Striano, Americas product head for trade and financial supply chain for the global transaction banking unit of Deutsche Bank.
The concern is that such an arrangement could prompt the Securities and Exchange Commission to require the company to reclassify its trade payables as short-term bank debt, potentially impacting loan covenants and leverage ratios.
In 2005, the SEC started an informal investigation into whether aluminum maker Alcoa properly classified its payments and any discounts received. Several years later, Alcoa reported that it had heard nothing more from the regulator and considered the case closed. Nevertheless, news of the investigation was splattered across the pages of major papers—publicity that would make any investor relations executive shudder.
Major accounting firms, including PricewaterhouseCoopers, Ernst & Young and Deloitte, declined to comment on the issue.
The accounting treatment for SCF arrangements became a particular concern to banks, which may act as a company’s SCF provider as well as its lender, after Robert Comerford, a former professional accounting fellow in the SEC’s Office of the Chief Accountant (OCA), addressed the issue in speeches in 2003 and 2004. Comerford posed several rhetorical questions about SCF arrangements, including whether the financial institution makes any sort of referral or rebate payments to the client, and whether it reduces the amount due from its client so that the payment is less than it otherwise would have paid to the vendor.
“OCA Staff believes that a trade creditor is a supplier that has provided an entity with goods and services in advance of payment,” Comerford said, and then asked whether it seemed “appropriate” to classify amounts payable to a financial institution as a trade payable on the balance sheet.
“Ever since then, the issue of revenue sharing or rebates has been pretty much taboo, because it runs into the reasonable chance that the trade payable gets reclassified as short-term debt,” says a banker who spoke on background.
Shelly Luisi, senior associate chief accountant in the SEC's OCA, says that to her knowledge, the SEC hasn’t provided any additional public guidance on how to account for potentially problematic payables transactions since Comerford’s comments.
Nonbanks supporting SCF programs may have advantage. Robert Kramer, vice president of working capital solutions at PrimeRevenue, says that Comerford was talking specifically about bank-run SCF programs where the buyer company signed a contract with the bank
“The buyer made contractual guarantees and commitments to the bank that they didn’t make to suppliers,” Kramer said. “This was viewed as the buyer actually owing vendor payables to the bank, which required a reclassification of the trade payables to bank debt.”
PrimeRevenue offers marketing fees to some of its 70 clients for their payables information, and then seeks to negotiate early payments for discounts among their suppliers while arranging financing among its network of banks. Two of its clients have subjected their programs to the OCA’s filing consultation process and received a green light, Kramer says, but neither accepted marketing fees.
The crux of the issue is whether the relationship between the company and its supplier is replaced by a new relationship between the company and the third party, such as a bank or technology vendor. If the third party offers new terms to the company—typically involving a discount—that differ from those the company established with its supplier, the arrangement may be interpreted as a financing and have to be reclassified as short-term bank debt.
Marketing fees could be construed as providing a discount in a new financing program. On the other hand, if the third party provides the marketing fee to purchase information about the company’s suppliers to independently negotiate factoring agreements with the suppliers, and there’s no change in the company’s obligations to its suppliers, the arrangement can probably be accounted for as a payable.
“The company may be sending the money to a different bank account, but if its relationship with the vendor stays the same, then the arrangement could very well be acceptable,” Luisi says.
She emphasizes that the OCA has yet to see two such arrangements that are the same and says each arrangement has to be examined individually to determine the proper accounting treatment. Luisi adds that OCA is occasionally asked to review a company’s accounting treatment for a supply-chain-finance program through its filings consultatation process, which allows companies to submit the details of a transaction along with the proposed accounting to see if OCA has any objection to the proposal.
“We haven’t seen a consultation request that’s included marketing fees since about the time of [Comerford’s] speech,” Luisi says.
For a look at how companies are using supply chain finance these days, see Supplier Finance Advantage.