As more companies adopt supply chain finance (SCF) programs, andeven look to such programs to bolster the bottom line, concerns aregrowing that third-party arrangements could trigger accountingproblems.

In some SCF programs, an intermediary pays a “marketing fee” tothe company for information about its payables and then approachesthe company's suppliers to offer them early payment in return for adiscount.

“As a matter of course, we can offer solutions like this, but westrongly caution our clients to seek clear guidance and approvalfrom their auditors,” says Rick Striano, Americas product head fortrade and financial supply chain for the global transaction bankingunit of Deutsche Bank.

The concern is that such an arrangement could prompt theSecurities and Exchange Commission to require the company toreclassify its trade payables as short-term bank debt, potentiallyimpacting loan covenants and leverage ratios.

In 2005, the SEC started an informal investigation into whetheraluminum maker Alcoa properly classified its payments and anydiscounts received. Several years later, Alcoa reported that it hadheard nothing more from the regulator and considered the caseclosed. Nevertheless, news of the investigation was splatteredacross the pages of major papers—publicity that would make anyinvestor 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 aparticular concern to banks, which may act as a company's SCFprovider as well as its lender, after Robert Comerford, a formerprofessional accounting fellow in the SEC's Office of the ChiefAccountant (OCA), addressed the issue in speeches in 2003 and 2004.Comerford posed several rhetorical questions about SCFarrangements, including whether the financial institution makes anysort of referral or rebate payments to the client, and whether itreduces the amount due from its client so that the payment is lessthan it otherwise would have paid to the vendor.

“OCA Staff believes that a trade creditor is a supplier that hasprovided an entity with goods and services in advance of payment,”Comerford said, and then asked whether it seemed “appropriate” toclassify amounts payable to a financial institution as a tradepayable on the balance sheet.

“Ever since then, the issue of revenue sharing or rebates hasbeen pretty much taboo, because it runs into the reasonable chancethat the trade payable gets reclassified as short-term debt,” saysa banker who spoke on background.

Shelly Luisi, senior associate chiefaccountant in the SEC's OCA, says that to her knowledge, theSEC hasn't provided any additional public guidance on how toaccount for potentially problematic payables transactions sinceComerford's comments.

Nonbanks supporting SCF programs may have advantage. RobertKramer, vice president of working capital solutions atPrimeRevenue, says that Comerford was talking specifically aboutbank-run SCF programs where the buyer company signed a contractwith the bank

“The buyer made contractual guarantees and commitments to thebank that they didn't make to suppliers,” Kramer said. “This wasviewed as the buyer actually owing vendor payables to the bank,which required a reclassification of the trade payables to bankdebt.”

PrimeRevenue offers marketing fees to some of its 70 clients fortheir payables information, and then seeks to negotiate earlypayments for discounts among their suppliers while arrangingfinancing among its network of banks. Two of its clients havesubjected their programs to the OCA's filingconsultation process and received a green light, Kramer says,but neither accepted marketing fees.

The crux of the issue is whether the relationship between thecompany and its supplier is replaced by a new relationship betweenthe company and the third party, such as a bank or technologyvendor. If the third party offers new terms to thecompany—typically involving a discount—that differ from those thecompany established with its supplier, the arrangement may beinterpreted as a financing and have to be reclassified asshort-term bank debt.

Marketing fees could be construed as providing a discount in anew financing program. On the other hand, if the third partyprovides the marketing fee to purchase information about thecompany's suppliers to independently negotiate factoring agreementswith the suppliers, and there's no change in the company'sobligations to its suppliers, the arrangement can probably beaccounted for as a payable.

“The company may be sending the money to a different bankaccount, but if its relationship with the vendor stays the same,then the arrangement could very well be acceptable,” Luisisays.

She emphasizes that the OCA has yet to see two sucharrangements that are the same and says each arrangementhas to be examined individually to determine the proper accountingtreatment. Luisi adds that OCA is occasionally asked to reviewa company's accounting treatment for a supply-chain-financeprogram through its filings consultatation process, whichallows companies to submit the details of a transaction along withthe proposed accounting to see if OCA has any objection to theproposal.

“We haven't seen a consultation request that's includedmarketing fees since about the time of [Comerford's] speech,” Luisisays.

For a look at how companies are using supply chainfinance these days, see Supplier Finance Advantage.