Key Accounting Considerations For Supplier Finance Arrangement

Key Accounting Considerations For Supplier Finance Arrangement

In recent years, supplier finance arrangements, also commonly referred to as supply chain finance (SCF), trade payable financing, reverse factoring arrangements or structured payable transactions, are becoming popular as a means to facilitate faster payment by customers of their supplier invoices. These arrangements are popular across the industries but more common in metal & mining and FMCG sector. In such arrangements, generally a financial intermediary, viz., bank agrees to make upfront payment for amounts owed by an entity to its suppliers and the entity will make payment to the bank at a date later when payment to the suppliers is due or at the end of extended credit period. These arrangements may take various forms and terms and conditions of these arrangements may also vary significantly. Based on our understanding, given below are typical features of a common supplier finance arrangement:

• Involvement of a purchaser of goods/ services, a group of its suppliers and a financial intermediary (bank) who enter into a tri–partite or a series of bilateral agreements.
• Purchaser is often a large, creditworthy entity that uses a number of suppliers, many of which will have a higher credit risk/ lower credit worthiness than the purchaser.
• Arrangement is generally initiated by the purchaser as against the supplier.
• In many cases, these arrangements are put in place so that the purchaser gets extended payment terms from its suppliers. However, in other cases, the purpose may simply be to secure early payment for the supplier.
• Bank makes available to suppliers invoice discounting or factoring facility for invoices accepted by the purchaser.
• Purchaser will commit to pay the invoice on the due date or at the end of extended credit period.
• Interest and cross-default terms are included in the agreement to protect the bank in the event of the purchaser defaulting or missing the payment date.
• Generally, the bank considers credit risk of the purchaser to decide minimum interest rate, but it may still be able to charge somewhat higher financing cost to the supplier (as discount charge).
• It can be difficult to determine the overall financing costs of the arrangement, and who bears those costs, especially if the supply involves items for which the pricing is subjective/unobservable.

Key accounting considerations

With regard to payables covered under such arrangements, the following key questions arise:

• There is no doubt that the purchaser has a financial liability till it settles dues under the arrangement. The question is how should such payable be presented in the balance sheet? What are the key considerations to decide such a presentation?
• How should cash flows related to such arrangements be presented in the statement of cash flows of the purchaser?
• Are there any disclosures required for such arrangements in notes for the financial statements?

Key accounting question

Whether the purchaser should present amount payable as a trade payable or as a debt–like liability. This determination could have a significant impact on the purchaser’s financial position, particularly its leverage and/ or gearing ratios.

Recent development/ IFRIC Agenda Decision

In early 2020, Moody’s Investors Service (MIS) wrote to the IFRS Interpretations Committee (IFRIC) highlighting their concerns about the classification and disclosure of liabilities and liquidity risks arising from supply chain finance arrangements and asked the IFRIC to consider providing guidance. The MIS was mainly concerned that without adequate disclosure it is difficult for users of financial statements to compare entities using supply chain finance arrangement with those that do not, inadequate/ inappropriate disclosure of supply chain finance arrangements obscure the nature of debt-like liabilities and blurs the important distinction between operating and financing cashflows. The IFRIC, while considering this matter, described reverse factoring arrangements simply as ones in which a financial institution agrees to pay amounts an entity owes to the entity’s suppliers and the entity agrees to pay the financial institution at a date later than suppliers are paid. The IFRIC issued a final agenda decision in December 2020, stating that IFRS accounting standards (IFRS) already provide guidance on the appropriate accounting classification and disclosures for reverse factoring arrangements. Consequently, the IFRIC decided not to add supplier financing to its work plan.

Nevertheless, feedback and input received by the IFRIC, from investors and analysts, suggested the information entities provide about supplier finance arrangements applying existing IFRS requirements does not meet all the information needs which would allow the users of the financial statements to fully understand the arrangement in place and associated risks. As a result, in May 2023, the IASB has amended IAS 7 Statement of Cash Flows and IFRS 7 Financial Instruments: Disclosures to prescribe specific disclosures for such arrangements. An entity shall apply these amendments to IAS 7 and IFRS 7 for annual reporting periods beginning on or after 1 January 2024 with earlier application permitted.

On the lines of amendment to IAS 7 and IFRS 7, the Institute of Chartered Accountants of India (ICAI) has also issued the “Exposure Draft on Supplier Finance Arrangements – Amendment to Ind AS 7 and Ind AS 107” which will require additional disclosures and thereby enable users of financial statements to assess effects of those arrangements on the entity’s liabilities and cash flows and its exposure to liquidity risk. The proposed disclosures are likely to be effective for financial year beginning 1 April 2024.

Although IFRIC Agenda Decision was issued in the context of IFRS, it is clear that Ind AS requirements are substantially aligned to Ind AS albeit Schedule III to the Companies Act 2013 (as amended) contains additional/ top-up requirements for presentation of financial statements. Hence, similar considerations will apply with regard to presentation of such arrangements under Ind AS. Considering this, Ind AS and requirements under Division II of Schedule III (applicable to Ind AS companies) (hereinafter referred to as ‘Schedule III’), this article discusses key consideration for supplier finance arrangements.

Presentation in the balance sheet

There is no single Ind AS which deals with accounting/ presentation of such arrangements. Rather, there are multiple requirements which need to be considered. For example, Ind AS 1 Presentation of Financial Statements requires separate presentation of trade and other payables from financial liabilities. It also requires presentation of separate line item based on size, nature, and function of an item. Format of balance sheet given in Schedule III requires borrowings, trade payables and other financial liabilities to be presented separately on the face of the balance sheet. Whilst Schedule III requires separate presentation of borrowings on the face of the balance sheet, neither Ind AS nor Schedule III nor Guidance Note on Division II - Ind AS Schedule III to the Companies Act 2013 defines the term borrowing. However, Schedule III contains a list of items to be included/ presented under the head borrowing. Also, Guidance Note on Division II - Ind AS Schedule III to the Companies Act 2013 and Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets, contain guidance on liabilities to be included under the head trade payable.

How we see it?

There is no single Ind AS which deals with accounting/ presentation of payables covered under supplier finance arrangements. Rather, there are multiple requirements which need to be considered which makes evaluation complex and judgmental.

In addition to the above, Ind AS 109 Financial Instruments contains specific guidance on when an entity needs to derecognize old liability and recognize new liability. For example, it requires that an entity shall remove a financial liability from its balance sheet when, and only when, it is extinguished – i.e., when the obligation specified in the contract is discharged or canceled or expires. Further, an exchange between an existing borrower and lender of debt instruments with substantially different terms shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.

There are further format changes/ disclosures required/ allowed depending on materiality, nature of items and to bring substance of the arrangement.

Considering the requirements, an entity will need to evaluate carefully and determine whether it should present liabilities that are part of a supplier finance arrangement:

• Within trade payables
• Within borrowings, or
• Within other financial liabilities/ as a separate line item on the face of the balance sheet.

The above evaluation is not an accounting policy choice but requires exercise of judgment basis evaluation of terms of the arrangement and relevant guidance. We believe some key factors requiring consideration/ evaluation include:

• What are roles, responsibilities and relationships of each party (i.e., the entity, bank and supplier)?
• What is the purpose of introducing supplier finance and who negotiates the terms of the supplier finance arrangement?
• Is the supplier’s participation in the supplier finance arrangement optional?
• Has the entity directly/ indirectly received an extended credit period beyond the invoice original due date/ credit period normally available for purchases of similar nature?
• Have any discounts or rebates been received by the entity that would not have otherwise been received without bank’s involvement?
• Does the entity receive any fees or other payments from the bank, or make any payments to the bank other than payment of the original invoice under its terms? If not directly, has the entity made such payment indirectly say through adjustment in purchase price of goods/ services?
• Is there acceleration of payment on specified events of default?
• Does the arrangement directly/ indirectly involve utilisation of the entity’s line of credit with the bank?
• Is the entity obligated to maintain cash balances or are there credit facilities with the bank outside of the supplier finance arrangement that the bank can draw upon in the event of non-collection of the invoice from the entity?
• Whether additional security is provided as part of the arrangement, that would not be provided without the arrangement?
• Whether the terms of liabilities that are part of the arrangement are substantially different from the terms of the entity’s trade payables that are not part of the arrangement?
• Do the terms of the supplier finance arrangement preclude the entity from negotiating returns of damaged goods to the supplier?
• Is the entity/ buyer released from its original obligation to the supplier? More specifically, in case of non-payment, who has the legal right to initiate action against the entity – the bank directly or through seller?

The analysis of these as well as other indicators will likely help entities to decide appropriate presentation of payables covered under such arrangements. While the analysis should consider the indicators in totality, some indicators might carry more weight than others.

In our view, amount payable and covered under supplier finance arrangement can continue to be presented as trade payable only if the entity’s trade payables do not meet derecognition criteria of Ind AS 109 on payable getting covered under such arrangement and also such payable:

• Represents a liability to pay for goods and services
• Is invoiced and formally agreed with the supplier, and
• Is part of the working capital used in its normal operating cycle.

The entity will apply Ind AS 109 requirements to assess whether and when to derecognize trade payable and recognize a new liability at its fair value with resulting impact in the statement of profit and loss. Under Ind AS 109, an entity will need to derecognize trade payable and recognize a new liability, if:

• The entity is legally released from its original obligation to the supplier, and it assumes a new obligation toward another party, say, bank.
• Derecognition can also occur if the purchaser is not legally released from the original obligation, but the terms of the obligation are amended in a way that is considered a substantial modification. For example, the following changes indicate a substantial modification of liability.Trade payables normally do not entail a transfer of any collateral; however, such collateral is provided in a supplier finance arrangement. Under normal circumstances, a factoring arrangement between an entity’s supplier and a bank does not benefit the entity. However, in a case, where bank purchases a supplier’s receivables in a factoring arrangement at 95% of its face amount. Further, rather than collecting full amount of payable from the entity, the bank requires the entity to pay only 98% of that amount. In this case, the entity is receiving a benefit that it would not have received without the bank’s involvement, indicating a substantial change in liability terms. Supplier finance arrangement with a bank allows the entity to remit payment to the bank on a date later than the original due date of the invoice. In such a case, it is appropriate to derecognize trade payable to supplier and recognition of new financial liability immediately on the date of change in terms, i.e., on the date of supplier finance arrangement and not at expiry of credit period allowed under the trade payable invoice.

Howe we see it?

A purchaser will need to derecognise trade payable and recognise new debt like liability if the purchaser is legally released from its original obligation to the supplier, and/ or there is a significant change in terms of the original obligation to the supplier.

Based on an evaluation of derecognition requirements as well as other aspects stated above, if an entity concludes that presentation as trade payable is no longer justified, then it should evaluate other appropriate presentation of such liability, i.e., as borrowing, separate line item or as part of other financial liability. In the absence of any specific definition of the term ‘borrowing,’ such evaluation will depend on having a clear understanding of terms, nature and function of obligation for the entity and other related aspects. For example, assume an entity, which pursuant to supplier finance arrangement, has (i) obligation toward bank, (ii) is getting extended credit period such that obligation is no longer part of its working capital cycle, (iii) is paying interest, (iv) has provided additional security, and/ or (v) is recognized as borrower in bank books. In this case, it seems clear that nature of the obligation is borrowing for the entity and should be presented as such in the balance sheet.

Consider one more example, An entity has entered into supplier finance arrangement and pursuant to the arrangement it is getting an extended credit period beyond credit period normally allowed by the supplier. However, the overall period is still such that it is still part of the working capital cycle. Also, other terms of the arrangement are such that the entity (i) continues to have an obligation toward the supplier, (ii) will not directly/ indirectly pay interest, (iii) has not provided any security or guarantee, and (iv) is not treated as borrower in the bank books nor bank has used any credit limit of the entity. In such cases, one may argue that whilst the obligation is no longer trade payable due to extended credit period; however, its nature is not borrowing for the entity and there is a need to consider alternate presentation in the balance sheet.

How we see it

Appropriate presentation of payable under supplier finance arrangements requires careful evaluation of terms and conditions of the arrangement as well as exercise of significant judgment. This may result in diversity of presentation as borrowings or otherwise, if presentation as trade payable is no longer justified. To avoid such diversity, we recommend that the Institute of Chartered Accountants of India (ICAI), the National Financial Reporting Authority (NFRA) or the Ministry of Corporate Affairs (MCA) should provide additional guidance on the matter. Till such guidance is provided, each entity should consider guidance available and develop its accounting policy for presentation of obligation covered under such arrangements. If impact is material, accounting policy as well as judgment exercised should be appropriately disclosed.

Presentation in the statement of cash flows

In respect of the presentation in the statement of cash flows, an entity that has entered into a supplier finance arrangement would need to determine whether to classify cash flows under the arrangement as cash flows from operating activities or cash flows from financing activities. This in turn poses the following challenges:

• Should the remittance of cash directly to the supplier by the bank be reflected at all in the statement of cash flow or is it a non-cash transaction?
• Should the presentation of the liability to the bank in the balance sheet impact the presentation of cash flows? For example, if the liability is presented outside of trade and other payables, should the ultimate payment to the bank be presented as a financing outflow?

With regard to the first question above, paragraph 43 of Ind AS 7 provides that “Investing and financing transactions that do not require the use of cash or cash equivalents are excluded from an entity’s statement of cash flows. Such transactions shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities.” Hence, if a cash inflow and cash outflow occur for an entity when an invoice is factored as part of a reverse factoring arrangement, the entity presents those cash flows in its statement of cash flows. If no cash inflow or cash outflow occurs for an entity in a financing transaction, the entity discloses the transaction elsewhere in the financial statements in a way that provides all the relevant information about the financing activity.

How we see it

With regard to the first question above, certain entities may argue that the relationship between themselves and the bank is, in substance, a principal/ agent relationship and the bank is acting as an agent of the entity and is, therefore, incurring cash flows on behalf of the entity when paying the supplier. Hence, they need to present operating cash outflow and financing cash inflow.

Alternatively, some entities may assess payment made by the bank to the supplier as non-cash transaction for the entity requiring disclosure in notes.

In our view, entities will need to consider the facts and circumstances and apply judgement when determining the appropriate impact on the cash flow statement.

With respect to the second question above, we believe that an entity’s assessment of the nature of the liabilities that are part of the arrangement may help in determining whether the related cash flows arise from operating or financing activities. For example, if the entity considers the related liability to be a trade payable or other financial liability/ separate line item that is still part of the working capital used in the entity’s principal revenue-producing activities, the entity presents cash outflows to settle the liability as arising from operating activities in its statement of cash flows. In contrast, if the entity considers that the related liability is neither a trade payable nor part of the working capital because the liability represents borrowings/ other financing of the entity, the entity presents cash outflows to settle the liability as arising from financing activities in its statement of cash flows.

How we see it

Assessing how to present liabilities and cash flows related to supplier finance arrangements may involve judgement and attention is drawn to Ind AS 1 requirement for disclosure of judgements that management has made in this respect if they are among the judgements made that have the most significant effect on the amounts recognized in the financial statements, as well as any information that is relevant to an understanding of the entity’s financial statements.

Disclosure in notes to financial statements

Existing disclosures required under Ind AS

With regard to supplier finance arrangement, the following disclosures required under Ind AS may be particularly relevant:

(a) Since an entity applies judgement in determining appropriate presentation of payable in the balance sheet and cash flow statement and it may have a material impact on financial statements, the following disclosures may be relevant:

1. An entity discloses judgements that management has made in this respect if they are among the judgements made that have the most significant effect on the amounts recognized in the financial statements (paragraph 122 of Ind AS 1).


2. An entity provides information about reverse factoring arrangements in its financial statements to the extent that such information is relevant to an understanding of those financial statements (paragraph 112 of Ind AS 1).

(b) Paragraph 44A of Ind AS 7 requires an entity to provide ‘disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non-cash changes.’ Such a disclosure is required for liabilities that are part of a supplier finance arrangement if the cash flows for those liabilities were, or future cash flows will be, classified as cash flows from financing activities.

(c) Ind AS 107 defines liquidity risk as ‘the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset’. Reverse factoring arrangements often give rise to liquidity risk because:

1. The entity has concentrated a portion of its liabilities with one bank rather than a diverse group of suppliers. The entity may also obtain other sources of funding from the same bank providing the supplier’s finance arrangement. If the entity were to encounter any difficulty in meeting its obligations, such a concentration would increase the risk that the entity may have to pay a significant amount, at one time, to one counter party.


2. Some suppliers may have become accustomed to, or reliant on, earlier payment of their trade receivables under the supplier finance arrangement. If the bank were to withdraw the supplier’s finance arrangement, those suppliers could demand shorter credit terms. Shorter credit terms could affect the entity’s ability to settle liabilities, particularly if the entity was already in financial distress.

(d) Paragraphs 33-35 of Ind AS 107 require an entity to disclose how exposures to risk arising from financial instruments including liquidity risk arise, the entity’s objectives, policies and processes for managing the risk, summary quantitative data about the entity’s exposure to liquidity risk at the end of the reporting period (including further information if this data is unrepresentative of the entity’s exposure to liquidity risk during the period), and concentrations of risk. Paragraphs 39 and B11F of Ind AS 107 specify further requirements and factors an entity might consider in providing liquidity risk disclosures.

Proposed disclosures

As stated above, the ICAI has issued Exposure Draft on amendments to Ind AS 7 and Ind AS 107 (ED) to increase the level of disclosure and transparency about entities’ supplier finance arrangements. The ED proposes the following disclosure for supplier finance arrangements:

• Terms and conditions of the arrangements
• As at the beginning and end of the reporting period:
  • The carrying amounts of supplier finance arrangement financial liabilities and the line items in which those liabilities are presented.
  • The carrying amounts of financial liabilities and the line items for which the finance providers have already settled the corresponding trade payables.
  • The range of payment due dates for financial liabilities owed to the finance providers and for comparable trade payables that are not part of those arrangements.
• The type and effect of non-cash changes in the carrying amounts of supplier finance arrangement financial liabilities, which prevent the carrying amounts of the financial liabilities from being comparable.

The proposed amendments will require an entity to aggregate information about its supplier finance arrangements. However, the entity must disaggregate information about unusual or unique terms and conditions of individual arrangements when they are dissimilar. Explanatory information about payment due dates, when those payment due date ranges are wide, must also be disaggregated.

How we see it

The proposed amendments are particularly relevant considering that supplier finance arrangements are becoming more popular. However, the fact that the amendments do not define arrangements that are within the scope will make their application more challenging and increase the amount of judgement that entities will have to apply.

In order to prepare for compliance with the proposed requirements, entities must consider if they need to improve their financial reporting systems and/or obtain legal permission from finance providers in order to collect the information that is required to provide the new disclosures. As a result, it is key that entities allow sufficient time to prepare for the implementation of the new disclosure requirements.