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February 2015

Supplier’ Cred it – Whet her de bt or trade payable ?

By Dolphy D’Souza | Chartered Accountant
Reading Time 8 mins
Arrangements with respect to payment to suppliers
could vary substantially and may not always be straight-forward. To ease
working capital pressure, companies enter into structured transactions
that involve the supplier and bank/s. These are commonly referred to as
supply-chain finance, supplier finance, reverse factoring and structured
payable transactions. Broadly, the arrangement allows a company to pay
its supplier invoices when due (under the extended terms negotiated with
a supplier) and gives the supplier the option to accelerate collection
through a factoring arrangement. Under the factoring arrangement, the
supplier sells its receivables (i.e., invoices) from the company to the
bank at a discount. The company is then legally obligated to pay the
bank in full (i.e., the amount specified in the original invoice) since
the bank is now the legal owner of the receivables. Such an arrangement
may better enable a supplier to monetize the receivable that has
extended payment terms.

Can a company (buyer of goods and services) continue
to classify the liability related to the supplier’s invoice as a trade
payable or whether it must reclassify the liability as bank debt?

evaluating a structured payable arrangement, companies should determine
the classification based on the substance and individual facts and
circumstances, including the following:

What are the roles, responsibilities and relationships of each party (i.e., the company, bank and supplier)?

the company relieved of its original obligation to the supplier and is
now obligated to the bank? However, being obligated to a bank instead of
the supplier does not necessarily mean that the liability is a debt.
One needs to further assess whether the liability to the bank entails a
financing element or it is merely a payment of the liability to the bank
instead of to the supplier.

Have any discounts or rebates been
received by the company that would not have otherwise been received
without the bank’s involvement?

Has the bank extended the date on which payment is due from the company beyond the invoice’s original due date?

terms of the structured payable arrangement must be carefully
considered to determine whether the arrangement changes the roles,
responsibilities and relationships of the parties. To continue
classifying the liability as a trade payable, the company must remain
liable to the supplier under the original terms of the invoice, and the
bank must have assumed only the rights to the receivable it purchased.
If the terms of the company’s obligation change as a result of the
structured payable arrangement, that may be an indication that the
economic substance of the liability is more akin to a financing

Under normal circumstances, a factoring arrangement
between a company’s supplier and a bank does not benefit the company.
That’s why it is important to understand whether the company receives
any benefit as a result of the structured payable arrangement. For
example, a bank may purchase a supplier’s receivables in a factoring
arrangement at 95% of its face amount. However, rather than collect the
full amount payable from the company, the bank may require the company
to pay only 98% of that amount. In this case, the company has received a
benefit that it would not have received without the bank’s involvement,
indicating that the liability may be more akin to a financing

If a structured payable arrangement with a bank
allows a company to remit payment to the bank on a date later than the
original due date of the invoice, that may also indicate that the
company has received a benefit that it would not have received without
the bank’s involvement, suggesting the liability may more be more akin
to a financing arrangement.

The analysis should focus on whether
the terms of the payable change as a result of the involvement of the
bank. If the payment terms do not change (i.e., the company must pay the
bank on the original terms of the invoice) the characteristics of the
payable may not have changed and would not reflect a financing. If the
terms of the payable have changed as a result of the bank’s involvement,
the characteristics of the liability have changed and it may no longer
be appropriate to classify the liability as a trade payable.

Other factors that may be considered include:

the supplier’s participation in the structured payable arrangement
optional? If not, the company should evaluate whether the substance of
the transaction is more reflective of a financing.

Do the terms
of the structured payable arrangement preclude the company from
negotiating returns of damaged goods to the supplier?

Is the
company obligated to maintain cash balances or are there credit
facilities or other borrowing arrangements with the bank outside of the
structured payable arrangement that the bank can draw upon in the event
of noncollection of the invoice from the company?

structured payable arrangements require that, as a condition for the
bank to accept an invoice from a supplier (i.e., the receivable) for
factoring, a company must separately promise the bank that it will pay
the invoice regardless of any disputes that might arise over goods that
are damaged or don’t conform with agreed-upon specifications. In the
event of a dispute, a company that agrees to such a condition would need
to seek recourse through other means, such as adjustments on future
purchases. This provision is typical among structured payable
arrangements since it provides greater certainty of payment to the bank.
However, this provision may indicate that the economic substance of the
trade payable has been altered to reflect that of a financing. It is important to consider the substance of any such condition in the context of the company’s normal practices.
For a company that buys enough from a supplier to routinely apply
credits for returns against payments on future invoices, this condition
might not be viewed as a significant change to existing practice.

some factoring arrangements, the bank may require that the company
maintain collateral or other credit facilities with the bank. These
requirements aren’t typical in factoring arrangements and may indicate
that the economic substance of the liability has changed to be more akin
to a financing arrangement. For the liability to be considered a trade
payable, the bank generally can collect the amount owed by the company
only through its rights as owner of the receivable it purchased from the
supplier. As can be seen from the above discussion, whether supplychain
finance should be presented as debts or trade payable is a matter of
significant judgement and would depend on the facts and circumstances of
each case.

Below are four simple examples, and the author’s opinion on whether those result in debt or trade payable classification.

The company issues a promissory note to the supplier, agreeing in
writing to pay the supplier a fixed sum at a fixed future date or on
demand by the bank (discounting bank).

2. The company accepts a
bill of exchange and its banker simultaneously issues a bank guarantee
in favour of the supplier, making the bank liable to pay the supplier if
the company fails to honour its commitment on the due date. The bank
guarantee is not invoked at the reporting date. No interest is charged
to the company, and there is no impact on its credit limits.

3. The company buys goods from a supplier and needs to pay for them immediately.  as it does not have the cash, it arranges for a 90 day LC in favour of the supplier.  the supplier discounts the LC and receives payment immediately. the discounting charges/interest for 90 days is borne by the company. the credit limit of the company is utilised.

4. The company has entered into a separate credit limit with the bank wherein the bank will make payment to selected suppliers on company’s behalf.  as per the arrangement, the supplier will invoice the company with a credit period between 180 to 240 days. This is not a normal credit period which is also appropriately reflected    in    the    pricing    of    the    product.        The    bank    will    make    payment to the supplier after deducting discounting charges. At the due date, the company will make the full payment to the bank. The bank has no recourse against the supplier.

It may be noted that to take a proper view more detailed facts will be required, including the exact arrangement terms and the legal requirements/interpretations. on the basis of the limited information and above discussion it appears that the first     two     examples     represent     traditional     factoring     arrangement,    the    arrangement    would    result    in    the    classification    as    “trade    payables.”        In    the    last    two    examples,    the    classification would be more likely a “debt”.

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