Seller financing arrangements would have to be disclosed in the notes of companies’ financials in an update proposed this week by the Financial Accounting Standards Board (FASB). 

The arrangements, sometimes called reverse factoring because they’re initiated by the buyer of goods or services rather than the seller, involve third-party finance companies making early payments to suppliers on behalf of the buyer. 

Buyers tend to like the arrangements because they help them manage cash more efficiently and sellers like them because they’re more assured of getting timely payments, although in exchange they typically accept discounted payment amounts. 

Investors, analysts and accountants have had concerns over the increasingly common arrangements because they’re typically reported as part of the accounts payable line item on the balance sheet even though they represent a form of debt liability.

Without disclosure of the terms of the arrangements and the amounts involved, investors and analysts won’t necessarily know of the liability they represent should the third-party payer run into financial trouble or otherwise end the relationship, forcing the buyer to make payments they weren’t prepared to.  

The poster-child for what can go wrong is Carillion, a U.K. construction management company that went bankrupt in 2018 in part because of payments it owed from undisclosed third-party arrangements that went bad. 

Disclosure flexibility

Under FASB’s proposal, buyers would have to disclose enough information about the arrangements in their notes to enable investors to understand their terms, how much they’re used and how much of a liability they represent. 

Exactly what should be disclosed would be left to companies as long as they meet FASB’s intent. 

“The Board decided to provide management with discretion to identify which program terms are the key terms that must be disclosed,” FASB said. “The Board considered but decided not to specify which program terms are key terms because that could lead to those terms being viewed as scope criteria or balance sheet presentation criteria. In addition, some Board members believe that management is in the best position to identify the key terms of a program.” 

To help companies decide what to disclose, FASB included an example of a hypothetical key terms disclosure in the discussion portion of its proposed update. 

The board also considered requiring companies to disclose the arrangements on the balance sheet as a line item but decided against that, saying it was better to act quickly as long as the terms were sufficiently disclosed in the notes.

“The Board believes that reconsidering balance sheet presentation requirements would delay the immediate investor need for disclosure improvements,” FASB said. 

FASB is looking for companies to comment on the proposal so it can factor in concerns before it releases the update for effect. Comments are due March 21.