Auditors are reminding companies to take a close look at their accounts payable to be sure they haven’t inadvertently created debt that might alter leverage ratios and violate other loan covenants.
As companies and their lenders have innovated in recent years in search of new ways to access working capital, structured payable programs have become more popular, says Robert Rostan, CFO and principal at education firm Training The Street. It’s a program where a company arranges with a lender for its vendors to be paid under a factoring arrangement. Depending on the specific facts and circumstances, such arrangements could turn short-term accounts payable into longer-term debt that requires different treatment in financial statements. It could also change the equation in leverage ratios and affect other loan agreements that set limits on the amount of debt the company is allowed to carry. “Banks and finance companies have been aggressive pushing for these, and it’s the end of the year,” says Rostan. “These things tend to sneak up on you.”
A recent alert from PwC says structured payable programs are increasingly popular, especially with companies that have big buying power and are looking for ways to lengthen payment terms of their trade payables. Working with a third party, such as a bank or other finance company, the company arranges for the vendor to monetize the receivable. That way, the vendor is paid, and the buyer owes the payable to the bank instead of the vendor.
On the balance sheet, the difference between a short-term trade payable and a long-term debt arrangement is not critical, says Rostan. “How it goes through the cash flow statement is even more important,” he says. “The SEC has been concerned about cash flow presentation, whether or not you’re accurately reporting into the three categories of cash flow.” Those three categories are operating, investing, and financing activities. Debt belongs in financing activities, while trade payables are classified as operating activities.
Charles Goldstein, managing director at consulting firm Protiviti, says he sees such arrangements in distress situations where companies are looking for creative ways to stretch their liquidity. It’s also a means by which companies can free up cash to finance growth, he says.
“Over the last couple of years, we’ve continued to get questions as banks have approached companies with some ideas on how to arrange their cash. Companies are always looking for ways to arrange their cash better.”
Donald Doran, National Office Leader, PwC
“Over the last couple of years, we’ve continued to get questions as banks have approached companies with some ideas on how to arrange their cash,” says Donald Doran, PwC’s national office leader in financial services. “Companies are always looking for ways to arrange their cash better.”
Accounting guidance has little to say about how to classify such structured payable arrangements, says Brian Markley, a partner in transaction services at professional services firm SolomonEdwards. “There’s not a specific GAAP standard to address structured payables, so a company needs to look at the substance of the transactions,” he says.
In the absence of specific accounting rules, accountants and auditors are still relying on a handful of speeches by staff members at the Securities and Exchange Commission roughly a decade ago, says Mark Scoles, a partner at Grant Thornton. “Oftentimes it’s very facts-and-circumstances specific,” he says. “We’ve seen more of these in the past two years than in the five previous years. The banks are out there selling these products and services.”
TRADE PAYABLE OR DEBT?
Below, PwC gives companies some considerations to weigh in determining whether an obligation is akin to a trade payable or a debt.
Notwithstanding these considerations, the presence of certain terms may suggest that the obligation is, in substance, debt. These include:
• An incremental increase in the price of the goods to compensate vendors who provide extended payment terms
• The original liability being extinguished, such as when a company charges the payable balance to a credit card
• Interest accruing on the balance prior to the due date (although penalties for non-payment may be imposed after that)
• The bank having the right to draw on the company’s other accounts without its permission if the designated payment account has insufficient funds, if not part of the company’s normal banking arrangement
• Altering the trade payable’s seniority in the company’s capital structure
• Requiring the company to post collateral on the trade payable
• Default on invoice payment under the arrangement triggering a cross-default (other than a general debt obligation cross-default)
To distinguish the proper classification of structured payables, accounting experts say there are a number of indicators to consider, no one of which provides a clear-cut answer by itself. “If you’re extending the terms, if the price is changing, if it will cause default of other debt,” says Rostan. “One of these things is not going to break the camel’s back, but a bunch of them will make it look like debt.”
Doran says the analysis should look at various terms of the arrangement. For starters, the analysis considers the jurisdiction in which the company is operating and whether there are standard terms that vendors have with suppliers regarding how long until payment is due and whether there are discounts for early payment. “That would be a typical trade payable,” he says. “It’s what’s on the invoice and it’s standard for that particular jurisdiction.”
Add to that a review of the arrangement itself. “If you start having guarantees, if you start to pay the bank any fees related to the arrangement, if you start to have different rights and obligations than you did when you had an invoice with a payable,” those might be indicators that the structured payable should be classified as debt, says Doran.
Another important factor, says Scoles, is whether the buyer’s rights with the vendor change as a result of the structured payable arrangement. “Did their rights to return goods that were normal returns change in any way?” he says. “Or damaged goods? Do they have to pay that payable regardless because now it’s payable to a bank? Those are the types of things you have to consider.”
Goldstein says it’s critical for companies anytime they enter into a structured payment arrangement, or even consider it, to assure the finance folks are communicating with the accounting folks to flag it for accounting purposes. “Companies need to make preparations for this beforehand,” he says. “It’s going to affect how payments are reflected in the system, so there are extra steps to make sure it is accounted for correctly.”
It’s also important, says Goldstein, to assure the other parties to the arrangement are treating it the same way in their books. “You can’t have one treat it as a payable and another treat it as a loan,” he says. “There has to be symmetry.” Finally, the arrangements also have implications for bankruptcy proceedings, should that ever come into play. “Under preference in bankruptcy proceedings, within 90 days of the filing, all payments made to creditors are subject to avoidance,” he says. “This type of arrangement muddies that look-back period.”
Scoles says it’s critical for accounting staff to recognize they won’t find written guidance in GAAP to tell them what to do. “If you go trolling through the [Accounting Standards] Codification, you’re not going to find anything that’s going to help you,” he says. “If there’s a three-party arrangement, you need to be on the lookout for it and assure it is classified correctly.”