Does your company use supplier finance programs to buy goods or services? If so, and if you must adhere to U.S. Generally Accepted Accounting Principles (GAAP), there will be changes starting next year. At that time, you must disclose the full terms of supplier finance programs, including assets pledged to secure the transaction. Here are the details of this new requirement under GAAP.

Gap in GAAP

Supplier finance programs — sometimes called “structured payables” and “reverse factoring” — are popular because they offer a flexible structure for paying for goods and services. In a traditional supplier arrangement, the buyer agrees to pay the supplier directly within, say, 30 to 45 days.

Conversely, with a supplier finance program, the buyer arranges for a third-party finance provider or intermediary to pay approved invoices before the due date at a discount from the stated amount. Meanwhile the buyer receives an extended payment date, say, 90 to 120 days, in exchange for a fee. This enables the buyer to keep more cash on hand. However, many organizations haven’t been transparent in disclosing in their financial statements the effects those programs have on working capital, liquidity and cash flows.

That’s the reason the Financial Accounting Standards Board recently issued Accounting Standard Update (ASU) No. 2022-04, Liabilities — Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations. It will require buyers to disclose the key terms of supplier finance programs and where any obligations owed to finance companies have been presented in the financial statements.

More details

Supplier finance programs are a relatively new form of arrangement that continues to evolve and grow in popularity. Even after this ASU becomes effective, GAAP doesn’t provide any specific guidance on where to present the amounts owed by the buyers to finance companies. It’s up to the buyer to decide whether these obligations should be presented as accounts payable or short-term debt.

However, the updated guidance does require that in each annual reporting period, a buyer must disclose:

• The key terms of the program, including a description of the payment terms and assets pledged as security or other forms of guarantees provided for the committed payment to the finance provider or intermediary, and
• For the obligations that the buyer has confirmed as valid to the finance provider or intermediary 1) the amount outstanding that remains unpaid by the buyer as of the end of the annual period, 2) a description of where those obligations are presented in the balance sheet, and 3) a roll-forward of those obligations during the annual period, including the amounts of obligations confirmed and obligations subsequently paid.

In each interim reporting period, the buyer must disclose the amount of obligations outstanding that the buyer has confirmed as valid to the finance provider or intermediary as of the end of the period.

Ready, set, go 

The new rules take effect for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on roll-forward information. That provision is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. Contact us for more information or help implementing the changes.

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One of the best ways to tackle financial statement fraud is to conduct periodic surprise audits. In fact, surprise audits were associated with at least a 50% reduction in both median loss and median duration, according to Occupational Fraud 2022: A Report to the Nations published by the Association of Certified Fraud Examiners (ACFE) earlier this year.

Surprisingly, however, less than half of respondents (42%) conduct surprise audits. So, numerous organizations have an opportunity to add this highly effective tool to their antifraud arsenal.

Cost of financial misstatement

Financial statement fraud happens when “an employee intentionally causes a misstatement or omission of material information in the organization’s financial reports.” Examples include a salesperson who prematurely reports sales to boost commissions or a controller who books fictitious revenue to hide theft — or lackluster financial performance.

These types of schemes can be costly. The ACFE’s survey found that the median loss from misstated financial results is roughly $593,000.

Element of surprise

Routine financial statement audits don’t provide an absolute guarantee against financial misstatement and other fraud schemes. In fact, external audits were the primary detection method in just 4% of the cases reported in the ACFE study. Although a financial statement audit serves as a vital role in corporate governance, the ACFE advises that it shouldn’t be relied upon as an organization’s primary antifraud mechanism.

By comparison, a surprise audit more closely examines the company’s internal controls that are intended to prevent and detect fraud. Here, auditors aim to identify any weaknesses that could make assets vulnerable and to determine whether anyone has already exploited those weaknesses to misappropriate assets. Auditors show up unexpectedly — usually when the owners suspect foul play, or randomly as part of the company’s antifraud policies — to review cash accounts, bank statements, expense reports, payroll, purchasing, sales and other areas for suspicious activity.

The element of surprise is critical. Announcing an upcoming audit gives wrongdoers time to cover their tracks by shredding (or creating false) documents, altering records or financial statements, or hiding evidence.

Perpetrators are likely to have paid close attention to how previous financial statement audits were performed — including the order in which the auditor proceeded. But, in a surprise audit, the auditor might follow a different process or schedule. For example, instead of beginning audit procedures with cash, the auditor might first scrutinize receivables or vendor invoices. Surprise audits focus particularly on high-risk areas such as inventory, receivables and sales. In the course of performing them, auditors typically use technology to conduct sampling and data analysis.

Big benefits

In the ACFE survey, the median loss for organizations that conducted surprise audits was $75,000, compared with a median loss of $150,000 for those organizations that didn’t perform this measure — a 50% difference. This discrepancy is no surprise in light of how much longer fraud schemes went undetected in organizations that failed to conduct surprise audits. The median duration in those organizations was 18 months, compared with only nine months for organizations that performed surprise audits.

Such audits can have a strong deterrent effect as well. While surprise audits, by definition, aren’t announced ahead of time, companies should state in their fraud policies that random tests will be conducted to ensure internal controls aren’t being circumvented. If this isn’t enough to deter would-be thieves or convince current perpetrators to abandon their schemes, simply seeing guilty co-workers get swept up in a surprise audit should do the trick.

Additional investigation

As with financial statement audits, an auditor’s finding of suspicious activity in a surprise audit will likely require additional forensic investigation. Depending on the type of scheme, an auditor might conduct interviews with suspects and possible witnesses, scour financial statements and records, and perform in-depth data analysis to get to the bottom of the matter. Contact us to schedule a surprise audit for your organization.

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What do you do with your financial statements when your auditor delivers them? Resist the temptation to just file them away — they’re more than an exercise in compliance. With a little finagling, you can calculate key financial ratios from line items in your company’s financial statements. These metrics provide insight into historical trends, potential areas for improvement and how the business is likely to perform in the future.

Financial ratios are generally grouped into the following four principal categories:

1. Operating

Operating ratios — such as the gross margin or earnings per share — evaluate management’s performance and the effects of economic and industry forces. Operating ratios can illustrate how efficiently a company is controlling costs, generating sales and profits, and converting revenue to cash.

This analysis shouldn’t stop at the top and bottom of the income statement. Often, it’s useful to look at individual line items, such as returns, rent, payroll, owners’ compensation, interest and depreciation expense.

2. Asset management

Asset management ratios gauge liquidity, which refers to the ability of a company to meet current obligations. Commonly used liquidity ratios include:

• Current ratio, or the ratio of current assets to current liabilities,
• Quick ratio, which only considers assets that can be readily liquidated, such as cash and accounts receivable,
• Days in receivables outstanding, which estimates the average collection period for credit sales, and
• Days in inventory, which estimates the average time it takes to sell a unit of inventory.

It’s also important to consider long-term assets, such as equipment, with the total asset turnover. This ratio tells how many dollars in revenue a company generates from each dollar invested in assets. Management must walk a fine line with 1) efficient asset management, which aims to minimize the amount of working capital and other assets on hand, and 2) satisfying customers and suppliers, which calls for flexible credit terms, ample safety stock and quick bill payment.

3. Coverage

Coverage ratios measure a company’s capacity to service its debt. One commonly used coverage ratio is times interest earned, which measures a firm’s ability to meet interest payments and indicates its capacity to take on additional debt. Another is current debt coverage, which can be used to measure a company’s ability to repay its current debt.

Before a company that already has significant bank debt seeks further financing, it should calculate its coverage ratios. Then it should consider what message management sends to potential lenders.

4. Leverage

Leverage ratios can indicate a company’s long-term solvency. The long-term debt-to-equity ratio represents how much debt is funding company assets.

For example, a long-term debt-to-equity ratio of five-to-one indicates that the company requires significant debt financing to run operations. This may translate into lower returns for shareholders and higher default risk for creditors. And, because the company needs to make considerable interest payments, it has less cash to meet its current obligations.

Basis of comparison 

Ratios mean little without appropriate benchmarks. Comparing a company to its competitors, industry averages and its own historical performance provides perspective on its current financial health. Contact us to help select relevant ratios to include in your analysis. We can help you create a scorecard from your year-end financial statements that your in-house accounting team can recreate throughout the year using preliminary financial numbers.

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