Balance sheet recognition of reverse factoring transactions

A reverse factoring program is an agreement between the customer of goods and services with its supplier, in addition to the actual service relationship. This agreement gives the customer the opportunity to sell the supplier's trade receivables to a factor. As a rule, in this three-way constellation the customer expects closer ties with strategically important suppliers along the supply chain. On the other hand, the supplier may receive the payment for its performance before the receivable’s actual due date and typically pays interests on it based on the customer's creditworthiness. For this reason, such transactions are especially relevant for companies with a better credit rating than possibly smaller suppliers. In such cases, the supplying company obtains liquid funds at lower interest rates compared to taking out its own credit line.

The customer company in turn is interested in the impact of the liability’s recognition in the balance sheet. Reverse factoring transactions typically involve trade liabilities (trade payables). Payments on these liabilities are generally reflected in the operating cash flow of the cash flow statement/CFS. Depending on how the transaction is structured, it can result in different recognition in the balance sheet:

a) a continuation of the original debt as a trade liability 
b) a derecognition of the initial debt and the recording of another liability (as a financing liability)
c) a coexistence of the initial debt and another liability.

Additionally, it depends on the structure of the transaction whether:

a) the payment to settle the debt is still shown in the CFS in the customer's operating cash flow
b) the payment of the debt by the factoring company is taken into account in the cash flow statement and, if applicable, triggers further cash flows in the customer's financing activities.

Due to often high volumes of reverse factoring transactions, they usually have an impact on a company’s key figures (e.g. working capital). In addition, they also trigger supplementary disclosures in the Notes.

The transaction is usually initiated by the customer or factor. In practice, various forms of reverse factoring transactions exist, often resulting in a change to the contractual terms of the original "trade payables". This amendment may include, for example, an extension of the payment term, waiving a plea of the statute of limitation or additional interest payments. 

On 26 October 2021, the “Institut der Wirtschaftsprüfer (IDW)” (Institute of Public Auditors) in Germany issued a new module pronouncement (IAS 1-M1) on doubtful issues regarding the accounting treatment of reverse factoring transactions, taking into account the agenda decision "Supply Chain Financing Arrangements - Reverse Factoring" published by the IFRS IC in December 2020. With its entry into force, previous statements of IDW RS HFA 48 (section 3.2.3.) and IDW RS HFA 9 (section 5.3.) were simultaneously repealed. From the customer's perspective, the module announcement addresses the presentation of such trade payables in the balance sheet, the presentation of cash flows in the cash flow statement, and any required disclosures in the Notes in connection with reverse factoring transactions. An additional national audit focus on reverse factoring programs set by BaFin for the 2021 fiscal year added additional focus to the topic. 

A customer's outstanding reverse factoring liability to the factor can now only continue to be recognized as a "trade payables" (IAS 1.54(k)) if the following criteria are cumulatively met:

• it is a liability exclusively for the payment of goods and services
• the liability was formally agreed upon and invoiced and by the supplier
• the liability is part of the working capital used in the company’s normal operating cycle  

The features of the customer's acknowledgement of debt to the factor in the event of transfer of the supplier's receivables are particularly important in this context. Based on how the contract is drafted, is there a declaratory acknowledgement of debt, which only confirms the existing debt without changing other features of the contract? If this is the case, the acknowledgement of debt is without further relevance. If not, it must be examined whether the contractual formulation indicates an abstract acknowledgement of debt. In the case of an abstract acknowledgement of debt, a further liability of the customer towards the factor arises in addition to the customer's existing liability towards the supplier. Such a new liability does not have the characteristics of a "trade payable".

Beyond this, other legal requirements must also be assessed and, if necessary, flanked with special measures so as to carry on a trade payable. 

Besides the assessment of the acknowledgement of the debt, it must be examined whether the reverse factoring transaction results in a substantial modification of the original liability. If a liability is substantially modified, this results in a disposal of the "trade payables" (IFRS 9.3.3.2) and to the addition of a liability to the factor. The new liability will typically not meet the criteria for a "trade payable". 

If there is a substantial modification, a reclassification to the balance sheet item "financial liabilities" (IAS 1.54(m)) or disclosure as a separate item (IAS 1.55) is to be expected on a regular basis. 

For the balance sheet presentation of a reverse factoring transaction, the draft module IAS 1-M1 states that, in accordance with the general rules of IFRS 9, it must be assessed on a case-by-case basis whether the original liability should be cancelled and a new liability recorded. Afterwards, the conditions under which a " trade payables" must be recognized are explained. Each reverse factoring program must be assessed individually in this respect, taking into account the contractual terms and conditions. 

Your Finance and Treasury Management team will be happy to discuss your needs.

Source: KPMG Corporate Treasury News, Edition 120, April 2022
Authors:
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, KPMG AG
Felix Wacker-Kijewski, Senior Manager, Finance and Treasury Management, KPMG AG