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RECEIVABLE FINANCING

Receivable financing refers to techniques of accelerating its cash inflow through the use
of receivables.

The common forms of receivable financing are:


1. Pledge of accounts receivable
2. Assignment of accounts receivable
3. Factoring of accounts receivable
4. Discounting of notes receivable

Pledge of Accounts Receivable


Refers to the use of receivables as collateral for a loan.
Borrowing company continues to collect the receivables.
No complex accounting entries.
Record the loan and disclose the pledge.
If the loan is not paid, the creditor has the right to collect the pledged receivables.

Assignment of Accounts Receivable


A more formal borrowing in which the receivables are used as security of
collateral for a loan.
Borrower transfers its rights in some of its accounts receivable to a lender in
consideration for a loan.
Assignor retains ownership of the accounts assigned.
The borrower is called the assignor while the creditor is the assignee.
Assignor signs a financing agreement and a promissory note.
There are two types of assignment of accounts receivable:
General assignment
All accounts receivable serve as collateral security for a loan.
Same as pledge

Assignment of specific receivables


Specific accounts receivable serve as collateral for a loan.
Features of assignment
Assignment may be either non-notification or notification basis.
Non-notification basis
Customers are not notified of the assignment.
Customers continue to pay to the assignor.

Notification basis
Customers are notified of the assignment.
Customers pay to the assignee.
Assignee lends only a certain percentage of the face value of the
receivables. The percentage depends on the quality of the receivables.
Assignee charges interest for the loan and service or financing charge for
the assignment arrangement.

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The assigned accounts are segregated from other accounts.
The equity of the assignor in the assigned accounts should be disclosed
parenthetically or through a note.

Factoring of Accounts Receivable


Factoring is sale of accounts receivable on a without recourse, notification basis.
Ownership of accounts receivable is transferred to the buyer of the receivables.
The seller of the receivables is called transferor while the buyer is called
transferee or factor.
Recourse is the right of the transferee to receive payment from the transferor
should the debtor fail to pay.
Factor assumes collection function and risk of collection.
Customers are notified and required to pay direct to the factor.
There are two types of factoring:
Casual factoring
A company is forced to factor its accounts receivable at a
substantial discount to obtain cash.
One-time deal.

On a continuing agreement
Involves a continuing arrangement where a financing company
purchases all of the accounts receivable of a company.
Factor charges commission or factoring fee.
Factor may withhold a predetermined amount as a protection
against customer returns and allowances. This is called factors
holdback.

US GAAP on Sale of Receivables with Recourse


Cash can be obtained by selling receivables with recourse.
This is different from factoring, which generally is on a nonrecourse basis.
Recourse is the right of a transferee of receivables to receive payment from the
transferor of those receivables for
a. Failure of the debtors to pay when due;
b. The effects of prepayments; or
c. Adjustments resulting from defects in the eligibility of the transferred
receivables
FASB specified in Statement No. 140 the conditions that must be met if a transfer
of receivables is to be accounted for as a sale. Those conditions are as follows:
1. The transferred assets have been isolated from the transferor. That is, the
transferor and its creditors cannot access the assets.
2. The transferee has the right to pledge or exchange the transferred assets.
3. The transferor does not maintain effective control over the assets through
either (a) an agreement to repurchase them before their maturity or (b) the
ability to cause the transferee to return specific assets.
Note: If these three conditions are not met then the transfer of receivables
is accounted for as a secured borrowing.

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Sale of receivables with recourse means that a purchaser (bank or finance
company) advances cash in return for receivables but retains the right to collect
from the seller if debtors (sellers customers) fail to make payments when due.

FASB No. 140, the seller is required to estimate the value of the recourse
obligation and recognize that liability. That is the seller must estimate the
amount that will be paid to the purchaser as a result of default on the receivables
that were sold.

Example
A firm raises funds by selling P5,000 of its receivables for P4,300. The receivables
have a net realizable value of P4,700. The receivables are sold with recourse and the
seller estimates (as required by SFAS No. 140) that the recourse obligation has a fair
value of P250. The finance company witheld 5% of the purchase price as protection
against sales returns and allowances.

Cash received 4,300.00


Estimated recourse obligation (250.00)
Net proceeds 4,050.00

Book value of the receivables 4,700.00


Net proceeds to be received (4,050.00)
Loss on sale of receivables 650.00

Cash 4,085.00
Receivable from factor 215.00
Allowance for bad debts 300.00
Loss on sale of receivables 650.00
Accounts receivable 5,000.00
Recourse obligation 250.00

Discounting of Notes Receivable


The transfer of negotiable notes to a bank or finance company willing to
exchange such instruments for cash.
Endorsement may be with or without recourse.

Pro-forma Entries
Pledge of Cash xxx
accounts Notes payable Xxx
receivable

Payment of loan Notes payable xxx


Interest expense xxx
Cash Xxx

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Adjusting entry, if Interest expense xxx
payment is to be Interest payable xxx
made beyond the
accounting period

Pledge of AR and Cash xxx


discounting of own Discount on notes payable xxx
note Notes payable xxx

Amortization of Interest expense xxx


discount Discount on notes payable xxx

Payment of loan Notes payable xxx


Cash xxx

Assignment of Accounts receivable-assigned xxx


accounts Accounts receivable xxx
receivable
Non-notification
Cash xxx
Finance charge xxx
Notes payable xxx

Sales return xxx


Accounts receivable assigned xxx

Cash xxx
Sales discount xxx
Accounts receivable assigned xxx

Note payable xxx


Interest expense xxx
Cash xxx

Accounts receivable xxx


Accounts receivable assigned xxx

Notification Note payable xxx


Interest expense xxx
Accounts receivable assigned xxx

Factoring Cash xxx


Casual Allowance for bad debts xxx

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Loss on factoring xxx
Accounts receivable xxx

Continuing Cash xxx


Allowance for bad debts xxx
Loss on factoring xxx
Receivable from factor xxx
Accounts receivable xxx

Discounting Cash xxx


notes receivable Interest expense xxx
With recourse Liability on discounted notes xxx
xxx
OR
Cash xxx
Interest income xxx
Liability on discounted notes xxx

Honored Liability on discounted notes xxx


Notes receivable xxx
OR
Dishonored Accounts receivable xxx
Cash xxx

Liability on discounted notes xxx


Notes receivable xxx

Without recourse Interest receivable xxx


Interest income xxx

Cash xxx
Loss on sale of notes receivable xxx
Notes receivable xxx
Interest receivable xxx

Financial Statement Presentation


Finance Charge Other Expense
Accounts Receivable Assigned Added to accounts receivable unassigned
to arrive at total accounts receivable
Discount on notes payable Deducted from notes payable to arrive at
amortized cost of notes payable.
Liability on discounted notes Current liabilities separate line item

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Loss on Factoring Other Expense
Loss on Sale of Notes Receivable Other Expense

Long Term Notes Receivable


Promissory notes
1. An unconditional promise to pay a certain sum of money at a specified time.
2. Negotiable instruments because it can be legally transferred by endorsement and
delivery.

Two kinds
1. Interest bearing
2. Non-interest bearing

Valuation in the balance sheet


1. Short-term notes stated at face value (less allowance)
2. Long-term notes
With a reasonable rate stated at face value
With unreasonable rate or with zero interest rate stated at amortized cost,
using effective interest method.

Effective interest rate


1. Rate used in the market to determine the value of the note
2. Discount rate used to determine the present value
3. Also referred to as market rate or effective yield

Stated interest rate


1. Face rate
2. Contract rate

Imputed interest rate (From Keiso, Fargher, Wise, Weygandt and Warfield, 2008)
1. Rate used to determine the present value of the note, if the fair value of the
property, goods, services or other rights is not determinable, and if the note has
no ready market.
2. Determined by the process of interest rate approximation called imputation.
3. The choice of a rate is affected by the prevailing rates for similar instruments of
issuers with similar credit ratings.
4. Choice of rate is also affected specifically by restrictive covenants, collateral
arrangements, payments schedules, existing prime (or base) interest rate, etc.

Pro-forma Entries
Receipt of note
Discount Notes receivable xxx
Asset/Income xxx
Discount on notes receivable xxx

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Amortization of Discount on notes receivable xxx
Discount Interest income xxx

Receipt of Cash xxx


Interest Interest income xxx

Collection of note Cash xxx


Notes receivable Xxx

Receipt of note Notes receivable xxx


Premium Premium on notes receivable xxx
Asset/Income Xxx

Amortization of Interest income xxx


Premium Premium on notes receivable Xxx

Receipt of Cash xxx


Interest Interest income Xxx

Collection of note Cash xxx


Notes receivable Xxx

Financial Statement Presentation


Discount on Notes Receivable Contra account subtracted from Notes
Receivable
Premium on Notes Receivable Valuation account added to Notes
Receivable
May 2009