Receivable Financing Textbook Notes

RECEIVABLE FINANCING RECEIVABLE FINANCING Refers to a business using outstanding accounts receivable as a means of collateral to generate cash. In other words, it is the financial flexibility of the company to generate cash out of its receivable. FORMS LOAN TRANSACTION Loan transaction uses receivables as security or collateral to generate cash. There shall be no gain or loss on sale. PLEDGING OF RECEIVABLES Also known as hypothecating and general assignment. It refers to borrowing of money where “general” receivables serve as collateral or security for loan. SELLING TRANSACTION Receivables are sold to another party, therefore, there shall be gain or loss on sale. ASSIGNMENT OF RECEIVABLES FACTORING OF RECEIVABLES This is a more formal loan transaction than pledging because unlike Pledging of receivables that general receivables serve as collateral, Assignment of Receivables assigns “specific” accounts receivable to be used as collateral. Sale of receivables to finance company (which is called) “factor”). The factor assumes responsibility for both the collection of payments and risk of uncollectible accounts. It is “with notification” or “without notification” basis. DISCOUNTING OF RECEIVABLES Sale, transfer, or endorsement of promissory note to a third party (usually a bank). The negotiation is either “with recourse” or “without recourse” basis. ILLUSTRATION: PLEDGE On March 02, 2024, Stylo Company borrowed from Mega Bank Php 2,000,000 for a year with nominal interest of 10%. Stylo Company pledged Php 2,700,000 Accounts Receivable. The bank deducted one year interest in advance. SOLUTION: There would be no Journal Entry required for pledging the Php 2,700,000 Accounts Receivable, only the Disclosure is required presented in the Notes to Financial Statement. If Stylo Company defaulted its payment of Php 2,000,000 after one year, then the Mega Bank will have the Php 2,700,000 collateral. However, Stylo Company should journalize the following: The amount that Stylo Company will pay to Mega bank in the future is 2,000,000. The bank will not just lend money to the company, they must earn from lending, therefore, Mega Bank will only give Stylo Company 1,800,000 cash. The difference then between 2million and 1.8 million is what the bank profits to. At the end of the year, the company will record interest expense from March 2024 to December 2024 (that is 10 months). The other 2 months interest expense will be recorded next year. (2,000,000 x 10%) x 10/12 = 166,667 NOTIFICATION BASIS ASSIGNMENT OF RECEIVABLES The customer of the company whose receivable has been assigned are informed that his “amount to be paid” to the company was used as collateral or security. The customer will remit the payment to the bank (assignee) and no longer to the company (assignor). NON-NOTIFICATION BASIS The customer of the company whose receivable has been assigned are not informed that his “amount to be paid” to the company was used as collateral or security. The customer will continue to remit payment to the company. Unlike pledge that uses all the receivables as collateral, the loan for “Assignment of Accounts Receivable” is only a percentage of Face Value of Accounts Receivable. Assignments are commonly a non-notification basis. Assigned Receivables. Notice that not all the accounts receivables are used as collateral, only receivables from Styro and Megan. Carrying amount of Accounts Receivable Less: Carrying amount of loans payable Equity on assigned accounts Equity on assigned accounts should also be disclosed in notes to Financial Statements. Thus, the assigned accounts are segregated from other accounts that are not used as collateral. JOURNAL ENTRIES NOTIFICATION BASIS NON-NOTIFICATION BASIS Notice that both Notification and Non-notification basis has similar journal entries, except for the collection and remittances. Remember that under Notification basis, the company’s customer will directly pay to the bank (assignee) while in Nonnotification basis, the customer will continue to pay the company and it is up to the company to remit the payment to the bank. DIFFERENCE BETWEEN PLEDGE and ASSIGNMENT of RECEIVABLES PLEDGE The General Accounts Receivable serves as collateral or security to the loan transaction. The pledge or hypothecation of Accounts Receivables does not require Journal Entries, only Disclosure. Upon pledge of Accounts Receivable, there is no transfer of rights and no transfer of ownership as well. The Accounts Receivables remains to be the asset of the company. ASSIGNMENT The Specific Accounts Receivable within the General Accounts Receivable serves as collateral or security to the loan transaction. The Assignment of Accounts Receivable requires Journal Entry to separate the assigned accounts to unassigned accounts. Thus, “Assignment of Accounts Receivable” is more formal transaction than pledge. Upon Assignment of Accounts Receivable, under notification basis, the right to collect the payment is transferred to the assignee (usually bank). Although there is a transfer of right, the company remains to be the owner of Accounts Receivables. ILLUSTRATION: ASSIGNMENT (Non - Notification basis) On October 06, 2024, AIR Bank granted loan to SEA Company for a promise to pay non-notification Php 500,000, 12%. The bank charges 3%. SEA Company assigned customer’s accounts amounting to Php 900,000 as collateral for the loan. During end of the year 2024, cash collections on the assigned accounts amounted to Php 250,000 and was remitted, including the interest due, to AIR Bank. 500,000 x 3% NOTE! If the problem is silent, the whole collections are applied as payment to the loan and there is a separate payment for interest. In non-notification basis, the customer will continue to remit his payment to the company, thus, use the account “cash” because the entity received money, and the company is responsible to remit the payment to the bank. The amount of Notes Payable is reduced because the SEA Company remits to AIR Bank the collection from customer of Php 250,000. (500,000 x 12% x 3/12) This is the interest that SEA company should pay starting from October 2024 to the cut-off date December 31, 2024. WITHOUT RECOURSE FACTORING WITH RECOURSE It means factoring is an outright sale to a finance company where the seller company is not liable when the customer does not pay. By form, factoring is a sale transaction but by substance, it is borrowing with collateral. It means that the seller company guarantees payment to the factor if the customer does not pay. Is the entity who bought the receivables. IMPORTANT FORMULAS: Gain / Loss on sale Cash Proceeds Factor’s holdback is a Receivable account. Net Selling Price Vs. Carrying Amount of AR Also known as “reserve”. It is a portion of purchase price that the Financial Institution temporarily holds back to make sure that there would be an amount to cover probable sales return, discount, and allowances. ILLUSTRATION: FACTORING Jordan Company asked Michael Company to factor Php 300,000 of its accounts receivable for Php 260,000. Michael Company agreed, provided that it will withhold 10% of the purchase price. There is an allowance for doubtful accounts amounting to Php 10,000. Assuming receivable is without recourse: 260,000 x 10% 300,000 – 10,000 Assuming receivable is without recourse: The Sale of Receivable is with recourse liability with an estimated fair value of Php 12, 000 WITHOUT RECOURSE The company who sold the receivables is no longer liable if the customer did not pay the transferee (or the entity who bought the receivables). DISCOUNTING OF NOTES WITH RECOURSE Secured Borrowing Conditional Sale The company who sold the receivables is liable if the customer did not pay the transferee. Gain/Loss on Discounting Carrying amount of Receivable Cash Proceeds PRINCIPAL + Accrued Interest MATURITY VALUE - Discount Maturity Value x Discount Rate x Unexpired time Principal + Total Interest Face amount x Rate x Expired time Face amount x Rate x Time ILLUSTRATION: DISCOUNTING On January 01, 2024, customer Joseph gave Alfonso Company Php 300,000, 12%, one year note. The discount on note is 11% on March 31, 2024. Unfortunately, the note was dishonored on maturity date and the company was charged by a protest fee and other bank charges Php 3,000 and Php 1,500 respectively. 300,000 x 12% x 12/12 336,000 x 11% x 9/12 300,000 x 12% x 3/12 Assuming receivable is without recourse: Assuming receivable is Secured Borrowing Assuming receivable is Conditional Sale