Generating Immediate Cash From Accounts Receivable

Generating Immediate Cash from Accounts Receivable
If a company has the need or desire to accelerate the receipt of cash from
accounts receivable they have three options: (1) pledging, (2) assigning, or
(3) factoring (sale) of the accounts receivable. FASB
Statement 140 has very specific guidelines on when these accounts
receivable have been transferred. The chart in Exhibit 7-2 of the text
provides a graphic overview of how to determine which of the three options a
company has used.
Pledging of Accounts Receivables

If a company pledges accounts receivables, they are essentially using the
accounts receivable as collateral for a loan. The company would keep control
and continue to collect the accounts receivable. They would record the loan
as a liability and note the fact that the accounts receivable are pledged.
Assigning of Accounts Receivables

Assignment of accounts receivable is usually very similar to pledging, with
the basic difference being that the company that is borrowing against the
accounts receivable uses the amount they collect to pay off the amount
borrowed. To protect the finance company against the threat of uncollectible
accounts or sales returns and allowances, the amount advanced to the
borrower is usually smaller than the total of the accounts receivables being
assigned.
As an example, assume that the Jerry Moore Company assigns $100,000 of
its accounts receivable to a finance company on March 1, 2011. The finance
company advances Jerry Moore 85% of the receivables and charges a $1,000
service charge. In addition, the finance company charges a 10% rate of
interest to any outstanding balance. The entry to record this:
Cash [($100,000 0.85) $1,000]
Assignment service charge
Note payable ($100,000 0.85)
Accounts receivable assigned
Accounts receivable
84,000
1,000
85,000
100,000
100,000
At the end of March, the Moore Company has collected $18,000 of the
accounts receivable.
Cash
18,000
Accounts receivable assigned
18,000
It pays this amount as well as the interest payment to the finance company.
Note payable 18,000
Interest expense ($85,000 0.10 1/12) 708
Cash 18,708
Factoring of Accounts Receivables

Factoring of accounts receivable is the same as selling the accounts
receivables. When receivables are factored the company selling the accounts
receivable removes them from their financial records and records the cash
received as well as the fee paid to the factor (buyer). In addition, most
factors will reserve 10% to 20% of the amount factored to protect against
uncollectible accounts and sales returns and allowances. Once the accounts
have been collected or written off, any of the reserve that has not been used
is returned to the selling company. This reserve is usually recorded as a
receivable on the books of the seller.
On June 1, 2011, Richie Williams Corporation factors $150,000 of receivables.
The factor requires a 15% reserve and charges a 12% fee. The entry to
record this would be as follows:
Cash [($150,000 0.85) $18,000]
Receivable from factor ($150,000 0.15)
Factor expense ($150,000 0.12)
Accounts receivable
109,500
22,500
18,000
150,000
Assignment of Accounts Receivable

Assignment of accounts receivable is an agreement between a lending
company and a borrowing company in which the later assigns its accounts
receivable to the former in return for a loan. By assignment of accounts
receivable, the lender gets a right to collect the receivables of the borrowing
company if it fails to repay the loan in time. The lender also receives finance
charges and service charges.
It is important to note that the receivables are not sold/transferred under an
assignment agreement. If the receivables have been transferred, the
agreement would be of sale/factoring of accounts receivable. Usually, the
borrowing company would itself collect the assigned receivables and remit
the loan amount as per agreement. It is only when the borrower fails to pay
as per agreement, that the lender gets a right to collect the assigned
receivables on its own.
The assignment of accounts receivable may be general or specific. A general
assignment of accounts receivable entitles the lender to proceed to collect
any accounts receivable of the borrowing company whereas in case of
specific assignment of accounts receivable, the lender is entitled only to
collect the accounts receivable specifically assigned to the lender.
The following example shows how to record transactions related to
assignment of accounts receivable via journal entries:
Example
On March 1, 20X6, Company A borrowed $50,000 from a bank and signed a
12% one month note payable. The bank charged 1% initial fee. Company A
assigned $73,000 of its accounts receivable to the bank as a security. During
March 20X6, the bank collected $70,000 of the assigned accounts receivable
and paid the principle and interest on note payable to the bank on April 1.
$3,000 of the sales were returned by the customers.
Record the necessary journal entries by Company A.
Solution
Journal Entries on March 1:

Cash
Finance Charge
Notes Payable
Accounts Receivable Assigned
Accounts Receivable
49,500
500
50,000
73,000
73,000
Journal Entries on April 1:

Cash
Sales Returns
Accounts Receivable Assigned
Notes Payable
Interest Expense
Cash
70,000
3,000
73,000
50,000
500
50,500

Generating Immediate Cash From Accounts Receivable

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Generating Immediate Cash from Accounts Receivable

Pledging of Accounts Receivables

Assigning of Accounts Receivables

Factoring of Accounts Receivables

Assignment of Accounts Receivable

Journal Entries on March 1:

Journal Entries on April 1:

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