Receivable Financing

- Is the financial flexibility or capability of an entity to raise money out of its

receivable by either selling the receivable or using the receivable as a collateral
from a loan. Form of Receivable Financing:

Using as collateral Sale of receivable

1. Pledge 1. Factoring
2. Assignment 2. Discounting

1. Pledge (a.k.a. hypothecation): Allows you to go to a lender and receive a loan using
your accounts receivable as collateral. Pledge is also known as general assignment
of receivable, because the pledged account is not separated to other accounts
receivable.

With respect to the pledged account, no entry would be necessary. The pledged
account receivable will be retained in the company’s balance sheet. It is sufficient
that disclosure thereof is made in a note to financial statement.

2. Assignment: The borrower (the company) transfers right in specific accounts

receivable to a lender (the bank or financial institution) in consideration for a loan.
Assignment is also known as specific assignment, because the account assigned is
separated from other receivable.

Usually, loan received from the bank is only a portion (example 75%, 80% or 90%)
of accounts receivable assigned, because the assigned account may not be fully
realized due to sales discount, sales return and default of customers.

The lender usually charge interest to the borrower and normally paid once a
remittance is made. Remittance is not applied to interest unless otherwise stated in
the problem.

Pledge Assignment
Any of the receivable maybe taken by Only specific receivable maybe taken by
the lender upon non-payment of the loan the lender upon non-payment of the loan

Collection of any of the receivable may Collection of accounts receivable-

or may not be remitted to the lender assigned is required to be remitted to the
lender

Receivable pledge will be retained in the Receivable pledge will be retained in the
 company’s balance sheet company’s balance sheet

lender has limited rights to inspect the lender will make an investigation of the
borrower’s records to achieve assurance specific receivables that are being
that the receivables do exist; proposed for assignment and will
approve those that are deemed worthy to
be held as collateral security.

Two types of assignment:

1. Non-notification basis – the customer whose account is assigned is not notified

that his account was assigned. Therefore, the customer will still pay to the
company and the company will remit the collection to the bank.

2. Notification basis – the customer is notified that his account is assigned to the
bank. In this case, the customer will pay directly to the bank.

Regardless of the type of assignment, the balance of accounts receivable –

assigned, loans payable and equity portion is not affected.

Journal Entries:
To separate the accounts receivable assigned:
Dr. Accounts receivable – assigned XX
Cr. Accounts receivable XX

To record the receipt of loan

Dr. Cash XX
Cr. Loans payable XX

To record the sales return from the customer whose account is assigned:

Dr. Sales return XX

Cr. Account receivable – assigned XX

To record the write of accounts receivable – assigned:

Dr. Allowance for bad debt XX

Cr. Account receivable – assigned XX
 For non-notification:
To record the collection from customer:

Dr. Cash XX
Dr. Sales discount (if any) XX
Cr. Accounts receivable – assigned XX

To record the remittance to the bank and payment of interest:

Dr. Loans payable XX

Dr. Interest expense XX
Cr. Cash XX

For notification:
To record the collection and direct remittance to the bank and payment of interest:

Dr. Loans payable XX

Dr. Sales discount XX
Dr. Interest expense XX
Cr. Accounts receivable - assigned XX

3. Factoring: Is a sale of accounts receivable on a without recourse, notification

basis. In a factoring arrangement, an entity sells accounts receivable to a bank or
finance entity called a factor.

Factoring differs from an assignment in that an entity actually transfers ownership of

the accounts receivable factored. Thus, account factored should be removed from
the company’s balance sheet.

Two types of factoring:

a. Casual factoring – factoring is unusual in the company’s operation. The
company sells it receivable below the face amount. Normally in casual
factoring, no service charge and interest are charged since the bank
already bought the accounts receivable at a discounted price.

b. Factoring as a continuing agreement: Factoring is part of the company’s

regular operation. In case type of factoring, the factored account is usually
sold at face amount but service charge (a.k.a. commission or assessment
fee), interest is charged by the bank.
 The bank may also request for factor’s holdback in case the account is not fully
realized due to sales returns and discount. Factor’s holdback is recognized as
receivable.

If absence of information, the selling price is equal to the face amount of account
factored

4. Discounting: Is a form of receivable financing where the company sold notes

receivable to a bank or financial institution. The company will transfer the
promissory note to the bank in exchange for cash equal to the maturity value less
discount charge by the bank.

On the maturity date, the maker of the note (the customer) will pay directly to the
bank (equal to the “maturity value”). In this disposition transaction, the company will
recognize the gain or loss from sale of its asset.

If the discounting is with recourse – the company will be liable to the bank if the
maker dishonors the note.

If the discounting is without recourse – the company avoids any future liability to the
bank even if the maker refuses to pay the bank on maturity date.

If the problem is silent, it is assumed that discounting is with recourse.

Types of Discounting:

1. Without recourse – the company will derecognize the NR from its record.
The company is free from any liability in case the note is dishonored. Journal
entry:

Dr. Cash (net proceeds, see no. 1) XX

Dr. Loss on discounting (see no. 6) XX
Cr. Notes receivable (face amount) XX
Cr. Interest receivable (IR sold, see no. 5) XX

2. With recourse conditional sale – the transaction recognized as sale with

the condition that the note will be collected successfully otherwise it will be
 recognized as borrowings. Contingent liability is recognized in the notes to
financial statement.

Dr. Cash (net proceeds, see no. 1) XX

Dr. Loss on discounting (see no. 6) XX
Cr. Notes receivable – discounted (face) XX
Cr. Interest receivable (IR sold, see no. 5) XX

Notes receivable – discounted account is deducted from the total notes receivable
when preparing the financial statement. In other words, it is a contra-asset
account.

3. With recourse secured borrowing – In this type of discounting, the note is

not actually sold but instead it is used as a collateral for a bank loan. This
there is no disposition of asset, no gain or loss to be recognized, instead it will
be recorded as interest expense.

Dr. Cash (net proceeds, see no. 1) XX

Dr. Interest expense (see no. 6) XX
Cr. Loans payable – (face) XX
Cr. Interest receivable (IR sold, see no. 5) XX

Notes Dishonored:

If the discounting is with recourse – conditional sale and the note is dishonored,
the company is required to pay the bank the maturity value of the note plus protest
fee.

The company will go after the maker/customer and may collect the amount paid to
the bank plus additional interest for the period of delay.

ILLUSTRATION

On July 1, 2019, Jon Snow Company sold equipment to Arya Stark Company for
P1,000,000. Jon Snow accepted a 10% note receivable for the entire sales price.
This note payable in two equal installments of P500,000 plus accrued interest on
December 31, 2019 and December 31, 2020. On July 1, 2020, the entity
discounted the note at a bank at an interest rate of 12%. What is the amount
received from the discounting of note receivable?

Principal 500,000
Add: Interest (500,000 x 10%) 50,000
Maturity Value 550,000
Less: Discount (550,000 x 12% x 6/12) 33,000
Net Proceeds 517,000