Subject: Financial Analysis and Reporting

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 Module 8: Receivable financing pledge, assignment and factoring

Intended Learning Outcomes (ILO)

By the end of the module, the students are expected to:

1. To identify the sources of financing through receivables

2. To know the accounting for pledge of accounts receivable
3. To know the accounting for assignment of accounts receivable
4. To understand factoring of accounts receivable
5. To know the classification and presentation of pledged, assigned and factored accounts receivable

Lecture Proper and Discussion

What Is Assignment of Accounts Receivable?

Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts
receivable to the lending institution. In exchange for this assignment of accounts receivable, the
borrower receives a loan for a percentage of the accounts receivable. This percentage may be as
high as 100%.

The borrower pays interest and a service charge on the loan and the assigned receivables serve as
collateral. That is, if the borrower fails to repay the loan, the agreement allows the lender to collect the
assigned receivables.

KEY TAKEAWAYS

• Assignment of accounts receivable is a method of debt financing whereby the lender takes
over the borrowing company's receivables.
• This form of alternative financing is often seen as less desirable, as it can be quite costly to the
borrower, with APRs as high as 100% annualized.
• Normally firms that are new and rapidly growing or those that cannot find traditional financing
elsewhere will seek this method.

Understanding Assignment of Accounts Receivable

With an assignment of accounts receivable, the borrower retains ownership of the assigned
receivables and therefore retains the risk that some accounts receivable will not be repaid. In this
case, the lending institution may demand payment directly from the borrower. This arrangement is
called an "assignment of accounts receivable with recourse." Assignment of accounts receivable
should not be confused with pledging or with accounts receivable financing.

An assignment of accounts receivable has been typically more expensive than other forms of
borrowing. Companies that use it often are unable to obtain less expensive options. Sometimes it is
used by companies that are growing rapidly or otherwise have too little cash on hand to fund their
operations.

New startups in Fintech are addressing this segment of the supply chain finance by creating
marketplaces for account receivables. One name in this space is C2F0. Liduidx is another Fintech
company providing solutions through digitization of this process and connecting funding providers.

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 What is Accounts Receivable Pledging?

Accounts receivable pledging occurs when a business uses its accounts receivable asset as
collateral on a loan, usually a line of credit. When accounts receivable are used in this manner,
the lender typically limits the amount of the loan to either:

• 70% to 80% of the total amount of accounts receivable outstanding; or

• A percentage of the accounts receivable that declines based on the age of the
receivables.

The latter alternative is safer from the perspective of the lender (and is therefore more commonly
used), since it allows for more specific identification of those receivables least likely to be
collected. For example, a bank may not allow any accounts receivable to be used as collateral if
they are more than 90 days old, 80% of all receivables between 30 and 90 days old, and 95% of
all receivables that are 30 days old or less. The lender may also specifically exclude any
receivables for which the company has granted unusually long payment terms. By being this
conservative in calculating the maximum amount to be loaned, the lender protects itself from
issuing debt that cannot be fully offset by collateral in the event of a payment default.

Under a pledging agreement, the company retains title to and is responsible for collecting
accounts receivable, not the lender. Even though the lender now has a legal interest in the
receivables, it is not necessary to notify customers of this interest.

The Borrowing Base Certificate

Under an accounts receivable pledging arrangement, the company subject to the arrangement
completes a borrowing base certificate following the completion of each reporting period, and
forwards the signed certificate to the lender. The lender may also require that a copy of the
month-end accounts receivable aging report be forwarded along with the certificate, in case the
lender wants to trace the amounts on the certificate back to the underlying accounts receivable
detail. This request is most commonly made at the end of the year, not for each monthly
certificate.

The borrowing base certificate itemizes the amount of accounts receivable outstanding at the
end of the reporting period into the age brackets specified by the lender, calculates the maximum
amount of borrowing allowable based on the amount of accounts receivable, and states the

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amount actually borrowed. The lender uses this certificate to monitor the amount of collateral
available, and whether it needs to adjust the amount of debt available to the company. If the
amount of debt outstanding exceeds the amount of accounts receivable stated in the borrowing
base certificate, the borrower must pay this amount back to the lender.

Accounts Receivable Financing

Accounts receivable financing involves either the pledging of receivables or the selling of receivables
(called factoring). The pledging of accounts receivable, or putting accounts receivable up as security
for a loan, is characterized by the fact that the lender not only has a claim against the receivables but
also has recourse to the borrower: If the person or firm that bought the goods does not pay, the
selling firm must take the loss. Therefore, the risk of default on the pledged accounts receivable
remains with the borrower. The buyer of the goods is not ordinarily notified about the pledging of the
receivables, and the financial institution that lends on the security of accounts receivable is generally
either a commercial bank or one of the large industrial finance companies. Factoring, or selling
accounts receivable, involves the purchase of accounts receivable by the lender, generally without
recourse to the borrower, which means that if the purchaser of the goods does not pay for them, the
lender rather than the seller of the goods takes the loss. Under factoring, the buyer of the goods is
typically notified of the transfer and is asked to make payment directly to the financial institution.
Because the factoring firm assumes the risk of default on bad accounts, it must make the credit
check. Accordingly, factors provide not only money, but also a credit department for the borrower.
Incidentally, the same financial institutions that make loans against pledged receivables also serve as
factors. Thus, depending on the circumstances and the wishes of the borrower, a financial institution
will provide either form of receivables financing.

Suggested Teaching Activities (TAs)

• https://youtu.be/ENeQFTMZjKo
• https://youtu.be/zRNbPb4htWo
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Assessment Tasks / Output (ATOs)

QUESTIONS:

1. Explain fully receivable financing

2. Enumerate the four common forms of receivable financing

3. What are the forms of financing related to accounts receivable

4. What is pledge of accounts receivable

5. What is assignment of accounts receivable?

6. Distinguish pledge and assignment of accounts receivable

7. What is factoring?

8. Jenica Company pledge P4,000,000 of accounts receivable as a collateral for a

P3,000,000 loan with a bank. The bank assessed a 10% finance fee on the amount of
the loan and charge 8% annual interest on the note at maturity. What is the journal entry to record the
transaction?

a. Debit cash P 3,000,000 and credit note payable P3,000,000.

b. Debit cash P2,700,000, debit finance charge P300,000 and credit accounts receivable P3,000,000.
c. Debit cash P2,700,000, debit finance charge P300,000, debit due from bank P1,000,000 and credit
to accounts receivable P4,000,000
d. Debit cash P2,700,000, debit finance charge P300,000 and credit note payable P3,000,000

Answer: D

9. On December 1, 2015, Angelica Company assigned on anon-notification basis accounts receivable

of P5,000,000to a bank in consideration for a loan of 80% of theaccounts less a 5 %
service fee on the accounts assigned.The entity signed a note for the bank loan. On December31,
2015, the entity collected assigned accounts ofP2,000,000 less discount of P200,000. The
entity remittedthe collections to the bank in partial payment for theloan. The bank applied
first the collection to the interestand the balance to the principal. The agreed interest is 1% per month
on the loan balance. The entity acceptedsales returns of P100,000 on the assigned accounts
andwrote off assigned accounts totalling P300,000.

What is the balance of accounts receivable assignedon December 31, 2015?

a. 3,000,000
b. 2,400,000
c. 2,600,000
d. 2,900,000

Answer: B

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10. Marlon Company factored P5,000,000 of accounts receivable. Control was surrendered
by the entity. The finance company assessed a fee of 5% and retains a holdback equal
to 10 % of the accounts receivable. In addition, the finance company charged 12%
interest computed on a weighted average time to maturity of the accounts receivable for 30days using
365 days in year.

What is the amount initially received for the factoring of accounts receivable?

a. 4,250,000
b. 4,700,000
c. 4,200,000
d. 4,200,685

Answer: D

Readings and Other References

1. Intermediate accounting volume 1; Conrado T. Valix, Jose F. Peralta, Christian Aris M. Valix
2. https://youtu.be/ENeQFTMZjKo
3. https://youtu.be/zRNbPb4htWo

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