Accounting: The Language of Business - Vol. 2 (Intermediate: Part 144)

• Proverbs 11:1

  "A false balance is an abomination to the Lord, but a just weight is his delight"

Short-Term Operating Assets: Cash and Receivables (Part I)

by

Charles Lamson

Financing with Accounts Receivable

In managing short-term operating assets, firms can secure immediate cash from accounts receivable rather than waiting for a customer to remit payment. In the next several parts, we address three alternative techniques—pledging or assigning accounts receivable, factoring accounts receivable, and securitization.

A company uses its receivables as collateral for a lending arrangement by pledging or assigning the receivables. Factoring involves selling the receivables to a third party at a discount. Securitization involves bundling together and selling an interest in many separate receivables.

Pledging and Assigning Accounts Receivable

Pledging and assigning receivables are both forms of collateralized borrowing. When a firm pledges accounts receivable, the receivables are collateral for a financing arrangement. When the company assigns accounts receivable, specifically designated receivables are collateral for the loan, but the company must use the receipts on collection of the receivables to repay the debt. These borrowing arrangements are often called asset-based lending. Any type of loan backed by assets can be called an asset-based loan. However, asset-based lending is typically used to describe a borrowing arrangement when the collateral is inventory, accounts receivable, or equipment.

When pledging and assigning, the accounts receivable remain on the balance sheet. If the receivables are used as collateral for a short-term loan, they continue to be classified as current assets on the balance sheet. If the liability is long term, then the receivables pledged or assigned are reclassified as noncurrent assets on the balance sheet. Footnotes to the financial statements indicate the contingent liability related to the transfer of the accounts receivable rights to others. Financial statement users should consider the potential adverse effects on liquidity from a default on the debt relating to the receivables pledged or assigned to third parties. Example 9.9 illustrates accounting for assigned accounts receivable.

*GORDON,RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 458-459*

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