Often in real life, a company’s management will decide that it would rather have cash immediately than wait for receivables to be collected.
There are two broad approaches to generating cash from receivables. In one, the receivables are pledged as collateral for a loan. In the other, the receivables are assigned to another party (a factor), much in the same sense that other assets are sold.
However, there are characteristics of these assignments that prevent some of them from being exactly like a sale. The illustration below summarizes the four possible methods:
- Assignment with recourse (assignor collects)
- Assignment with recourse (factor collects)
- Assignment without recourse
The use of non-uniform terms in practice makes it even more difficult to understand these practices. The meaning of pledging is generally unambiguous and, therefore, there is no problem.
However, many persons refer to the act of assigning as factoring. Some have even used assignment to refer to situations in which accounts are assigned with recourse while using factoring to refer to situations where there is no recourse.
We have chosen the approach in this category for its descriptiveness, simplicity, and similarity to legal usage.
We encourage the reader to understand the concept of each approach. Then, when these situations are encountered in practice, they will be accounted for according to their nature rather than the terminology used.
This example demonstrates disclosures when receivables are used to generate cash. Consider the following information about the Rath Packing Company’s current assets:
NOTE 5: Financing Agreement
All receivables and inventories have been pledged as collateral for borrowings under a financing agreement.
The lender is a commercial finance company; however, two banks participated in the borrowings up to a maximum amount of $4,000,000 until 3 September 2018.
One of the banks has continued to participate up to a maximum amount of $2,000,000 since that date.
The total amount available for borrowing under the agreement varies as determined by the commercial finance company. It amounted to $10,000,000 on 27 September 2018.