CHAPTER 8
RECEIVABLE FINANCING
PLEDGE, ASSIGNMENT, AND FACTORING
TECHNICAL KNOWLEDGE
To identify the sources of financing through receivables.
To know the accounting for pledge of accounts receivable.
To know the accounting for assignment of accounts receivables.
To understand factoring of accounts receivable.
To know the classification and presentation of pledge, assigned and factored accounts receivable.
Concept of receivable financing
Receivable financing is the financial or capability of an entity to raise money out of its
receivables.
During the general business decline, an entity may find itself in tight cash position because sales
decrease and customers are not paying their accounts on time.
But the entity’s current accounts and notes payable must continue to be paid if its credit standing
is not to suffer.
The entity then would be in a financial distress as collections of receivable are delayed but cash
payments for obligations must be maintained.
Under these circumstances, if the situation becomes very critical, the entity may be forced to
look for cash by financing its receivables.
Forms of receivable financing
The common forms of receivable financing are:
a.
b.
c.
d.
Pledge of accounts receivables
Assignment of accounts receivable
Factoring of accounts receivable
Discounting of notes receivable
Pledge of accounts receivable
When loans are obtained from the bank or any lending institution, the accounts receivable may
be pledged as collateral security for the payment of the loan.
Normally, the borrowing entity makes the collections of the pledge accounts but may be required
to turn over the collections to the bank in satisfaction for the loan.
No complex problems are involved in this form of financing except the accounting for the loan.
The loan is recorded by debiting cash and discount on note payable if loan is discounted, and
crediting note payable.
The subsequent payment of the loan is recorded by debiting note payable and crediting cash.
With respect to the pledged accounts, no entry would be necessary. It is sufficient that disclosure
thereof is made in a note to financial statement.
Illustration
On November 1, 2019 an entity borrowed P1, 000,000 from Philippine National Bank and issued
a promissory note for the same.
The term of the loan is one year and discounted at 12%. The entity pledged accounts receivable
of P2, 000,000 to secure the loan.
On November 1, 2019 the journal entry to record the loan is:
Cash
880,000
Discount on note payable 120,000
Note payable –bank
1,000,000
If the loan is discounted, in the banking parlance this means that the interest for the term of the
loan is deducted in advance.
Face value of loan
Interest deducted in advance (1,000,000 x 12%)
Net proceeds
1,000,000
(120,000)
880,000
Statement presentation
On December 31, 2019 using the straight line method, the discount on note payable is
amortized as interest expense for two months from November 1 to December 31.
Interest expense (120,000 x 2/12)
20,000
Discount on note payable
20,000
At this point, if a statement of financial position is prepared on December 31, 2019, the note
payable-bank and the discount on note payable are presented as follows:
Current liabilities:
Note payable –bank
Discount on note payable
Carrying amount
1,000,000
(100,000)
900,000
A note to financial statement may appear as follows:
“The note payable to bank matures on November 1, 2020 and is secured by accounts receivable
with face value of P2,000,000.”
On November 1, 2020 the payment of the bank loan is recorded.
Note payable-bank
Cash
1,000,000
1,000,000
And the discount on note payable is finally amortized.
Interest expense
100,000
Discount on note payable
100,000
Assignment of accounts receivable
Assignment of accounts receivable means that a borrower called the assignor transfers rights in
some accounts receivables to a lender called the assignee in the consideration for a loan.
Actually, assignment is a more formal type of pledging of accounts receivable. Assignment is
secured borrowing evidenced by a financing agreement and a promissory note both of which the
assignor signs.
However, pledging is general because all accounts receivable serve as collateral security for the
loan.
On the other hand, assignment is specific because specific accounts receivable serve as collateral
security for the loan.
Assignment may be done either on a nonnotification or notification basis.
When accounts are assigned on a nonnotification basis, customer are not informed that their
accounts have been assigned.
As a result, the customers continue to make payments to the assignor, who in turn remits the
collection to the assignee.
When accounts are assigned on a notification basis, customers are notified to make their
payments directly to the assignee.
The assignee usually lends only a certain percentage of the face value of the accounts assigned
because the assigned accounts may not be fully realized by reason of such factors as sales
discount, sales return and allowances and uncollectible accounts.
The percentage maybe 70%, 80%, or 90% depending on the quality of the accounts.
The assignee usually charges interest for the loan that it makes and requires a service of
financing charge or commission for the assignment agreement.
Illuatration – Nonnotification basis
April
1
An entity assigned P700,000 of accounts receivable to a bank under a nonnotification
arrangement. The bank advances 80% less a charge of P5,000.
The entity signed a promissory note that provides for interest of 1% per month on the
unpaid loan balance.
To separate the assigned accounts:
Accounts receivable-assigned 700,000
Accounts receivable
700,000
To record the loan:
Cash (560,000-5,000)
Service charge
Note payable-bank
555,000
5,000
560,000
5 Issued a credit memo for sales return to a customer whose account was assigned, P20,000.
Sales return
20,000
Accounts receivable-assigned
20,000
10 collected P300,000 of the assigned accounts less 2% discount.
Cash
294,000
Sales discount (2% x 300,000)
6,000
Accounts receivable-assigned
300,000
30 Remitted the total collections to the bank plus interest for one month.
Note payable-bank
Interest expense (1% x 560,000)
Cash
294,000
5,600
299,600
May
7 Assigned accounts of P15,000 proved worthless.
Allowance for doubtful accounts 15,000
Accounts receivable – assigned
15,000
20 Collected P300, 000 of the assigned accounts.
Cash
300,000
Accounts receivable-assigned
300,000
30 Remitted the total amount due the bank to pay off the loan balance plus interest for one
month.
Note payable-bank (560,000-294,000) 266,000
Interest expense
(1% x 266,000)
2,660
Cash
268,680
To transfer the remaining balance of assigned accounts to accounts receivable:
Accounts receivable
65,000
Accounts receivable-assigned
65,000
Total accounts receivable-assigned
Less: collections (294,000+300,000) 594,000
Sales discount
6,000
Sales return
20,000
Worthless accounts
15,000
Balance
700,000
635,000
65,000
Illustration –notification basis
July
1 An entity assigned P1, 000,000 of accounts receivable to a bank under a notification
arrangement.
The bank loans 80% less 4% service charge on the gross amount assigned.
The entity signed a promissory note that provides for 1% interest per month on the unpaid
loan
balance.
July 1 Accounts receivable-assigned
Accounts receivable
1,000,000
Cash (800,000-40,000)
Service charge (4% x 1,000,000)
Note payable-bank
1,000,000
760,000
40,000
800,000
31 Received notice from the bank that P600,000 of the assigned accounts were collected less 2%
discount. A check was sent to the bank for the interest due.
Note payable –bank
Sales discount (2% x 600,000)
Accounts receivable- assigned
Interest expense (1% x 800,000) 8,000
Cash
588,000
12,000
600,000
8,000
August
31 Received notice from bank that P300,000 of the assigned accounts were collected. Final
settlement was made by the bank for the excess collections together with the uncollected
assigned accounts of P100, 000.
Cash
85,880
Interest expense
2,120
Note payable-bank
212,000
Accounts receivable- assigned
300,000
Accounts receivable
100,000
Accounts receivable-assigned 100,000
Computation
Loan from bank
Less: July collection by bank
Balance due the bank
800,000
588,000
212,000
August collection by bank
Less: loan balance
Excess collection
Less: Interest (1% x 212,000)
Remittance from bank
300,000
212,000
88,000
2,120
85,880
Statement presentation
An entity provided the following accounts at year-end:
Accounts receivable-unassigned
Accounts receivable-assigned
Allowance for doubtful accounts
Note payable-bank (related to assignment)
Accounts receivable- unassigned
Accounts receivable –assigned
Total
Allowance for doubtful accounts
Net realizable value
4,000,000
1,000,000
100,000
400,000
4,000,000
1,000,000
5,000,000
(100,000)
4,900,000
The net realizable value of P4,900,000 is included in the caption “trade and other receivables”.
Equity in assigned accounts
Moreover, the entity shall disclose its equity in the assigned accounts determined as follows:
Accounts receivable-assigned
Note payable –bank
1,000,000
(400,000)
Equity in assigned accounts
600,000
Factoring
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.
Accordingly, a gain or loss is recognized for the diferrence between the proceeds received and
the net carrying amount of the receivables factored.
Factoring differs from an assignment in that an entity actually transfer ownership of the accounts
receivable to the factor.
Thus, the factor assumes responsibility for uncollectible factored accounts.
In assignment, the assignor retains ownership of the accounts assigned.
Because of the nature of the transaction, the customers whose accounts are factored are notified
and required to pay directly to the factor.
The factor has then the responsibility of keeping the receivable records and collecting the
accounts.
Factoring may take the form of the following:
a. Casual factoring
b. Factoring as a continuing agreement.
Casual factoring
if an entity finds itself in a critical cash potion, it may be forced to factor some or all of its
accounts receivable at a substantial discount to a bank or finance entity to obtain the much
needed cash.
For example, an entity factored P100,000of accounts receivable with an allowance for doubtful
accounts of P5,000 for 80,000.
Journal entry to record the sale
Cash
Allowance for doubtful accounts
Loss on factoring
Accounts receivable
80,000
5,000
15,000
100,000
Factoring as a continuing agreement
Factoring may involve a continuing arrangement where a finance entity purchases all of the
accounts receivable of a certain entity.
In this setup, before a merchandise is shipped to a customer, the selling entity requests the
factor’s credit approval.
If it is approved, the account is sold immediately to the factor after shipment of the goods.
The factor then assumes the credit functions as well as the collection function.
For comprehension, typically the factor charges a commission or factoring fee of 5% to 20% for
its services of credit approval, billing, collecting, and assuming uncollectible factored accounts.
Moreover, the factor may withhold a predetermined amount as protection against customer
returns and allowances and other special adjustments.
This amount withheld is known as the “factor’s holdback.”
The factor’s holdback is actually a receivable from factor and classified as current asset.
Final settlement of the factor’s holdback is made after the factored receivables have been fully
collected.
Illustration
An entity factored accounts receivable of P500,000 with credit terms of 2/10, n/30 immediately
after shipment of the goods to the customer.
The factor charged a 5% commission based on the gros amount of the receivables factored.
In addition , the factor withheld 20% of the amount of the receivables factored to cover sales
return and allowances.
Journal entry to record the factoring
Cash
Sales discount
Commission
Receivable from factor
Accounts receivable
365,000
10,000
25,000
100,000
500,000
Computation
Gross amount
Less: Sales discount
Commission
Factor’s holdback
Cash received from factoring
500,000
(2% x 500,000)
10,000
(5% x 500,000) 25,000
(20% x 500,000) 100,000
135,000
365,000
If the customer is subsequently allowed a credit of P50,000 for the damaged merchandise, the
journal entry is:
Sales return and allowance
Sales discount (2% x 50,000)
Receivable from factor
50,000
1,000
49,000
When all the receivables factored are collected by the factor with no further returns and
allowances, the final settlement with the factor is recorded as follows:
Cash (100,000 – 49,000) 51,000
Receivable from factor
51,000
Credit card
A credit card is a plastic card which enables the holder to obtain credit up to a predetermined
limit from the issuer of the card for the purchase of goods and services.
The credit card has enabled retailers and other businesses to continue to sell goods and services
where the customers obtain possession of the goods immediately but do not have to pay for the
goods for about one month.
The major credit cards in the Philippines are Diners Club, American Express, VISA, Master
Card.
These entities are generally responsible for approving the credit of customers and collecting the
receivables for a service fee from 1% to 5% of the credit card sales.
Generally, if a customer buys goods and uses a credit card, the credit card receipt must be
forwarded by the retailer to the card issuer who will then pay the retailer the appropriate amount
minus the credit service charge.
Two entries are necessary, one entry at the time of sale and another entry when payment is
received from the card issuer.
Illustration
Credit card sales to customers using Diners Club amount to P200, 000 for a certain period.
The credit card receipts are forwarded to Diners Club and payment is subsequently received from
Diners Club minus a 3% service charge.
1. To record the credit sales:
Accounts receivable-Diners Club
Sales
200,000
2. To record the payment from Diners Club:
200,000
Cash
Credit card service charge (200,000 x 3%)
Accounts receivable-Diners Club
194,000
6,000
200,000
Another illustration
There are some credit cards that allow the retailer business to deposit the credit card
receipts directly to a current account.
The bank accepts the credit card receipts and immediately increases the current account
of the retailer for the amount of credit card sales minus the credit card service charge.
This arrangement is in effect a form of factoring of accounts receivable because the credit
card sales are treated as cash sales by the retailers.
For example, credit card sales amount to P200, 000 with 5% service charge or P10, 000.
The journal entry to record the credit card sales under this form of arrangement is:
Cash
Credit card service charge
Sales
190,000
10,000
200,000
QUESTIONS
1. Explain fully receivable financing .
2. Enumerate the four common forms of receivable financing.
3. What are the forms of financibg related to accounts receivable?
4. What is pledge of accounts receivble?
5. What is assignment of accounts receivable .
6. Distinguish pledge and assignment of accounts receivable .
7. What is the meaning of nonnotification and notification basis with respect to assigbment of accounts
receivable ?
8. What is factoring ?
9. Explain casual factoring and factoring as a continuing agreement .
10. What is credit card ?
PROBLEMS
Problem 8-1 (ACP)
Pittance Company provided the following information in connection with a bank loan.
March 1 Pittance Company borrowed P2,000,000 from bank on six-month note carrying an interest of
12% per annum. Accounts of P3,000,000 are pledged to secure the loan.
April 1 Pledged accounts of P1,000,000 are collected minus 2% discount .
June 1 The remaining pledged accounts are collected
September 1 The bank loan is repaid plus interest.
Required: Prepare journal entries to rexord the trabsactions.
Problem 8-2 (ACP)
Idealist Company secured a one-year bank loan of P4,000,000 on October 1, 2019. The loan was
discounted at 10%.
The entity signed a note fir the loan and pledged P5,000,000 of its accounts receivable as collateral for
tge same. The accounting period of the entity ends on Decemver 31.
Required:
1. Prepare journal entries , including adjustmeng from the date of loan up to date of maturity.
2. Statemwnt presentation of the bank loan with adequate disclosure on December 31, 2019.
Chapter 4 Related Parties
TECHNICAL KNOWLEDGE
To understand the concept of related parties.
To identify related parties.
To know the requirements for disclosure of relates party relationship.
To know the requirements for disclosure of related party transactions.
DEFINITION
Related party - parties are considered to be related if one party has :
a. The ability to control the other party.
b. The ability to exercise significant influence over the other party.
c. Joint control over the entity.
Control is the power over the investee or the power to govern the financial and operatibg
policies of an entity so as to obtain benefits.
Control is ownership directly or indirectly through subsidiaries of more than half of the voting
power of the entity.
Significant influence is the power to participate in the financial and the operating policy
decision of an entity, but not control of those policies.
Significant influence may be gained by share ownership of 20% or more.
If an investor holds directly or indirectly rhrougj subsidiaries, 20% or more of the voting power
of the investee, it is presumed that the investor has significant influence , unless it can be clearly
demonstrated that this is not the case.
Beyond the mere 20% threshold of ownership, the existence of significant influence is usually
evidenced by the following factors :
a. Representation in the board of directors.
b. Participation in policy making process.
c. Material transactions between the investor and the investee.
d.Interchange of managerial personnel.
e Provision of essential technical information.
Joint Control is the contractually agreed sharing of control over an economic activity.