Conversion of Receivables
Hello Buddies😊 How do you do ?In our today's post we are going to discuss on conversion of receivables before their due date and related terminologies, e.g if you gave me a note which should be payable within 30 days, and by chance if you want your money in the 20th day before our agreed due date, then how do you record these events? So, by just reading the following short note properly you will get an answer for this question.
As we tried to see through example above, Some times companies convert receivables to cash before they are due. Reasons for this include the need for cash or a desire to not be involved in collection activities.
Converting receivables is usually done either:👇
1) By selling(factoring) or
2) By using them as security for loan(pledging)
1) Factoring (Selling) Receivables
👉Companies sometimes need cash before customers pay their account balances. In such situations, the company may choose to sell accounts receivable to another company that specializes in collections.
This process is called FACTORING, and the company that purchases accounts receivable is often called a FACTOR. The factor usually charges between one and fifteen percent of the account balances. The reason for such a wide range in fees is that the receivables may be factored with or without recourse. RECOURSE means the company factoring the receivables agrees to reimburse the factor for uncollectible accounts. Low percentage rates are usually offered only when recourse is provided.
Suppose a company factors $500,000 in accounts receivable at a rate of 3%. The company records this sale of accounts receivable by debiting cash for$r485,000, debiting factoring expense (or service charge expense) for $l5,000, and crediting accounts receivable for $500,000.
Cash.........................485,000
Factoring fees exp...15,000
A/R.........................500,000
(Factor accounts worth $500,000)
👌ex stands for expense.
In practice, the credit to accounts receivable would need to identify the specific subsidiary ledger accounts that were factored, although to simplify the example this is not done here.
2) Pledging Accounts Receivable
A company can also raise cash by borrowing money and then pledging its accounts receivable as security for the loan. Pledging receivables does not transfer the risk of bad debts to the lender. The borrower remains ownership of the receivables. But if the borrower defaults on the loan, the lender has the right to be paid from cash receipts when the accounts receivable are collected. When KK Company borrowed $35,000 and pledged its receivables as a security, it recorded this transaction as👇
Cash.......35,000
Notes receivable......35,000
(Borrowed money with a note secured by pledging accounts receivable)
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