How to Dispose of Receivables
Instead of waiting for the customer or debtor to pay, a company may opt to “sell” a receivable to another company at a discount. Cash flow is a major factor in these sorts of instances.
If a company finds that it lacks funds to make payroll or cut a check to pay some other type of expense, the company may prefer to accept a lesser amount for a receivable transaction than try to get a working capital (short-term) loan.
A company can structure disposing of receivables in a variety of ways. The most prevalent are pledging, assignment, and factoring.
You may remember these terms from previous accounting classes but don’t quite remember the difference in the three. Never fear! Here’s a thumbnail sketch of all three:
Pledging: Nope, you’re not applying for fraternity membership. Pledging takes place when the company uses a receivable as security for a loan for which the company is the debtor. When this situation occurs, the company discloses it in the balance sheet parenthetically — as in, “Accounts receivable ($500,000 of which has been pledged as collateral for bank loans)” — or as a note disclosure.
Assignment: A formal transfer of the debt takes place from one company to another. Often this process is invisible to the debtor. The debtor merrily continues to make payments to the original company, none the wiser. Assigned accounts stay on the balance sheet of the original issuer, with disclosure similar to pledging.
Factoring: Factoring takes place when there’s an outright sale of the receivable to a new owner. Notification goes to the debtor that payments are henceforth to be made to the new owner of the debt.
Sales transactions can be either recourse, which means the seller guarantees payment to the purchaser in case the debtor doesn’t pay, or nonrecourse, which means the seller has no further obligation for collectability.
Current assets are cash or any asset that the company anticipates converting to cash within a 12-month period from the date of the balance sheet. List current assets in order of liquidity on the balance sheet. Because cash is the most liquid (duh, it’s cash!), it shows up on the balance sheet first. Other common current assets are marketable securities, accounts receivable, inventory, prepaid assets, and deferred tax assets.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
