Requirement 1
These methods can be described by one of two basic arrangements: 1. A secured borrowing, or
2. A sale of receivables.
When a company chooses between a borrowing and a sale, the critical element is the extent to which it (the transferor) is willing to surrender control over the assets transferred. Specifically, the transferor is determined to have surrendered control over the receivables if and only if three sale conditions are met.
Secured borrowings usually take the form of an assignment of receivables. An assignment of receivables is a promise by the borrower (the owner of the receivables) that any failure to repay debt owed to the lender in accordance with the debt agreement will cause the proceeds from collecting the receivables to go directly toward repayment of the debt. This arrangement is no different from the use of a building as collateral for a mortgage loan. The assignor (borrower) assigns the assignee (lender) the rights to specific receivables as collateral for a loan. A variation of assigning specific receivables is when trade receivables in general rather than specific receivables are pledged as collateral. The responsibility of collection of the receivables remains solely with the company. This variation is referred to as a
pledging of accounts receivable.
Two popular arrangements used for the sale of receivables are factoring and securitization. A factor is a financial institution that buys receivables for cash, handles the billing and collection of the receivables, and charges a fee for this service. Actually, credit cards like VISA and Mastercard are forms of factoring arrangements. The seller relinquishes all rights to the future cash receipts in exchange for cash from the buyer (the factor).
Another popular arrangement used to sell receivables is a securitization. In a typical accounts receivable securitization, the company creates a Special Purpose Entity (SPE), usually a trust or a subsidiary. The SPE buys a pool of trade receivables, credit card receivables, or loans from the company, and then sells related securities, for example bonds or commercial paper, that are backed (collateralized) by the receivables.
Similar to accounts receivable, a note receivable can be used to obtain immediate cash from a financial institution either by pledging the note as collateral for a loan or by selling the note. The transfer of a note is referred to as discounting.
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7–86 Intermediate Accounting, 7/e
Requirement 2
In an assignment of specific receivables, usually the amount borrowed is less than the amount of receivables assigned. The difference provides some protection for the lender to allow for possible uncollectible accounts. Also, the assignee (transferee) usually charges the assignor an up-front finance charge in addition to stated interest on the collateralized loan. The borrower, assignor, records the loan liability, the finance fee expense, and the cash borrowed.
No special accounting treatment is needed for an assignment of receivables in general, and the arrangement is simply described in a disclosure note.
The specific accounting treatment for the sale of receivables using factoring and securitization arrangements depends on the amount of risk the factor assumes, in particular whether it buys the receivables without recourse or with recourse.
When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer has no recourse to the seller if customers don’t pay the receivables. In that case, the seller simply accounts for the transaction as a sale of an asset. The buyer charges a fee for providing this service, usually a percentage of the book value of receivables. Because the fee reduces the proceeds the seller receives from selling the asset, the seller records a loss on sale of assets. The typical factoring arrangement is made without recourse.
When a company sells accounts receivable with recourse, the seller retains the risk of uncollectibility. In effect, the seller guarantees that the buyer will be paid even if some receivables prove to be uncollectible. Even if receivables are sold with recourse, as long as the three conditions for sale treatment are met, the transferor would still account for the transfer as a sale. The only difference would be the additional requirement that the transferor record the estimated fair value of the recourse obligation as a liability. The recourse obligation is the estimated amount that the transferor will have to pay the transferee as a reimbursement for uncollectible receivables.
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Solutions Manual, Vol.1, Chapter 7 7–87
Real World Case 7–10
Requirement 1
Sanofi-Aventis uses the terms “provision for impairment” and “impairment” for “allowance for bad debts.” The (€126) is the allowance necessary to adjust gross accounts receivable for estimated bad debts.
Requirement 2
Sanofi-Aventis does not factor or securitize its receivables. We know this because note D.10 states, “Group policy is to retain receivables until maturity, and hence not to use receivables securitization programs.”
Requirement 3
a. Accounts receivable would be reduced in the period of change, as Sanofi- Aventis would collect outstanding receivables and immediately securitize new receivables.
b. Cash flow from operations would be increased in the period of change, as Sanofi-Aventis would show cash inflows both from collecting outstanding receivables and from immediately securitizing new receivables.
c. Accounts receivable would be stable at a relatively low level, as Sanofi- Aventis would immediately securitize new receivables.
d. Cash flow from operations would return to approximately its former level, as Sanofi-Aventis would show cash inflows only from immediately securitizing new receivables.
Requirement 4
The answers to requirement 3 highlight that decisions to increase or decrease the extent of securitization create one-time changes in receivables and cash flows in the period in which the company transitions to the new level. For example, increasing securitization will boost cash flow in the period of change. However, the increased cash flow is only temporary—in future periods cash flow will revert to former levels unless the company increases the extent of securitization yet further.
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7–88 Intermediate Accounting, 7/e
Requirement 1
When a company sells accounts receivable without recourse, the buyer assumes the risk of uncollectibility. This means the buyer cannot pursue collection from the seller (has no recourse) if customers don’t pay the receivables.
Requirement 2
FASB ASC 860–10–40–5: “Transfers and Servicing—Overall—Derecognition— Criteria for a Sale of Financial Assets.”
The transferor is determined to have surrendered control over the receivables if and only if all of the following conditions are met:
a. The transferred assets have been isolated from the transferor—put presumptively beyond the reach of the transferor and its creditors—even in bankruptcy or other receivership.
b. Each transferee has the right to pledge or exchange the assets it received.
c. The transferor does not maintain effective control over the transferred assets through either (1) an agreement that the transferor repurchase or redeem them before their maturity or (2) the ability to cause the transferee to return specific assets.
(These criteria were included in Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" subsequently modified by SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140.” (The above conditions can be found in paragraph 9 of the standard.)
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Solutions Manual, Vol.1, Chapter 7 7–89
Case 7–11 (concluded)
Requirement 3
Cash (90% x $400,000) ... 360,000 Loss on sale of receivables (to balance) ... 31,000 Receivable from factor ($25,000 fair value – [4% x $400,000]) 9,000
Accounts receivable (balance sold) ... 400,000 Requirement 4
FASB ACS 860–10–40–24: “Transfers and Servicing—Overall—Derecognition – Effective Control Through Both a Right and an Obligation (previously paragraph 47 of SFAS No. 140)lists the following conditions:
a. The assets to be repurchased or redeemed are the same or substantially the same as those transferred.
b. The transferor is able to repurchase or redeem them on substantially the agreed terms, even in the event of default by the transferee.
c. The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price.
© The McGraw-Hill Companies, Inc., 2013
7–90 Intermediate Accounting, 7/e
Requirement 1
Del Monte Smithfield
Receivables turnover = 3,627 = 17.61 times 12,202.7 = 18.33times
205.95 665.55
Average collection = 365 = 20.73 days 365 = 19.91 days
period 17.61 18.33
The receivable turnover ratios are in a close range with one another. This is not surprising since the companies operate in the same industry, selling similar products with similar terms and customers.
Requirement 2
The objective of this requirement is to motivate students to obtain hands-on familiarity with actual annual reports and to apply the techniques learned in the chapter. You may wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.
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Solutions Manual, Vol.1, Chapter 7 7–91
Analysis Case 7–13
Requirement 1
Note 1 indicates “Cash and Cash Equivalents—All highly liquid investments, including credit card receivables due from banks, with original maturities of three months or less at date of purchase, are reported at fair value and are considered to be cash equivalents. All other investments not considered to be cash equivalents are separately categorized as investments.”
Requirement 2
$13,913 (in millions)—from the balance sheet.
Requirement 3
($ in millions, from Note 12) 2011 2010
Net receivables $6,493 $5,837
Add: Allowance 96 115
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7–92 Intermediate Accounting, 7/e
Requirement 1
AF indicates the following:
3.10.1 Valuation of trade receivables and noncurrent financial assets
Trade receivables, loans and other noncurrent financial assets are considered to be assets issued by the Group and are recorded at fair value then, subsequently, using the amortized cost method less impairment losses, if any. The purchases and sales of financial assets are accounted for as of the transaction date.
This approach is consistent with U.S. GAAP. The receivables are recorded initially at their fair value (their value when the sales transaction occurs). If they are discounted for the time value of money, the amount of any discount is amortized to interest revenue over the life of the receivable. And, an allowance for bad debts is set up to account for uncollectible accounts (per note 24, they call that allowance a “valuation allowance”), which they refer to as “impairment losses” in the footnote.
Requirement 2
Valuation Allowance for Trade Accounts Receivable ________________________________________
89 Beg. Bal.
14 bad debt expense
write-offs 15 currency translation adj. 1
reclassification 4
_________________
83 End. Bal.
Requirement 3
AF has bank overdrafts of €129 as of March 31, 2011. Under IFRS, those overdrafts would be netted against AF’s total cash and cash equivalents of €3,717 if the overdrafts are payable on demand and are part of the AF’s normal cash management process. Instead, the overdrafts are shown as a current liability, consistent with U.S. GAAP and suggesting that the overdrafts don’t meet IFRS’s requirements for netting against the cash balance.