FAR CPA Practice Questions Explained: Transferring Trade Receivables

Transferring Trade Receivables

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In this video, we walk through 5 FAR practice questions teaching about transferring trade receivables. These questions are from FAR content area 2 on the AICPA CPA exam blueprints: Select Balance Sheet Accounts.

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Transferring Trade Receivables

When it comes to transferring trade receivables, companies have several options, including secured borrowing, factoring (with or without recourse), assignment, and pledging. Each method has different implications for how the company records the transfer in its financial statements. In this guide, we’ll walk through the required journal entries for each type of transfer and highlight the key points we’ve covered in our CPA exam-style questions.

Secured Borrowings, Pledging, and Assignment: Similar Concepts

For the CPA exam, these three types of receivables transfers are considered very similar. Each involves using trade receivables as collateral rather than outright selling them. The common element is that the company retains control and collection responsibilities for the receivables until the debt is settled.

  • Secured Borrowing:
    The company borrows against its receivables and records a Notes Payable for the loan amount. The receivables stay on the books, and the lender’s interest is usually disclosed.
  • Pledging:
    The company promises receivables as collateral but retains them on the balance sheet. There is no specific assignment of receivables.
  • Assignment:
    The company formally assigns specific receivables to the lender. The collection responsibility might pass to the lender upon default.

Journal Entry Example for All Three:

  • Debit: Cash (for the loan amount)
  • Credit: Notes Payable (for the loan amount)

Factoring Without Recourse: Buyer’s (Factor’s) Perspective

When a company purchases receivables without recourse, the factor (buyer) assumes all risk of non-payment. This means the buyer records the full amount of receivables as an asset and recognizes any expected credit losses at the time of purchase.

  • Journal Entry for the Factor:
    • Debit: Trade Receivables (full amount of purchased receivables)
    • Credit: Cash (amount paid to the seller)
    • Debit: Credit Loss Expense (expected uncollectible portion)
    • Credit: Allowance for Credit Losses (to offset expected losses)
    • Credit: Gain on Factoring (difference between receivables’ value and cash paid)

Factoring Without Recourse: Seller’s Perspective

From the seller’s perspective, factoring without recourse means the transfer of receivables and removal of risk. The seller is no longer responsible for the receivables and removes them from its balance sheet, recognizing a gain or loss based on the cash received.

  • Journal Entry for the Seller:
    • Debit: Cash (amount received from factor)
    • Debit: Loss on Sale of Receivables (if applicable)
    • Credit: Trade Receivables (full amount of receivables sold)

Factoring With Recourse

Factoring with recourse is a more complex scenario. The seller transfers the receivables but retains responsibility for uncollectible accounts, creating a recourse liability. This means the seller must record the expected loss and liability on its books.

  • Journal Entry for the Seller:
    • Debit: Cash (amount received)
    • Debit: Loss on Sale of Receivables (includes both the initial loss and the estimated recourse expense)
    • Credit: Trade Receivables (full amount of receivables)
    • Credit: Recourse Liability (for the estimated uncollectible portion)

Key Takeaways for Recording Receivables Transfers

  • Secured Borrowing, Pledging, and Assignment: Involve collateral agreements and require little or no adjustment to the receivables. Focus on the recognition of the loan liability.
  • Factoring Without Recourse: The seller transfers the risk entirely, removing receivables from the books and recognizing a gain or loss. The factor records the receivables and the expected credit losses.
  • Factoring With Recourse: The seller retains risk and must record a recourse liability and a higher loss on the sale.

Example: Factoring Without Recourse

Oakwood Furniture decides to sell $300,000 of its trade receivables to River Finance under a factoring agreement without recourse. Oakwood Furniture needs immediate cash, and River Finance charges a 5% factoring fee on the total receivables. River Finance also estimates that 3% of the receivables will be uncollectible and wants to record the potential credit losses when the transaction occurs.

1. Seller’s Perspective: Oakwood Furniture

  • Factoring Fee:
    Factoring fee = 300,000 * 0.05 = $15,000
  • Cash Received by Oakwood Furniture:
    Cash = 300,000 – 15,000 = $285,000
  • Journal Entry for Oakwood Furniture:
    • Debit: Cash $285,000
    • Debit: Loss on Sale of Receivables $15,000
    • Credit: Trade Receivables $300,000

Explanation: Oakwood Furniture removes the full value of the receivables from its books and records a loss due to the factoring fee. After the sale, Oakwood Furniture has no further obligation or risk associated with the receivables.

2. Buyer’s Perspective: River Finance

  • Total Receivables Purchased: $300,000
  • Factoring Fee:
    300,000 * 0.05 = $15,000
  • Expected Credit Losses (3% of $300,000):
    300,000 * 0.03 = $9,000
  • Cash Paid by River Finance:
    Cash Paid = 300,000 – 15,000 = $285,000
  • Journal Entry for River Finance:
    • Debit: Trade Receivables $300,000
    • Credit: Cash $285,000
    • Credit: Gain on Factoring $15,000
    • Debit: Credit Loss Expense $9,000
    • Credit: Allowance for Credit Losses $9,000

Explanation: River Finance records the full value of the receivables as an asset and recognizes the factoring fee as a Gain on Factoring. It also immediately sets up an Allowance for Credit Losses for the expected uncollectible accounts.

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