Factoring: Using Receivables as an Immediate Source of Cash
Receivables can also be used as a source of cash by assigning or pledging them as security for a loan, Pledging receivables as security for a loan does not actually involve selling them.
However, selling its accounts receivable differs for the seller from borrowing money and pledging the re- ceivables as collateral in two ways:
• After it sells its receivables to the factor, the seller of the receivables no longer owns the receiva bles, so the receivables are removed from the seller's balance sheet.
• The seller also does not report a loan outstanding on its balance sheet for the funds received in the sale of the receivables.
The factor notifies the seller's customers to begin remitting their payments directly to the factor, and the factor receives repayment of its "loan" as it collects the receivables.
The two forms of factoring are called "without recourse" and "with recourse."
Traditionally, factoring is without recourse, which means the factor assumes the risk of any credit losses on the receivables. If a receivable the factor purchased proves to be uncollectible, the factor has no recourse against the seller of the receivable-the loss is the factor's loss. Some companies factor their receivables without recourse in order to transfer the credit loss risk in this manner. However, the greater the risk of credit losses, the less cash the selling company will receive from the factor.
Note: If the receivables are sold without recourse, any credit loss expense and balance in the allowance for credit losses account already recorded by the seller for the receivables needs to be reversed.
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Sometimes the sale is with recourse. In a sale of receivables with recourse, if a customer does not pay the receivable, the seller of the receivable is liable to the factor for the credit loss, Therefore, when a factor purchases receivables with recourse, the factor's risk of credit losses is limited. Because of the lower level of risk to the factor, it will pay more when buying receivables with recourse..
Note: If receivables are factored with recourse, the seller will carry a liability, called recourse liability or recourse obligation, on its balance sheet for the estimated amount of any expected credit losses. The recourse liability is very similar in process to the allowance for credit losses account used by a company that collects its own receivables and bears the risk of the associated credit losses.
A company will not be able to sell its receivables for the full amount of their face value, however. The factor takes some of the value of the receivables as fees for its service provided. Furthermore, if the factor pur chases the receivables without recourse and thus assumes the risk of credit losses, the amount the selling company will receive for its receivables will be even more reduced.
If the equity security does not have a readily determinable fair value and the investor has been estimating its fair value at its cost minus impairment adjusted for observable price changes in accordance with ASC 321-10-35-2, that paragraph provides that if the investor identifies an observable price change in an orderly transaction for the same or a similar investment of the same issuer, the investor measures the equity security at fair value as of the date the observable trans- action occurred. The investor's own purchase of the additional investment is an observable transaction if the investor determines that the price it paid per share represents the fair value of the security.
Therefore, before recording its purchase of the additional shares, ASC 323-10-35-33 provides that the investor remeasures the current basis of its previously-held interest in the investee according to the fair value per share as established by its own subsequent purchase (assuming the investor determines that the price it paid represents the fair value) and recognizes a gain or loss in earn- ings. 76
The investor then proceeds to record its subsequent purchase at its purchase price and then applies the equity method of accounting to its entire investment in the investee.