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Assignment of Accounts Receivable: Meaning, Considerations
Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.
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What Is Assignment of Accounts Receivable?
Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution. In exchange for this assignment of accounts receivable, the borrower receives a loan for a percentage, which could be as high as 100%, of the accounts receivable.
The borrower pays interest, a service charge on the loan, and the assigned receivables serve as collateral. If the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables.
- Assignment of accounts receivable is a method of debt financing whereby the lender takes over the borrowing company's receivables.
- This form of alternative financing is often seen as less desirable, as it can be quite costly to the borrower, with APRs as high as 100% annualized.
- Usually, new and rapidly growing firms or those that cannot find traditional financing elsewhere will seek this method.
- Accounts receivable are considered to be liquid assets.
- If a borrower doesn't repay their loan, the assignment of accounts agreement protects the lender.
Understanding Assignment of Accounts Receivable
With an assignment of accounts receivable, the borrower retains ownership of the assigned receivables and therefore retains the risk that some accounts receivable will not be repaid. In this case, the lending institution may demand payment directly from the borrower. This arrangement is called an "assignment of accounts receivable with recourse." Assignment of accounts receivable should not be confused with pledging or with accounts receivable financing .
An assignment of accounts receivable has been typically more expensive than other forms of borrowing. Often, companies that use it are unable to obtain less costly options. Sometimes it is used by companies that are growing rapidly or otherwise have too little cash on hand to fund their operations.
New startups in Fintech, like C2FO, are addressing this segment of the supply chain finance by creating marketplaces for account receivables. Liduidx is another Fintech company providing solutions through digitization of this process and connecting funding providers.
Financiers may be willing to structure accounts receivable financing agreements in different ways with various potential provisions.
Accounts receivable (AR, or simply "receivables") refer to a firm's outstanding balances of invoices billed to customers that haven't been paid yet. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payments due within one year.
Accounts receivable are considered to be a relatively liquid asset . As such, these funds due are of potential value for lenders and financiers. Some companies may see their accounts receivable as a burden since they are expected to be paid but require collections and cannot be converted to cash immediately. As such, accounts receivable assignment may be attractive to certain firms.
The process of assignment of accounts receivable, along with other forms of financing, is often known as factoring, and the companies that focus on it may be called factoring companies. Factoring companies will usually focus substantially on the business of accounts receivable financing, but factoring, in general, a product of any financier.
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Assignment of accounts receivable is an agreement in which a business assigns its accounts receivable to a financing company in return for a loan. It is a way to finance cash flows for a business that otherwise finds it difficult to secure a loan, because the assigned receivables serve as collateral for the loan received.
By assignment of accounts receivable, the lender i.e. the financing company has the right to collect the receivables if the borrowing company i.e. actual owner of the receivables, fails to repay the loan in time. The financing company also receives finance charges / interest and service charges.
It is important to note that the receivables are not actually sold under an assignment agreement. If the ownership of the receivables is actually transferred, the agreement would be for sale / factoring of accounts receivable . Usually, the borrowing company would itself collect the assigned receivables and remit the loan amount as per agreement. It is only when the borrower fails to pay as per agreement, that the lender gets a right to collect the assigned receivables on its own.
The assignment of accounts receivable may be general or specific. A general assignment of accounts receivable entitles the lender to proceed to collect any accounts receivable of the borrowing company whereas in case of specific assignment of accounts receivable, the lender is only entitled to collect the accounts receivable specifically assigned to the lender.
The following example shows how to record transactions related to assignment of accounts receivable via journal entries:
On March 1, 20X6, Company A borrowed $50,000 from a bank and signed a 12% one month note payable. The bank charged 1% initial fee. Company A assigned $73,000 of its accounts receivable to the bank as a security. During March 20X6, the company collected $70,000 of the assigned accounts receivable and paid the principle and interest on note payable to the bank on April 1. $3,000 of the sales were returned by the customers.
Record the necessary journal entries by Company A.
Journal Entries on March 1
Initial fee = 0.01 × 50,000 = 500
Cash received = 50,000 – 500 = 49,500
The accounts receivable don't actually change ownership. But they may be to transferred to another account as shown the following journal entry. The impact on the balance sheet is only related to presentation, so this journal entry may not actually be passed. Usually, the fact that accounts receivable have been assigned, is stated in the notes to the financial statements.
Journal Entries on April 1
Interest expense = 50,000 × 12%/12 = 500
by Irfanullah Jan, ACCA and last modified on Oct 29, 2020
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Assignment of Accounts Receivable
The financial accounting term assignment of accounts receivable refers to the process whereby a company borrows cash from a lender, and uses the receivable as collateral on the loan. When accounts receivable is assigned, the terms of the agreement should be noted in the company's financial statements.
In the normal course of business, customers are constantly making purchases on credit and remitting payments. Transferring receivables to another party allows companies to reduce the sales to cash revenue cycle time. Also known as pledging, assignment of accounts receivable is one of two ways companies dispose of receivables, the other being factoring.
The assignment process involves an agreement with a lending institution, and the creation of a promissory note that pledges a portion of the company's accounts receivable as collateral on the loan. If the company does not fulfill its obligation under the agreement, the lender has a right to collect the receivables. There are two ways this can be accomplished:
General Assignment : a portion of, or all, receivables owned by the company are pledged as collateral. The only transaction recorded by the company is a credit to cash and a debit to notes payable. If material, the terms of the agreement should also appear in the notes to the company's financial statements.
Specific Assignment : the lender and borrower enter into an agreement that identifies specific accounts to be used as collateral. The two parties will also outline who will attempt to collect the receivable, and whether or not the debtor will be notified.
In the case of specific assignment, if the company and lender agree the lending institution will collect the receivables, the debtor will be instructed to remit payment directly to the lender.
The journal entries for general assignments are fairly straightforward. In the example below, Company A records the receipt of a $100,000 loan collateralized using accounts receivable, and the creation of notes payable for $100,000.
In specific assignments, the entries are more complex since the receivable includes accounts that are explicitly identified. In this case, Company A has pledged $200,000 of accounts in exchange for a loan of $100,000.
balance sheet , current assets , factoring , disposition of accounts receivable , allowance for doubtful accounts , special allowance accounts
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Pledging Accounts Receivable
Written by True Tamplin, BSc, CEPF®
Reviewed by subject matter experts.
Updated on February 21, 2023
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Definition and explanation.
Pledging accounts receivable is essentially the same as using any asset as collateral for a loan. Cash is obtained from a lender by promising to repay.
If the loan is not repaid, the collateral will be converted to cash, and the cash will be used to retire the debt.
The receivables can be either an identified set of notes and accounts or a general group in which new ones can be added and old ones retired.
The collection of a pledged receivable has no impact on the loan balance.
The pledging agreement usually calls for the substitution of another receivable for the one collected.
As an example, suppose that Sample Company borrows $80,000 on 31 December 20x1, and agrees to pay back $81,600 on 1 April 20x1.
Further, it pledges $100,000 of trade receivables for the loan. The company would make three journal entries as follows:
The last two entries can be combined, but they are shown separately here to facilitate a comparison of pledging with the other approaches.
The only financial statement disclosures provided for pledged receivables are notes or parenthetical comments.
A similar notation is provided for the notes payable .
As an alternative to pledging, the company may decide to assign its receivables to a lending institution.
Under this arrangement, the original holder essentially transfers title to the third party but agrees to collect the receivables and pay the cash to the factor .
Suppose that Sample Company obtains $80,000 cash on 31 December 20x1 by assigning $100,000 of its trade receivables.
The company agrees to place the collections in a special restricted checking account from which it will repay the original $80 000 plus a $2,400 finance charge on April 1, 20x2.
These journal entries would be made as follows:
To record partial collection of the assigned accounts :
To accrue the finance charge:
To reclassify the uncollected accounts and unrestricted cash:
The disclosures that would be provided on various balance sheet dates are shown in the following example, under the simplifying assumption that no other activity took place.
Notice that the payable to the factor is contra to the assigned accounts. Any restricted cash balance is, in turn, contra to the payable account.
Most arrangements of this type call for more frequent payments than the example shows.
The net result of the assignment is that Sample Company obtained $80,000 by giving up $82,400 of receivables.
Pledging Accounts Receivable FAQs
What is pledging accounts receivable.
Pledging Accounts Receivable means that a business gives up some of its rights to an asset in order to borrow money. For example, you could pledge your car title as collateral for a loan. If the loan isn't repaid, the lender can take possession of your car.
What are the journal entries for pledging accounts receivable?
There are no Special Journal entries required when you pledge your Accounts Receivable as collateral for a loan. The lender still has to approve giving up your Accounts Receivable before making the loan.
How are accounts receivable journal entries prepared?
Accounts Receivable are money owed to a company by their customers for products they've already received. Accounts are recorded in the balance sheet as assets.
What are the journal entries for assigning Accounts Receivable as collateral for a loan?
The entry to record assignment of Accounts Receivable as collateral would be a credit to cash, and a debit to assign Accounts Receivable. The cash account is debited because the company gave up the assigned receivables. The assign Accounts Receivable account is credited because they still owe this money to their customers.
What are the main financial statements in an assignment of accounts receivable?
The three main Financial Statements in an assignment of Accounts Receivable are the income statement, balance sheet, and Cash Flow statement. The income statement and Cash Flow statements would report the repayments on the receivables.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website , view his author profile on Amazon , or check out his speaker profile on the CFA Institute website .
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Assignment of accounts receivable
What is the assignment of accounts receivable.
Under an assignment of accounts receivable arrangement, a lender pays a borrower in exchange for the borrower assigning certain of its receivable accounts to the lender. If the borrower does not repay the loan , the lender has the right to collect the assigned receivables. The receivables are not actually sold to the lender, which means that the borrower retains the risk of not collecting payments from customers .
The amount loaned is usually a percentage of the outstanding receivables in the accounts assigned to the lender. The exact terms may vary - for example, the lender may require that all receivables be assigned to it. Under this arrangement, the borrower pays interest on the loaned funds, as well as a service charge. In essence, the assigned receivables act as collateral for the loan. The borrower may choose to separately classify assigned receivables in a different asset account, to clarify the extent of the arrangement with the lender.
When to Use Assignment of Accounts Receivable
This type of financing is expensive, and so is only considered by entities that have failed to obtain less expensive forms of financing. It is typically used when a company is not sufficiently capitalized or is growing rapidly, and so does not have enough cash on hand to fund its operations. Other organizations are more likely to use traditional forms of financing, such as a line of credit to handle shortages in the level of working capital .
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