Disposition of Accounts Receivable
The financial accounting term disposition of accounts receivable is used to describe several approaches companies can take to accelerate the receipt of cash from receivables. The two most common methods include factoring and assignment; whereby the company transfers receivables to another party in exchange for cash.
In the normal course of business, customers are constantly making purchases on credit and remitting payments. Over time, the relative size of accounts receivable may reach a point where the company has significant resources dedicated to managing this process.
By transferring receivables to another party, the company reduces the sales to cash revenue cycle time. Also known as disposition and transfers of accounts receivable, this process provides additional cash to the business, which can be used in operations or to purchase additional assets. Disposing of accounts receivable also relieves companies of the burden of creating and staffing additional resources in their billing and collections department.
Generally, there are two ways a company can dispose of, or transfer, receivables:
- Assignment: the owner of the receivable borrows cash from a lender, using accounts receivable as collateral on the loan.
- Factoring: the owner of the receivable sells it to a factor, which then assumes responsibility for collecting money owed directly from customers.
In this first example, Company A would like to transfer $100,000 of receivables to First Factors Collection Group. Company A agrees to sell its receivables at a 5% discount, and will establish an account at 2% for sales discounts and returns customers may request when First Factors attempts to collect money owed. The factoring journal entries for Company A would be:
|Due from Factor (sales discounts, returns)||$2,000|
|Loss on Sale of Receivables||$5,000|
In this second example, Company A is obtaining a loan from First National Bank for $93,000 and will be using $100,000 of receivables as collateral. The assignment journal entry for Company A would be:
Company A would also disclose the use of $100,000 in accounts receivable as collateral in the notes to its financial statements.