You are spending your summer working for a local wholesale furniture company, Beds and Beyond, Inc. The company is considering a proposal from a local financial institution, Old Faithful Financial, to factor Bed and Beyond’s receivables. The company controller is unfamiliar with the most recent FASB pronouncement that deals with accounting for the transfer of financial assets and has asked you to do some research. The controller wants to make sure the arrangement with the financial institution is structured in such a way to allow the factoring to be accounted for as a sale. Old Faithful has offered to factor all of the company’s receivables on a “without recourse” basis. Old Faithful will remit to Samson 90% of the factored amount, collect the receivables from Beds and Beyond ‘s customers, and retain the remaining 10% until all the receivables have been collected. When Old Faithful collects all receivables, it will remit to Beds and Beyond the retained amount, less a 4% fee (4% of the total factored amount). Required: Prepare a report to the company controller that addresses each of the following questions.
1. Describe the alternative methods available for a company to use their receivables to obtain immediate cash.
Some alternative methods available for a company to use their receivables to obtain immediate cash are as follows: I. Sales of receivables: These have increased substantially in the recent years. Its types are as follows: a. Factoring receivables: it is popular among textile, apparel, footwear, furniture, and home furnishing industries. In this, factoring companies purchase receivables from other companies and collect the receivables from the debtors. They make profit by retaining a certain percentage of the total receivable. b. Securitization: The process of aggregating similar instruments, such as credit card receivables, mortgage receivables, or car loan receivables, into a negotiable security. This securities are backed up by the assets aggregated towards it. II. Secured borrowing: In this scenario, when a loan is required, the company uses the receivables are the collateral. This makes the loan secure for the lender because if the company taking the loan does not pay the loan back on time, they can convert the receivables into cash to get back the amount they lent.
2. Explain the meaning of the term without recourse. Provide the specific paragraph citation.
When purchasing the receivables, the factoring company recognizes that it will have to bear any loss due to failure of debtors to pay when due, the effects of prepayments, and adjustments resulting from defects in the eligibility of the transferred receivables. (ASC 860-30-20)
3. Identify the relevant Codification section that addresses the transfer of receivables. The relevant Codification section that addresses the transfer of receivables is (ASC 860-10-05-15).
4. What are the objectives for reporting transfers of receivables? Provide the specific paragraph citation(s) that supports your answer.
An objective in accounting for transfers of financial assets is for each entity that is a party to the transaction to recognize only assets it controls and liabilities it has incurred, to derecognize assets only when control has been surrendered, and to derecognize liabilities only when they have been extinguished. Another objective is that recognition of financial assets and liabilities should not be affected by the sequence of transactions that result in their acquisition or incurrence unless the effect of those transactions is to maintain effective control over a transferred financial asset. For example, if a transferor sells financial assets it owns and at the same time writes an at-the-money put option (such as a guarantee or recourse obligation) on those assets, it should recognize the put obligation in the same manner as would another unrelated entity...