Company sold accounts receivables with full recourse.These receivables are not collected. The question is find out debt/equity ratio after adjusting relevant accounts for off-balance sheet financing. I found solution to mention to increase account receivable and current liabilities by the amount of receivables sold that have not collected. So, they added liabilities by account receivable amount. I did not understand how liability arises to account for uncollected A/R. I thought retained earnings will be adjusted. Any comments?
the thing to remember when A/R is sold is that assets and liabilities are both understated, and CFO is overstated, since the proceeds flow through CFO. So obviously, if you want to adjust for the A/R sale, you have to reverse the above effects.
When A/R is sold with recourse, the company that sold it still bears the risk/ownership of the A/R. In effect it really just borrowing money that is collaterized by the A/R that the company owns. So for analysis you need to add the A/R back to the balance sheet, and increase liabilities by same amount, since the money from the sales of A/R is considered debt (that the company will pay off as A/R is received).
Excellent replies. Now I understood. thanks a lot