Sale of accounts receivables to SPV

CFA Level II FRA
#1

Hello everyone,

I am well confused with the procedure on accounts receivables transferred/sold to a 3rd company. Would appreciate it if you can help me to make it out.

Example. A firm XYZ has sold x million of short-term accounts receivable to a 3rd party company., subject to recourse. This info is reflected in the notes to FS. The question is what kind of adjustments are required to make in order to have an accurate view on firm XYZ’s financials? According to curriculum (if I understood it right), an analyst must increase firm XYZ accounts receivables and current liabilities. Here is where I am confused.

As I understand, once the company sale the product on deferred payment, it records a revenue on its income statement and records respective increase in accounts receivables. When it finally collects cash from customer, it reduces its account receivable balance and increases its cash balance, which means that current liabilities are not affected.

Also, I though that when company sales account receivables to 3rd company, it should reduce its accounts reveivables and increase its cash.

So the question is, why does analist need to increase current liabilities as curriculum requires?

PS: I am note a native speaker, and would appreciate it a lot if you can correct my mistakes (improper use of words, structural mistake or anything esle) :slight_smile:

Many thanks for all your replies!

#2

The key to this answei is the phrase, “subject to recourse”. This means that if XYZ’s customers don’t make their payments on the A/R, XYZ has to make the payments. Thus, the economic substance of the transaction is that XYZ has a liability (as if they borrowed the money, instead of selling their A/R) and merely pledged their A/R as collateral for the loan. An analyst will make adjustments to reflect the economic substance: record the liability and return the A/R to XYZ’s assets.

#3

Thanks for clarification, but still not entirely clear.

Subject to recourse means, that the risk of non-payment under A/R remains with XYZ. But XYZ is not be required to make any payment unless the final customer defaults, therefore it is a contingent obligation and is more similar to the nature of guarantees. And guarantee is an off-balance sheet obligation and should not be treated equally with actual full-scale liability (please correct me if i miss anything). If so, how much is it justified to adjust the current liability for the full amount?

#4

Instead of thinking of it as a contingent obligation, think of it the way I suggested: XYZ must make the payment to the third party, and might get paid from its customers. The obligation is not contingent, but the net amount is uncertain.