I am going crazy with the following EOC:
Reading 27, Q. 16 from CFA FRA book.
Can someone please explain why do we add sold receivables (267.5) to the assets? How does securitization of receivables work? Isnt it simply exchange of receivables for cash?
Thanks a lot!
any idea guys? I d really appreciate your help
can you put a bit more info about the question? i don’t have access to my books at the moment. cheers
don’t have the book, but I assume securitization of receivables is done thru a SPV in that case the parent transfer the receivables to the SPV, so the SPV put the receivables on its balance sheet (as an asset). The parent still has responsibilities/risks of those receivables.
Hey, just had a look in the book. I don’t get it either. Surely if you put the receivables back on the balance sheet, you’d have more receivables but less cash so overall assets would be unchanged. Also if you look on page 170 where they go through the examples of the balance sheet impacts of securitizing, it says ‘from a ratio perspective Odena’s debt to equity and equity to total assets ratios would be unaffected by the sale’. So I am confused too. Anyone else??
just had a thought, maybe they’re assuming that the company would borrow against the receivables if it left them on the balance sheet. which would mean it would have cash (from the loan) AND the assets. but if that’s the case, it’s not very clear…
A - the Assets have both Receivables and Cash components. When you securitize the receivables - you reduce receivables, increase cash. When you wind back the transaction - you increase receivables, reduce cash. There is also a component that treats the entire securitization process as a “secured loan” - so there is a component of the loan interest charges that need to be rolled back. but if you look at it only from a balance sheet perspective - either way - having the receivables or the cash - does not affect the Assets at all. And since the Liabilities are the same - the Equity remains the same. So Debt to Equity (both numerator and denominator are the same) and Equity to Total Assets (numerator and denominator) are unaffected by the sale. Hope this helps.
Just had a look at the example. As thought in my earlier posting, software assoc. has sold the receivables to an SPV. Remember that in securitization of receivables, the company has essentially borrowed some money (from a bank) with collateral in the receivables. The money collected from the receivables later on will be used to repay the loan. On the balance sheet, it looks like the company has sold it off since it does not show up there. In reality, the company still retains (some if not all) risks for the receivables. To take into account this off-balance sheet financing, you need to add BOTH the receivables BACK as well as the obligation to pay back the loan. The total asset is therefore increased by 267.5. BEFORE Current assets 1412.9 Liabilities 2634.1 Other assets 2197.7 Equities 976.1 Total asset 3610.6 Total Liabilities + equities 3610.6 After (assuming receivables =0 before) Current assets 1412.9 Liabilities 2634.1 Receivables 267.5 Loan to bank 267.5 Other assets 2197.7 Equities 976.1 Total asset 3878.1 Total Liabilities + equities 3878.1 As you see, equities do not increase, but assets and liabilities increase so Debt to Equity, Equity to Total Assets all changed
elcfa, Thank you very much for your help. So just to clarify, I thought they are selling receivables to SPV? How does the bank get involved here? Or I borrow against receivables, thus increasing A and L by 267.5 and THEN sell it to SPV? But what am I selling? Is it essentially a transfer of cash and liabilities to an SPV? What is the purpose? Would really appreciate if you could clarify it a bit. Thank you!
They borrow money from the bank using the receivables as ‘collateral’. To do that, they set up the SPV specific for this purpose then transfer the receivables and the loan as mentioned. The reason is to ring fence the receivables. In case of the company goes bankrupt, the receivables are not touchable for the company’s other creditors. According to IFRS, the company needs to consolidate this SPV for financial reporting.