In Schwesser concept checkers for Long-Term Liabs. and Leases question 16 states “For a company that has sold recievables but retained the credit risk, which of the following is least likely to require adjustment by an anlyst?” A. Current Ratio B. Inventory Turnover C. Debt-to-Equity The answer is B, which i understand, I also understand that the recievable turnover and debt-to-equity need to be adjusted. But i do not understand why the current ratio needs to be adjusted. If you have $10K cash and $10K in rec. and $15K in current liabilities your current ratio is 1.33. (10K+10K/15K) If you sell your $10K in recievables for $10K in cash you will still have the same curent ratio. $20K cash/$15K current liabs.
there is a cost to sell your receivables, so you dont get exactly $10k in return for 10k in receivables
Is this in the curriculum??
To be honest, I’ve had a little trouble understanding this concept as well but I’ll try to give an answer. Anyone with a better explanation please share! A sale of A/R while still maintaining the credit risk (sale with recourse) is essentially collateralized borrowing. The current ration adjustment should then be as follows: increase A/R to the amount it was before the sale, and increase your current liabilities since you still responsible for any default. If it were to be a sale without recourse then the accounting process would be a decrease in A/R and an increase in cash.
An idea… When you sell the A/R, the A/R is reduced as well as the current liabilities are understated. As we all know, a buyer-recourse provision still allows the buyer to dump the A/R on the seller. But, the cash received from the buyer allowed the company more favorable financing in the short run. If the company needed financing and they didn’t sell their A/R, the company would’ve had to take out a short-term liability/loan…and the discount for selling receivables for cash is much more favorable than the short-term liabilities for cash. -maybe an adjustment for the “un”-incurred interest too?
Also- when a person sells A/R, it is sold at a discount. They don’t receive dollar-for-dollar.