Company A has USD 15M in total assets, and it has sold USD 1.5M of receivables with recourse to AZ Financiers. Had the securitized receivables been held in the balance sheet, financial leverage ratio would have:
a) Increased b) Decreased c) Stayed the same
The answer is apparently a) Increased, but there is something I don’t get. For me, if you sell a receivable to a third party you are just exchanging asset lines, so what was in receivables now is in cash, which in turn makes the financial leverage ratio (A/E) unchanged given that total assets did not change.
Of course, if Company A had sold the receivables to an SPV controlled by itself, which purchased the receivables through debt issuance, the situation would be different. However, it does not seem to be the case.
If you sell the receivables with recourse, you are effectively NOT transferring the risks and rewards associated with those receivables over to the buyer and hence do not have grounds to remove them from the balance sheet. The receivables stay as they were, you get an inflow of cash = 1.5 mln and the same amount appears as a liability on the other side. So TOTAL ASSETS do change.
If the sale was without recourse, you would be more likely to remove the receivables from the balance sheet, in which cas the transaction would have the effect which you described.
Why do you have a liability now? I don’t see that. I think it would also be useful to know how the buyer of the receivables account for this transaction.
Ok, if you COULD dercognise (remove) the receivables from the balance sheet, you would do:
Cash up and Receivables down, so the Assets total would not change, and you would have no reason to touch Liabilities.
If you CANNOT derocgnise the receivables (which is the case if you sell them with full recourse), they need to stay on your balance sheet. The criteria for derecognition are simply not met.
You need to record the Cash coming in from the sale, but this is not accompanied by a removal of Receivables, so your Assets total changes and for the balance sheet to balance, you need to create a Liability equal to the amount of cash received. You are basically showing that you received money from the sale, but you may have to give it back if the receivables’ buyer is unable to collect the money due. This Liability, as well as the Receivables, both stay in the balance sheet until the receivables’ buyer collects all amounts and your obligation to give anything back under the recourse mechanism extinguishes. At this point both the Receivables and the Liability are removed from the balance sheet.
From the point of veiw of the buyer of these receivables, still assuming full recourse to the seller, they have no grounds to recognise the receivables on their balance sheet. So, the accounting antries are:
Cash down and still within assets, receivables up by the same amount. But this is more of a receivable against the seller (who received money but is liable to give it back if the collection process is not successful), not the guys who owed him/her money.
Back in the 2013 Curriculum there used to be a nice example of factoring of receivables with/without recourse which was based on the financial statements of FIAT. The example has since been removed, so perhaps this is no longer strictly within the scope.