Editor's note: Also read "Asset-Based Financing Basics," by Robert A. Modansky, CPA/CFF, and Jerome P. Massimino, CPA, in the August 2011 issue of the JofA.
Example 1: GAAP Treatment of Acceleration Clauses and Lockboxes
The following is a summary of the provisions of FASB Accounting Standards Codification (ASC) Subtopic 470-10 as they pertain to subjective acceleration clauses and lockboxes:
|Provision in Agreement||Balance Sheet Classification|
|1. Subjective acceleration clause||Classify as short term if circumstances so indicate. Those circumstances would include, for example, whether the borrower has recurring losses or liquidity problems. If the position of the company is strong, classify the debt as long term.|
|2. Subjective acceleration clause coupled with a lockbox||Always classify the debt as short term.|
|3. Lockbox alone||Most likely classify debt as short term unless there is a springing lockbox.|
As a practical matter, most revolving credit agreements require that a lockbox system be implemented at the inception. Significantly, most revolvers will be classified as current because most agreements are entered into for one year and, at the balance sheet date, the remaining term will be less than one year.
Example 2: GAAP Treatment for Factoring Agreement With Recourse
Company A enters into a factoring agreement with Factor which provides that:
- Certain accounts receivable are unconditionally sold by Factor to Company A.
- Any account that remains unpaid after 90 days will be considered ineligible, and such amount shall be charged back to Company A.
- The chargeback of such accounts shall not be deemed a reassignment of such receivable, and title to the receivable will remain with Factor.
ASC Section 860-10-40 provides a three-part test that must be satisfied before the transfer of financial assets can be considered sales. All three tests must be satisfied:
- Isolation of transferred assets. The transferred assets have been isolated from the transferor—put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership. Conclusion: The isolation condition is met.
- Each transferee has the right to pledge or exchange the asset. Conclusion: Factor, as owner of the receivable, presumably has the right to pledge or exchange it.
- Effective control. The transferor does not maintain effective control over the transferred assets through either of the following:
- An agreement that both entitles and obligates the transferor to repurchase or redeem the receivables before their maturity (see ASC paragraphs 860-10-40-23 through 40-27).
- The ability to unilaterally cause the holder to return specific assets, other than through a cleanup call (see ASC paragraphs 860-10-40-28 through 40-39).
Condition 1. Condition 1 is satisfied. The company is not entitled to repurchase the receivable under the terms of the agreement.
Condition 2. Condition 2 is also satisfied. The factor is not obligated to return the asset to the company. As discussed above, under the terms of the agreement, the chargeback of such accounts shall not be deemed a reassignment of such receivable, and title to the receivable will remain with the factor.
Since both conditions are satisfied, the transaction should be accounted for as a sale of the receivable to the factor and not as a secured borrowing.
Example 3: Footnote Disclosure Examples
Factored Accounts Receivable
Amounts due from factor and accounts receivable are summarized as follows:
|Receivables sold to the factor|| |
|Advances received from the factor|| |
|Net amount due from factor|| |
|Unfactored accounts receivable|| |
|Allowances for doubtful accounts, returns and discounts|| |
|Net receivables|| |
In accordance with a factoring agreement with Worldwide Factors Inc., the factor imposes a fee of 0.25% of the receivables sold. The advances for factored receivables are made pursuant to a revolving credit agreement which expires on Dec. 31, 20SY. Per the agreement, the company must maintain specified levels of working capital and tangible net worth (as defined) in addition to other covenants. Collateral for the amounts advanced by the factor consist of all of the company’s receivables, inventory and equipment (per UCC filings by the lender).
The company draws down working capital advances and opens letters of credit (up to an aggregate maximum of $10 million) against the facility in amounts determined on a formula that is based on factored receivables, inventory and cost of imported goods under outstanding letters of credit. Interest is charged at the prime rate plus 1% (6.25% on Dec. 31, 20CY) on such advances. As of Dec. 31, 20CY, the company is in compliance with the covenants under its revolving credit facility.
Revolving Line of Credit
The company enters into a revolving credit facility with Acme Business Credit (Acme) that permits it to borrow up to 85% of eligible accounts receivable as defined and 50% of its inventory with a limit of $1.5 million. The maximum borrowing available is $30 million. Interest is payable at the prime rate (6.25% on Dec. 31, 20CY). The facility is secured by a first security interest in all of the company’s assets and automatically renews annually, unless canceled by either party. The company’s president also provides a personal guarantee to Acme. The agreement contains various financial and nonfinancial covenants with which the company is in compliance on Dec. 31, 20CY.
SEC Proposes Additional Disclosures
In September 2010 the SEC issued a proposed rule that would require additional disclosure of short-term borrowing arrangements. The proposals would require a registrant to provide, in a separately captioned subsection of Management’s Discussion and Analysis of Financial Condition and Results of Operations, a comprehensive explanation of its short-term borrowings, including both quantitative and qualitative information. As of this writing, the rule hadn’t been finalized. The proposed rule (release nos. 33-9143; 34-62932; file no. S7-22-10) is available here.