 Hello and welcome to this session. This is Professor Farhad. In this session we would look at disposal of receivable and receivable turnovers. These topics are covered in an introductory financial accounting course as well as intermediate accounting. So if you feel I did not go in depth in this recording it's because this is an introductory financial accounting course. You can go to my intermediate accounting if you're interested in more detailed information. These topics are covered on the CPA exam. As always I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, tax and finance lectures. This is a list of all my courses. If you like my lectures please click on the like button. It doesn't cost you any share them. Put them in playlists. If they benefit you it means they might benefit other people especially during the coronavirus. These lectures are very helpful to students who are home looking for supplemental resources and please connect with me on Instagram. On my website you will find additional resources if you'd like to supplement your accounting education or study for your CPA exam. The first topic we're going to look at today is disposal of receivable and this topic as I mentioned earlier it's covered much more in depth in intermediate accounting and this topic was a front story during the financial crisis of 2007-2008 because certain companies, not certain companies, companies like Cleveland as well as well as other financial institution they try to blur the line between the disposal of receivable, if they dispose of the receivable, if they sold it or if they pledged it. We're going to look at the difference in a moment and I will tell you the importance of this. It's beyond the scope of this course but it's very important to put things into perspective. Let's talk about the idea of pledging the receivable. Let's first take a look at the idea of disposal of receivable where you get root of your receivable. How do you get root of your receivable? One way to do it is you can do what's called factor. You can factor your receivable, the company that does this it's called a factor, the process is called factoring. So let's talk about the disposal of receivable. The disposal of receivable is when you get root of your receivable. There are two ways to get root of your receivable. One way to do it is to sell it. Selling receivable is called factoring. You sell the receivable and the process is called factoring and you sell it to a factor. A factor could be a bank, could be a financial institution, could be any individual that's willing to pay you for your receivable. So how does it work? Well simply put let's assume you have one million of receivable. So you have an account receivable and you have a list, a bunch of customers and your receivable total one million. Now you gave your customers 30 or 60 days or 90 days to pay. That's fine. If you made that promise you have to stick with it. However you need the money now so you cannot wait 30 or 60 days because you have payroll, you have to pay your loans, you have to pay your suppliers, you have to pay your vendors. So what do you do? You'll find a company that's willing to buy your receivable in a form of financing. Let's assume this is the factor, this is the company so you'll go to the factor and you will tell them I'm going to sell you my receivable and in return you'll give me some money. Well they might pay you for your receivable depending on the agreement, what they agreed upon. Maybe sometime they sell it with recourse, without recourse we're not going to go into that in this course and in my intermediate accounting we go into those details but let's assume for the sake of illustration they gave you for your million dollar 980 000. So simply put you sold your receivable and they gave you 980 dollars. Guess what? You lost 20 000 dollars. You did not really lose it. It's a cost of financing. If you want the money there's a cost for money. It's an expense. It's a cost of money. So this is basically the disposal of receivable. So simply put companies can convert the receivable to cash before they are due. So they sell it. So the journal entry would look something like this. You credit your receivable in my situation. You credit for example here they credited a million at 20 000 in my example. I credited a million. They debited cash 19 000, 19 200 in my example. I debited cash 980 and there's a factoring fee expense of 800 in this example and my example the fee is 20 000. It's just using two different numbers. So here what I did I sold my receivable. I sold my receivable and received cash. So that's one way to do it. Another way to raise cash is by pledging. Pledging your receivable. What do we mean by pledging? Maybe you are familiar with this concept. Maybe you are not. Well when you buy a home what you do is you pledged your home. You say well this is my home but I'm going to give you the title. I'm going to give the bank the title over the home and in return the bank will give me money or if you have a car and you want to borrow money you go to the bank. The bank will say okay hand me the title. Give me the right to the right to sell the car and I'll give you the money. So what you do is you pledge your car. So you pledge your car and you'll get the loan. Now the bank is secured. Why? Because in case you can't pay off your mortgage you cannot pay off your mortgage the bank will take your home. If you can't pay your loan the bank will take your car. So this is the idea of pledging. So there is some security. So pledging is basically taken out a loan. So for example you go to the bank and you borrow money. You borrow 35 000. You debit cash credit receivable debit cash credit payable. And what you do behind the scene you will sign paperwork telling them if I don't pay back this 35 000 you have the right to collect that money from my customers. Now it's very important to differentiate between selling of a receivable between selling and pledging. Selling versus pledging. Although this is beyond the scope of the scores but during 2007-2008 financial crisis it made the difference whether you sold your receivable or you pledged it. A company like Clemen Brother what they did is that's before they went out of business again this is beyond the scope of the scores but it's good to kind of look at a realistic example is what they did they used to raise money they used to bring money by pledging by pledging certain security. So what they did they did not pledge a receivable they had securities they had assets they had financial assets specifically mortgage back securities but those mortgage back securities were really I'm going to use the word crappy okay they were not good. So they will pledge them they will pledge them and they will get money but what they did but what they did is they did not say they pledged them they acted as if they sold them and when you sell something remember when we sold the receivable notice what happened here when we sell the receivable we remove the asset we remove the asset from our books when we pledge something for a loan notice we did not remove the asset we still have the account receivable and what they did so why did they do so why did they say it's a it's a selling and not a pledge because when you pledge your asset for something else for money you still have that asset and the asset that Lehman had was as I said sorry for the language shitty asset so what they wanted to do they wanted to get rid of this asset from their balance sheet before year end so the auditors will not value that asset at a low price and record losses so they acted as if they sold the asset not pledged it once again just know that there's a difference between selling and pledging and in the real world there's there is consequences to whether you pledged or whatever use whether you sold this asset okay and that's enough for that I don't want to go any further because you don't need more than that um account receivable turnover is determines how well the company is managing the receivable how do you manage your receivable well you sell on credit you collect your money you sell on credit you collect your money so the point is how many times you are selling on credit and collecting your money how many times is it every 30 days is it every 45 days is it every 50 days how many times are you doing that throughout the year so one way to measure this is to compute a ratio okay this ratio provides useful information for evaluating how efficient management has been in granting credit so how well are you in granting credit because the way you are granting credit the way you are granting credit is a judge by how fast you are collecting your money how fast you are collecting your money okay so one to compute this you will take net sales net sales now in the real world in the real world in other words if you are dealing with a publicly traded company they don't give you the credit sales usually it's mostly the credit sales but you cannot have this information divided by the average receivable now go back to the real world when I was in the real world kind of when I was practicing I used to prepare financial statements for many companies we used to call them reviews we used to do reviews and part of the reviews is to compute the financial ratios so to determine if things make sense if things are in order and a counter-receivable turnover was one of those important ratios especially for retailers I used to do two retailer company because retailer sells on credit so every three month management wanted to know how well they are managing their credit so one way to do it is to compute their account receivable turnover account receivable turnover now let's take look at some numbers now I just want you to know I looked at these numbers earlier I just don't believe those numbers there's something missing something does not make any sense but it doesn't matter we don't have to determine the business sense of it we need to know the computation and the meaning of the numbers but if we look at visa versus mastercard visa is has an asset account receivable turnover of 16.9 for the current year the prior year was 16 so this year is better okay they improved their receivable turnover and two years ago it was better than year one but the current year is the best versus mastercard their account receivable turnover is 7.4 worse than the prior year and the prior year is worse than two years ago because it was 8.8 so you want this number to be high now you can take this number and convert it in two days let's go ahead and convert this number in two days so if we take 365 days in a year divided by 16.9 and if we take 365 days in a year divided by 7.4 so let's go ahead and compute those to find out how many days 16.9 it's taken visa 21.5 days let's make it 22 because it's 21.59 and for mastercard 365 divided by 7.4 it's taken them approximately 49 days so notice here again I'm not really sure why there's a huge difference I'm not expecting this and this is why ratios are important for example if I am if I am preparing my financial statements for a certain company and I notice so this actually this is a good learning opportunity and if I notice their account risk account turnover went from 22 to 49 let's assume it's the same company this will raise red flags will be like this does not make any sense it's either something wrong in my computation or something wrong for the company actually it's funny because I was in practice I was practicing 2007 2008 and those numbers did spike because customers were not paying their bill and as a result a count receivable turnover went up substantially but there's an explanation but I cannot explain the difference here between visa and mastercard why is it taken mastercard almost 50 days to collect their money versus visa there must be an explanation I don't have enough information nor I'm an expert in this industry but I find it interesting and I would say this is a red flag okay because they should be comparable because they're similar companies but again I'm not very familiar with their businesses but this is how we compute the account receivable turnover if you like this recording please click on the like button subscribe subscribe share it with others and if you are interested in learning more to supplement your accounting education especially if you're studying for your CPA exam I strongly suggest you visit my website for additional resources good luck and please stay safe during those coronavirus days