 Hello, and welcome to the session in which we would look at the idea of pledging receivable. This topic is covered in intermediate accounting, the CPA exam, as well as the CMA exam. What is the idea of pledging receivable? Well, when we make a sale, for example, for a particular month, we might have a total of a million dollar sales on account. So we debit account receivable, we credit sales, revenue for that a million dollar. This is for the particular month and we gave our customers maybe 30, maybe 60 days to pay. Who knows? Maybe 90 days to pay. Now we gave them that credit option, but we cannot wait for the money. Now, why did we give it to them then? Well, if we don't, maybe they don't buy from us, they go to our competitor. So we do have to give them the option to pay us within 30 or 60 days, so they buy from us, but we need the money now. So what we will do then, we're going to use this receivable as a pledge. We're going to go to the bank and pledge this receivable against a loan. And that's the idea behind this chapter, behind this concept. So how do we pledge the receivable, how to account for it? This topic is covered on the CPA exam, as well as I mentioned in intermediate accounting. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. Keep it. I'm a useful addition to your CPA review course. I explained the material differently. I explained the concept behind, I explained the theory behind the concept, so you'll understand it better. Your risk is one month of subscription. Your potential gain is adding 10 to 15 points to your CPA exam score. If not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. My course catalog include many courses, including intermediate, managerial, advanced, tax, governmental, so on and so forth. My CPA supplemental resources are aligned with your CPA review course, whether it's Roger, Becker, Wiley, Gleam or any other course you are taking. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So the idea is to raise money quickly because we need the money. Now, why do we need this money? Well, do we need reasons why we need money? Well, to make payroll, to pay our suppliers, to pay bills, to take advantage of an opportunity. There is endless amount of reasons why we need the cash quickly. Now, actually, we have two options. We can do the pledging, the pledging is secured borrowing. We can do a secured borrowing or we can sell the receivable. This will be discussed in the next session. Say that's going to be with the recourse, without the recourse, we'll talk about this. But you need to understand what do we mean by secured borrowing and how do we process the entries for secured borrowing? The best way to illustrate this concept is to actually work an example. Let's assume on March 1st, 2020 X5 Adam Company pledges, which has assigned 700,000 of its receivable to Bank of America for a collateral, as a collateral for a half a million dollar note. In simple English, we wanted money. We went to Bank of America, BOA, Bank of America and we said, look, we need the money and we're willing to put up our collateral as a pledge. In other words, if we don't pay you the money, we'll give you the right to collect money from our customers. So now the bank is, well, what would the bank do under those circumstances? The first thing they do, and I was a loan officer at some point in my lifetime, they review your customers and they want to make sure you have credit worthy customers because if you don't have credit worthy customers, it's going to be risky lending you the money. If we're going to lend you the money, we're going to have to ask for a higher rate of return, a higher interest rate or a higher fee. Let's assume here, Adam's customers are credit worthy. That's a good loan in a sense that we are secured. We're only giving half a million for against 700,000 in assets. And here's the deal. Adam will continue to collect the money from the customers and the customers are not even aware of this deal. Then Bank of America, they're going to assess a finance charge of 1.5. So upfront, we're going to charge you a fee of 1.5 for this deal of your account receivable. And we're going to charge you interest of 12%. This is annually, it means 1% monthly. There are two fees. They're going to charge us a fee upfront in the monthly interest expense. Okay. And Adam will make monthly payments to the bank after they receive the money from the customers. So Adam would receive the money from the customers, pay the bank, receive money from the customers and pay the bank. So we're going to go ahead and see the journal entries for Adam's company as well as for Bank of America. Starting with the first entry is record the entry on March 1st when the deal takes place. When Adam goes to the bank, walk out with the check. Here's what's going to happen. Adam's going to walk out with $492,500. Why? Well, the note is for half a million, they assess 1.5% fee. 1.5 times half a million is 7,500. So upfront, Adam will pay, we call it interest expense. This is the fee. This is the fee, the finance charge. This is the fee. This is the 1.5. This is one time fee upfront. Now, again, we can call it a fee, but really when you borrow money and you're paying money for that money, it's technically interest expense. So we paid upfront 7,500. This is for Adam. Bank of America, they have a notes receivable from Adam for half a million. They immediately earned 7,500 in interest revenue and they lent Adam 492,500. Notice those entries are the mirror image of each other. Interest expense, interest revenue, notes payable, notes receivable. Okay, notes receivable for Bank of America. Now, this is Marsh first. Now, we're going to collect money during Marsh. In Marsh, we collected 434,000 of our receivable, less 5,000 of cash discount and customers returned 12,000 worth of merchandise. So we collected this much, but some customers, we granted them a cash discount and some customers return the actual merchandise. So the cash collected is 434. We have to debit sales discount of 5,000 because we gave them discount, therefore we reduced the receivable and customers returned 12,000 worth of goods and services. They did not want goods, sales returns and allowances. So our receivable went down by 451. So technically, our receivable went down by 451, but we only collected 434. Why? Because we grant them $5,000 for early payment and 12,000 of our receivable, customers don't want the product, they return it, therefore we reduce the receivable. So now think about it. Our receivable in total was 700,000 minus 451, because remember we pledged that much. So the remaining account receivable that we still have that the customers did not pay us yet for, we did not collect it, it's 249,000. This is the uncollected. Now we collected this money during March. What do Bank of America do? Nothing really, nothing until we make the payment. We're gonna be making the payment on April 1st. On April 1st, after we collected the money, now we're gonna make the payment to the bank plus interest. So we're gonna make what we collected, we collected 434, that's the deal, plus we have to pay the interest. So how do we do this entry? Well, we're gonna pay the bank 439,000. Why 439,000? Simple, we have a loan at the bank. We have a loan of half a million right here. We have a loan of half a million. We have a loan of half a million and this loan is accruing interest at 1%. So half a million times 1%. What is 1% monthly? We said 12% semi-annually divided by 12 is 1%. Therefore, there is an interest component of 5,000. We'd have an interest expense of 5,000 and of the 400, we're gonna pay 439,000. 434 is the money that we collected that's gonna go against the note, it's gonna reduce the note and 5,000 is the interest expense. Now remember, when we started with the note, it was 500,000, the note was 500,000, we paid off the note 434,000. Therefore, we still owe Bank of America 66,000. So this is the entry that we make. Now let's take a look at the entry for Bank of America. Bank of America, they're gonna receive cash 439,000, we paid. They're gonna reduce their notes receivable 434,000. Remember, they have a notes receivable of half a million from us. Now we paid them 434, they still have 66,000. Notice, we owe them 66, their claim against us is 66, remaining 66 and the 5,000, for us it was interest expense for Bank of America, it's interest revenue. So this is the mirror image of the journal entry. So remember, at this point, we still owe Bank of America 66,000, 66,000. Now here comes April, we collected in April the remaining balance, remember the remaining balance for the receivable is 249, let me show you the remaining balance, 700,000, but we collected 451. So minus 451, we still have 249,000 of receivable. Now we collected the remaining balance but 1,000 was written off. It means we collected only 248. So this is 249. So after we collect 249, that's it. Our account receivable is down to zero. We collected all the money. We didn't really collect all of it. Some of it was sales return. Some of it was allowance. This is an allowance account. We had to write off an account but simply put we collected 248,000 in April. During April, we don't do anything until May 1st. On May 1st, we're gonna pay off the balance, the remaining balance for Bank of America plus interest. What is the remaining balance? Remember, the remaining balance is 66,000. The initial balance was half a million. In the first month, we collected enough cash to pay down the balance and the remaining is 66. Therefore, what we're gonna pay, we're gonna credit cash 66,660 dollars. Why this additional 6660 dollars? Remember, the balance was 66,000 times 1%. We have an interest expense of 66 dollars. Therefore, we debit interest expense 666. We debit notes payable to bring it down to zero, 66 minus 66, we paid off the balance. For Bank of America, it's the mirror image. They debit cash 66,660. This is a credit. They credit interest revenue 6660 because our interest expense for them is interest revenue and they reduce the note to zero, 66,660. Therefore, the notes receivable is zero. Everyone is happy. So we took out the loan. We took out the loan, collected the money, submit the payment plus interest. At the end, our loan went down to zero. Bank of America notes receivable went down to zero. Everyone is happy. At the end of this recording, I'm gonna remind you again, whether you are an accounting student or a CPA candidate to strongly take a look at my material, cpacredits.com. I can help you pass the CPA exam by working with your CPA review course hand in hand. You'll be able to understand the material better. You are risking one month of subscription to try me. If you find it helpful, keep it. If not, cancel, that's fine. But at least I can give you the chance to increase your score. Are you willing to take that chance? You should, it's worth it. The CPA exam is worth it. It's a lifetime investment. In the next session, we'll take a look at an example where we sell the receivable rather than pledging, we're gonna be selling the receivable. Good luck.