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Secured borrowing and a sale of receivables  
Receivables can be used to generate cash through two general categories of transactions:

1. A secured borrowing
2. A sale of the receivables

Both of these types of transactions require a transfer of the receivables to a new holder, typically
afinancial institution.

Required 
Distinguish between a secured borrowing and a sale of receivables as regards the rights of the transferor
and transferee as well as regards the accounting for each type of transaction.

Solution 
A secured borrowing uses the receivable as collateral for the loan. If the borrower assigning or pledging
the receivables defaults on the loan payments, the proceeds from the collection of the pledged or assigned
receivables will be applied directly to the payment of the debt. The term “assigning” signifies the
pledging of specific receivables as collateral, whereas the term pledging refers to pledging of say all trade
receivables as collateral.

The borrower typically cannot borrow up to the full amount of the receivables pledged. The lender retains
this difference in order to provide for accounts on which collection is not made. The lender also levies a
financing charge on the borrower in addition to the interest on the loan itself. Collection of the receivables
may be done by the borrower or the lender. In the case of pledging, the responsibility for collection of the
receivables rests entirely with the borrower.

In the case of a secured borrowing, the transferor maintains the receivables on its books, records a
liability, and recognizes interest expense over the term of the loan. If the transferee is not permitted to sell
or pledge the collateralized receivables unless the transferor defaults, then the transferor continues to
carry the assets with its trade accounts receivable. If the transferee is permitted to sell or pledge the assets,
then the transferor must reclassify the receivables and report them separately from other receivables.

A sale of receivables requires that the borrower surrender control over the receivables. Specific
requirements are provided by the FASB to determine if a borrower has in fact surrendered control. If
these requirements are met, then the receivables are removed from the borrower’s books and a gain or
loss is recognized. The lender will record the receivables received on its books at fair value.