Borrowers put all sorts of things in their agings. Overpayments, invoices, finance charges, debit memos, adjustments, freight adjustments, tax adjustments, Etc. All of that works great, it sits there and it looks to be a mess at times, but at least it is all there. But are the offsets all there?
Like a Teenager:
If you have ever tried to raise a teenager, they find the sneakiest ways to get that phone or MP3 player while they are supposed to be sleeping or they sneak cookies into their rooms. I think that Borrowers sometimes behave that way too. We Asset Based Lenders do some due diligence like audits and we have reporting requirements too. Borrower can observe the systematic flaws in our work a learn to avoid some of our behavior in the future. They can sneak those ineligible adjustment items out of the aging.
My favorite is probably unapplied cash (that includes overpayments). These items should reduce the AR balance. Some of the credits are over 90 and some are under 90 on your Borrowing Base Certificate (BBC). But they reduce the collateral and maybe the Borrower sees that as “bad” for the BBC collateral amounts?
Sooooooooo, they might reclassify these items into an “Accrued Liability” account labeled as “Accrued Deposits” or maybe they call it something similar or obtuse like “Deferred Revenues.” But now it’s not in the aging. Is that bad?
Where Did The Offsets Go?:
The teenager (OK Borrower) took them from the aging and reclassified these things to some accrued liability account. “They were there a minute ago, I saw them in the aging last month.” Hmmmmmm?
There are some accounting principles to consider here, but only one rings true:
The All Inclusive Principle – This was related to income and that it was better to include all income items on the financials. Taken to receivables, then all of the adjustments to revenues would also hit receivables (credit revenues and debit receivables to book the sale, do the opposite for reversals). This idea is a stretch to apply to receivables, but it has a little bit of merit to at least think about.
Liabilities – They are owed and can be booked when incurred. We have an overpayment or a deposit, so that must be a liability to perform a future service or deliver a product in the future right? Accountants are not supposed to offset liabilities and assets, they should be separate like the popcorn in those giant Christmas tins right? Cool thinking, but not exactly true because….
Substance Over Form – This is one of the Grand Daddy statements in accounting. A unifying concept, the “Prime Directive” of accounting for you Trekkies. This one trumps the above. The “substance” of overpayments and deposits is that they will go against receivables. So while they could be considered as liabilities in “form,” they are really related to receivables in “substance.” See, you can bang a liability against an asset and take the net in this case because Substance trumps form. Also note that this is generally accepted accounting practice in the real world because people account for this stuff in the AR accounts and the AR module of the accounting systems.
So Can You Hug Your Aging?
If accounts receivable were my collateral and on my BBC, I would want to have 100% of the receivable transactions in the aging report. I would want to see all of the transactions that are right, wrong or indifferent in nature. I would want substance over form. I would want to hug my aging and know that it contains all of the transactions and that the potential offsets are in there for me to see.
But what about when the teenagers play games and reclassify things? How do you find that? How do you prevent that? What games can be played with potential offsets? That’s what experience and training are for, to help you cover your assets.
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