Accurately Recording BHPH Note Sales Keeps Everyone on Track

It’s Really Not That Complicated

Many buy here pay here dealers are finding it necessary to sell a portion or all of their installment receivables in order to raise cash. Dealers sell them typically to raise short-term cash or as part of a regular cash flow strategy or exit strategy prior to closing the business. The sale may consist of the entire note or a partial payment stream from an installment note.

The accounting for such a sale is predicated on the terms of the sale and should be handled carefully to accurately reflect the sale transaction. Let’s break down each aspect of the sale and address specific terms and the appropriate handling of each. A sale will probably have some method of reserving a portion of the purchase price as a hedge against bad debts. This “reserve” will only be paid to you, the seller, if the installment accounts pay out acceptably.

Whether you sell a portion of the remaining payments or the entire note, the accounting is the same. In this sale, we are selling a portion of the future payments to a third party for a negotiated amount that is less than the face value of the payments. For example, we are selling 12 payments of $200 each from a 36-payment note. The payment stream sold has a value of $2,400 for which we will receive 75 percent or $1,800. Since the portion of the note sold is less than the total note and you will resume collections after the payment stream expires, we want to book this sale so that the resumption of in-house collections is easiest when the time comes. The steps to follow are:

1. Apply a lump-sum payment equal to the total of the payments sold ($2,400) to your in-house BHPH software. The resulting journal entry is:
               

	Debit	Credit
Cash Clearing	$2,400
Notes Receivable		$2,400

2. Deposit the sale proceeds ($1,800) into your checking account, relieve CASH CLEARING for the full $2,400 and expense the difference of $600 to a cost-of-sale account for NOTE DISCOUNTS (as we may never receive this portion of the sale). The resulting journal entry is:

	Debit	Credit
Cash in Bank	$1,800
Cash in Clearing		$2,400
Note Discounts	$600

3. Place a hold on the account in your BHPH software to prevent interest from earning or late charges from being assessed.

While handling this payment stream sale in this manner is a bit counterintuitive, it allows your BHPH software to accurately apply the payments to the sold account and should make the resumption of collection efforts easier after the 12 payments have elapsed. This method also works when the remaining account balance is sold; simply substitute the payoff for the purchase amount and the difference in payoff and proceeds for the note discount amount.

Notice that we have not booked any of the reserve monies that were withheld from the initial sale proceeds. As most note purchase agreements state that you are not guaranteed to receive the reserve funds and that the reserve funds will be used to offset any bad debt losses on the accounts sold, we will only book these funds when they are actually received. In so doing, we limit the number and complexity of accounting entries until the outcome is actually known.

When you are notified that you must “buy back” a non-performing account, the purchaser will typically charge your reserve account and/or require you to write a check to repurchase the delinquent installment account. In our example, the buyback will be for a receivables principal balance of $1,700, requiring a cash payment of $1,250 and a reduction of reserve of $450. The accounting should be handled as follows:

1. Apply a reversing payment in your BHPH software against the account in question for the principal buyback amount.  The resulting journal entry should be:

	Debit	Credit
Notes Receivable	$1,700
Cash Clearing		$1,700

2. Issue a check to the note purchaser in the amount of $1,250, disbursing the check to CASH CLEARING and NOTE DISCOUNTS.  The resulting journal entry should be:

	Debit	Credit
Cash in Bank	$1,250
Cash Clearing		$1,700
Note Discounts	$450

These entries will re-establish your collectable account balance in your BHPH software and reduce the NOTE DISCOUNT cost incurred at the original sale. The caveat to be aware of when reinstating a BHPH note that was previously sold is that you may need to post a charge/adjustment to the account to force the pending unpaid interest to be correct.

The above entries are assuming that your BHPH software integrates with your accounting, yet still provides for a workable solution when the two are not integrated since all entries flow through the cash received account. You will want to be diligent in inspecting the entries generated in your particular case on the first several occurrences so you may make any adjustments that may be necessary.

The final aspect of selling notes occurs when you receive a distribution from your accumulated reserve balance. Whether you receive incremental distributions of reserve or a total reserve when the account pays out, simply deposit the monies received into your bank and offset the entry to a RESERVE INCOME account on your financial statement. A sample journal entry with $500 in reserves received follows:

	Debit	Credit
Cash in Bank	$500
Reserve Income		%500