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Contra-Accounts
Some companies both sell to and buy from other companies. In theory, this means that only the net amount needs to be paid. Under an A/R <--> A/P offset arrangement, two companies would have contra accounts in which each owes the other money. The two parties could agree to offset the mutual debt and for a single payment to be made to the company is owed more money. It should be noted that some contractual arrangement specifically prohibit offsets even in a scenario in which there are contra accounts that could be offset. There are a variety of reasons for including a contractual prohibition against offsets on contra accounts which are probably beyond the scope of this essey. It is probably sufficient to suggest that this issue should be reviewed before any offsets are done involving contra accounts.
Certain industries, such as the energy companies, have set up netting arrangements of this sort to facilitate payments without the need of moving large amounts of duplicate funds. The technique of contra-account settlement may be perfectly natural between two strong companies, but it can also be useful in cases where a strong supplier wants to protect itself against a customer that is financially weak. The supplier may insist on a contra-account arrangement. When the right of offset is to be exercised, the selling terms should be specific in stating that a contra-account arrangement has been made. It is important for a creditor to know if a customer has made such arrangements with other suppliers, since the supplier with the contra-account arrangement has a potentially stronger call on the customer's assets.
Credit professionals should be aware that the right to offset involving contra-accounts here and abroad may not apply if the other company files for bankruptcy protection. I encourage you to discuss this issue with your attorney, especially if you are counting on contra account offset rights to limit your credit risk in dealing with a marginal account.
Edited by Michael C. Dennis. Mr. Dennis is a consultant, author and lecturer. He can be reached by email at mcdennis13@yahoo.com