How Do You Account For Factoring Arrangements
Factoring is a financial transaction in which a business sells its receivables (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate cash. This can help improve a company’s cash flow.
The accounting for factoring can vary based on whether the factoring arrangement is considered a sale of receivables (without recourse) or a secured borrowing (with recourse).
- Factoring without Recourse (Sale): The company transfers all risks of default to the factor. In this case, the transaction is considered a sale of receivables. The company would derecognize the receivables and recognize any gain or loss on the sale.Debit: Cash (for the amount received) Debit: Loss on Sale of Receivables (if applicable) Credit: Accounts Receivable (for the full value of the receivables sold) Credit: Gain on Sale of Receivables (if applicable)
- Factoring with Recourse (Secured Borrowing): The company retains the risk of default. In this case, the transaction is considered a borrowing secured by the receivables. The company would continue to recognize the receivables and would recognize a liability for the obligation to repay the factor.Debit: Cash (for the amount received) Debit: Factoring Expense (for any fees or interest charged by the factor) Credit: Liability to Factor (for the cash received plus any retained interest)
Please note that these are general entries and may need to be adjusted based on the specifics of the factoring agreement. For example, the factor may withhold a certain amount (reserve) as protection against sales returns or allowances, or the factor may charge a factoring fee, both of which would affect the accounting entries.
As always, a company should consult with an accounting professional to ensure that the accounting for factoring arrangements is done in accordance with the applicable accounting standards.
Example of How to Account For Factoring Arrangements
Let’s walk through an example of both types of factoring arrangements – with recourse and without recourse.
Example 1: Factoring without Recourse
Let’s assume ABC Inc. sells $10,000 of its accounts receivable to a factor without recourse for $9,500 in cash. The accounts receivable is sold outright, with all risk of non-payment transferred to the factor.
The journal entries in the books of ABC Inc. would look like this:
Debit: Cash $9,500
Debit: Loss on Sale of Receivables $500
Credit: Accounts Receivable $10,000
In this case, ABC Inc. has taken a loss of $500 on the sale of the receivables, which is debited to Loss on Sale of Receivables.
Example 2: Factoring with Recourse
Now, let’s assume that ABC Inc. sells $10,000 of its accounts receivable to a factor with recourse for $9,500 in cash. If the customers fail to pay, ABC Inc. will be responsible for repaying the factor.
The journal entries in the books of ABC Inc. would look like this:
Debit: Cash $9,500
Credit: Liability to Factor $9,500
In this case, the accounts receivable remains on ABC Inc.’s balance sheet, and a new liability is created to reflect ABC Inc.’s potential obligation to the factor.
These are simplified examples and the actual accounting might include more complexities, such as a provision for recourse obligation, interest expenses, and factoring fees, etc. The specifics of the factoring agreement may also require different accounting treatment. Please consult with a professional accountant to understand the correct accounting treatment.
