Factoring of Accounts Receivable

Factoring is the sale of accounts receivable of a company to a financing company at discount. The financing company which buys the receivables is called a factor. Factoring helps a business convert its receivables immediately into cash instead of waiting for due dates of payment by customers.

The parties to the factoring agreement assess the recoverability of the accounts receivable, decide whether or not the factoring agreement will be with recourse and then they agree on a suitable discount factor to calculate the amount of fee to be charged by the factor. After deducting such fee from the value of accounts receivable, the factor pays in cash to originating company. The factor may also withheld an additional amount as a refundable security against bad debts which may arise.

As a result of the above transaction, the factor gains ownership of the accounts receivable and has access to the detailed records of those receivables. The factor collects cash from the debtors as the due dates approach. The procedure to be followed in a situation where a debt becomes irrecoverable depends on whether or not the factoring agreement is with recourse.

Recourse vs Non-recourse Factoring

Under non-recourse factoring, the factor may set off the sum retained as a security, if any, againts any bad debts that may arise but the factor is not entitled to be reimbersed by the originating company if the total of bad debts exceed the amount of security. In other words, the additional loss on bad debts under non-recourse factoring is borne by the factor. Under a factoring agreement with recourse, the company factoring its receivables agrees to pay bad debts in full to the factor. So if the security falls short of the total bad debts, the factor is entitled to be reimbursed for bad debts in full.

Non-recourse factoring is riskier than factoring with recourse for the factor, resulting in higher discount rates over factoring with recourse in general.

Factoring vs Assignment of Receivables

Factoring is different from a financing agreement involving assignment of receivables because the later uses receivables as a collateral security for a loan, but the actual ownership of receivables and the right to collect them is not transferred as long as the loan and any related interest payments are paid in time.

The following example illustrates the journal entries to record factoring with and without recourse:

Journal Entries and Example

On January 1, 20X5 Impatient Inc. factored its accounts receivable of $100,000 at a fee of 8%. Under the terms of the agreement, the company received $82,000 in cash and the rest of the amount was retained by the factor as a security for any bad debts that may arise. Any excess of this security sum over the total bad debts was agreed to be returned by the factor at the end of the accounting period i.e. December 31, 20X5.

On December 31, 20X5 the full amount of security sum was withheld by the factor because the actual bad debts totaled $11,000 exceeding the security sum.

Impatient Inc. had already provided allowance for doubtful debts in the factored accounts receivable and a bad debts expense was recognized in the income statement of year ended December 31, 20X4.

Required: Pass journal entries to record the above transancts for Impatient Inc. both under factoring with recourse and factoring without recourse.


January 1, 20X5: Here, the journal entry will be identical under both factoring with recourse and factoring without recourse.

Factoring Expense [0.08×100,000]8,000
Due from Factor10,000
Accounts Receivable100,000

December 31, 20X5: The journal entries will differ under the two types of factoring. Since the actual bad debts exceed the amount initially retained by the factor, Impatient' Inc must pay the factor, an additional $1,000 under factoring with recourse but there is no such remedy if the factoring is without recourse.

Under factoring with recourse:

Provision for Bad Debts11,000
Due from Factor10,000

Under factoring without recourse:

Provision for Bad Debts10,000
Due from Factor10,000

It is important to note that the type of factoring influences the amount of fee charged and the amount of security held by the factor and the scenario in this example is only for the purpose of comparing the two types. The amount of security retained may be zero under factoring with recourse because the agreement gaurantees the factor that any debts that may turn out to be irrecoverable will be reimbursed.

by Irfanullah Jan, ACCA and last modified on

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