By Yuriy Smirnov Ph.D.
Factoring of accounts receivable means selling of invoices to a third party called factor (usually a factoring company or a bank). Since the invoices have been factored, factor is entitled to collect receivables. Accounting for factored receivables requires several journal entries, which depend on whether the factoring agreement is with recourse or without recourse.
Accounting for factoring of accounts receivable depends on a recourse basis. Factoring without a recourse agreement means that the seller of receivables is not responsible for any losses of factor that exceed the retained amount. Under factoring with a recourse agreement, the seller of receivables is responsible for paying to the factor any bad debts in full.
When a business sells accounts receivable to a factoring company on a non-recourse basis, it should be recorded in the general journal as follows:
If sold accounts are collected by factor in full, it will repay the retained amount. It should be recorded by debiting the Cash account and crediting Due from the factor account.
If sold accounts are collected by factor incompletely but bad debts do not exceed the retained amount, factor will repay a retainer less the uncollected amount. The entries to be made in the general journal are as follows:
If the client defaults and uncollected receivables exceed the retained amount, the seller of accounts receivable does not bear any loss exceeding the retainer. The entry recognizes bad debts by debiting Allowance for doubtful accounts and crediting Due from factor for the retained amount.
Accounting for factoring of accounts receivable with recourse requires different entries to be made in the general journal than the non-recourse one. The reason is that the seller of receivables bears a loss if the client defaults to pay the factoring company. Accounting standards, such as IFRS and US GAAP, require that the seller estimate the possible loss and recognize it as recourse liability when receivables are factored. Thus, selling accounts receivable to a factoring company requires the following journal entries:
If factor collects receivables in full or the uncollected amount is less than estimated bad debts and the retainer, a business should record the following entries:
If uncollected receivables equal the estimation of bad debts, the business should record the following journal entries:
If uncollected accounts receivable exceeds the retained amount, the business is responsible for buying those receivables back from the factor. In such a situation, journal entries are as follows:
On April 2, 20X8, RetailX LTD factored its accounts receivable in the amount of $300,000. The factoring company provides a 70% cash advance and charges a 10% fee. Parties agreed that factor will pay any excess of the retained amount over uncollected accounts receivable at the end of 2nd financial quarter on June 30, 20X8.
RetailX LTD should record the following journal entries on April 2, 20X8:
Cash advance = $300,000 × 70% = $210,000
Fee = $300,000 × 10% = $30,000
Retained amount = $300,000 - $210,000 - $30,000 = $60,000
Let’s look at three possible scenarios.
Under Scenario A, the factoring company will pay the retained amount of $60,000 in full to RetailX LTD. It should be recorded in the general journal as follows:
Under Scenario B, $20,000 of accounts receivables remains uncollected. The factoring company will withhold it from the retained amount, and RetailX LTD should write off this amount as bad debts. The journal entries are as follows:
In Scenario C, $70,000 of receivables remained uncollected, and bad debts exceed the retained amount by $10,000, but under the non-recourse factoring agreement, RetailX LTD is not responsible for any loss of factoring company exceeding the retained amount. So, RetailX LTD should write off the amount due from factor in full as bad debts.
On October 16, 20X8, RetailX LTD sold $250,000 of accounts receivable to factoring company on a recourse basis. Factor offered an 80% cash advance and a 3% fee, provided that it would pay any excess of the retained amount over uncollected accounts receivable on November 15, 20X8.
The estimation of bad debts is based on historical data and set by RetailX LTD as 2%.
RetailX LTD should recognize factored accounts receivable as follows:
Cash advance = $250,000 × 80% = $200,000
Fee = $250,000 × 3% = $7,500
Retained amount = $250,000 - $200,000 - $7,500 = $42,500
Recourse liability = $250,000 × 2% = $5,000
Loss on factoring = $7,500 + $5,000 = $12,500
Let’s look at four possible scenarios.
Scenario A
As far as all accounts receivable were collected in full, factoring company will pay RetailX LTD the retained amount of $42,500. Please note that on October 16, 20X8, recourse liability of $5,000 was recognized as bad debt. Because receivables are fully paid, this bad debt should be restored by recognizing it as gain on factoring. So, the journal entries to be made are as follows:
Scenario B
Receivables of $3,000 was uncollected by November 15, 20X8; therefore, factoring company would pay to RetailX LTD $39,500 (retained amount of $42,500 less actual bad debts of $3,000). Considering that actual bad debts of $3,000 is less than the previously estimated amount of $5,000, the difference of $2,000 should be recognized as a gain on factoring. Thus, RetailX LTD should record these transactions as follows:
Scenario C
The uncollected amount of $25,000 does not exceed the retained amount of $42,500, so factoring company will pay to RetailX LTD the difference of $17,500 ($42,500 - $25,000). Please note that $5,000 of accounts receivable was recognized as a loss on October 16, 20X8; thus, RetailX LTD should recognize the additional $20,000 as bad debt and write it off on November 15, 20X8. These transactions should be recorded in the general journal as follows:
Scenario D
Uncollected receivables amounted to $55,000 ($250,000 - $195,000), which exceeds the retained amount of $42,500 by $12,500. Under the recourse agreement, RetailX LTD is responsible to buy receivables back and pay to factoring company an additional $12,500. Taking into account that $5,000 was already recognized as bad debt, RetailX LTD should recognize an additional loss on factoring of $50,000. It requires the following entries to be made:
