Accounting for Factoring of Receivables

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Accounting for factoring receivables is not complicated once you establish the appropriate accounts and understand how factoring works. Factoring is when a company sells the right to collect on its invoices in exchange for an up-front payment. This is useful if you are in need of cash to fund operations and cannot wait to collect on trade credit.

How Factoring Works

  • A company chooses a portion of their accounts receivable to send to the factor. Once transferred, the agent will pay a portion of the receivable's value in cash and another portion will be held in a reserve. This is to help protect the factor from suffering losses from uncollectible accounts. The receivables in the reserve will be paid back once they are collected. A fee is charged based on a percentage of the value of receivables. There are two types of factoring: with recourse and without recourse.

Factoring Without Recourse

  • Without recourse means that once the factor has taken over collection of the receivables, the factor also assumes the loss should any of the invoices become uncollectible. The agent will reduce the reserve for any sales discounts or allowances taken by customers. Since the company selling their receivables transfers the risk of bad accounts, the fees charged for factoring without recourse are higher than those with recourse.

Without Recourse Journal Entry

  • Example: $100,000 is factored with 30 percent reserved and a fee of 5 percent.

    (Debit) Cash $65,000

    (Debit) Receivable from Factor $30,000

    (Debit) Loss on Sale of Receivables $5,000

    (Credit) Accounts Receivable $100,000

Collection of Reserve

  • When the factor collects the $30,000, cash is debited and receivable from factor is credited. If customers take any discounts or allowances, the appropriate contra-revenue accounts are debited.

    For example:

    The factor collects a $30,000 reserve, but customers have taken $5,000 in allowances.

    (Debit) Cash $25,000

    (Debit) Allowances $5,000

    (Credit) Receivable from Factor $30,000

Factoring With Recourse

  • Factoring with recourse provides extra security for the factor by shifting liability for uncollectable accounts back to clients. Once an invoice is deemed uncollectable, the client's reserve is reduced to offset. If the reserve does not cover the uncollectable amount, the factor will require reimbursement. Since the agent is protected from liability, the fee is smaller than factoring without recourse.

With Recourse Journal Entry

  • The initial transaction is recorded the same as without recourse. However, should a receivable be deemed uncollectable, you will need to book the loss. This is done when the reserve is collected.

    Example:

    The factor collects on a $30,000 reserve, but $2,000 is deemed uncollectable.

    (Debit) Cash $28,000

    (Debit) Allowance for Doubtful Accounts $2,000

    (Credit) Receivable from Factor $30,000

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