Factoring of trade debtors

Factoring of trade debtors is by far the most common transaction entered into by non-financial entities that requires assessment against the derecognition criteria. Surprisingly, IFRS 9 does not mention it in its examples. Factoring of trade debtors can serve as a useful example to illustrate derecognition requirements. Factoring of trade debtors

Example: factoring with partial recourse that qualifies for derecognition

Entity A enters into a factoring agreement and sells its portfolio of trade debtors to the Factor. The face value and carrying amount of those debtors are €1 million and the selling price is €0.9 million. After the sale, Entity A absorbs first 1.8% of credit losses of the whole portfolio and the rest is absorbed by the Factor. The average credit loss on similar debtors in the past amounts to 2% with a standard deviation of 0.2%. Factoring of trade debtors

First, Entity A determines that is has transferred its rights to receive the cash flows under paragraph IFRS 9 3.2.4 (a). Next, Entity A needs to assess whether it has transferred substantially all risks and rewards under paragraph IFRS 9 3.2.6 (a). In doing this analysis, Entity A calculates expected variability before and after the transfer by modeling different scenarios of credit losses with assigned probabilities based on reasonable and supportable information about past events, current conditions and forecasts of future economic conditions. Discounting in this example is ignored for the sake of simplicity. Factoring of trade debtors

The variability before and after the transfer is summarised in the following tables: Factoring of trade debtors

Before the transfer:

Factoring of trade debtors

After the transfer (credit loss absorbed up to 1.8%):

After the transfer factoring of trade debtors

Of the original variability of €1,731, Entity A transferred €1,636 and retained €95 (95%/5%, no specific threshold given in IFRS 9). Therefore, Entity A concludes that it has transferred substantially all the exposure with the variability in the amounts and timing of the net cash flows of the transferred asset. As a result, substantially all risks and rewards have been transferred and trade debtors should be derecognised.

As a result of the transaction, Entity A derecognises trade debtors and recognises a one-off derecognition loss in PNL under paragraph IFRS 9 3.2.12. Additionally, Entity A needs to recognise retained credit risk as a liability (IFRS 9 3.2.6 (a)). Accounting entries made by Entity A are as follows:

Derecognition of trade debtors

1,000,000

Cash received

900,000

Provision for retained credit risk (liability not netted with trade debtors)

18,000

Derecognition loss (PNL)

118,000

IFRS 9 is silent on the PNL line item in which the derecognition gain/loss should be presented. The classification in PNL should be consistent with the classification of proceeds in the statement of cash flows.

How factoring interacts with the IFRS 9 classification model

Under IFRS 9, a financial asset is classified based on two criteria:

  1. The business model within which it is held
  2. Whether its contractual cash flows meet the solely payments of principal and interest (SPPI) test.

Under IFRS 9, an accounting derecognition is considered a sale for the purposes of assessing the business model; consequently, factoring that results in derecognition must be taken into account as part of the assessment

This means that entities that factor some or all of their trade receivables may be unable to conclude that those receivables are part of a ‘hold to collect’ business model which would preclude amortised cost classification (even if the SPPI test is met). This means that classification at Fair Value through Other Comprehensive Income (FVOCI) or at Fair Value through Profit or Loss (FVPL) may be required.

Business model

Hold to collect

Hold to collect and sell

Other business models

Cash flow characteristics

SPPI

Amortised cost

FVOCI

FVPL

Other

FVPL

FVPL

FVPL

The examples below illustrate some common scenarios that could arise.

1 – Mixed portfolio

Company A holds a portfolio of trade receivables which meet the SPPI test and are either held to collect their cash flows or are subject to factoring arrangements that result in derecognition. In the past, factoring has been frequent and significant in value but this depends on the day to day liquidity needs. At initial recognition, it is not known which receivables will be subject to factoring.

In this example, the portfolio of trade receivables is likely to fail the ‘hold to collect’ test and instead meet the ‘hold to collect and sell’ criteria. This is because cash flows are being generated through a combination of collection and sales (by factoring) and it is not known at initial recognition which receivables will be factored. This would result in a FVOCI classification meaning that Company A would be required to maintain both fair value and amortised cost (including Expected Credit Losses) accounting records.

2 – Segregated portfolio

Company B holds a portfolio of trade receivables which meet the SPPI test. The trade receivables relate to customers in two different countries; Country X receivables are held to collect their cash flows whereas Country Y receivables are always subject to factoring arrangements (as payment terms in that region are much longer than average). The factoring arrangement results in derecognition.

Here it seems likely that Company B will in a position to segregate its portfolio and apply different business models to each sub-portfolio. Country X receivables would be in a ‘hold to collect’ business model and classified at amortised cost whereas Country Y receivables would be in an ‘other’ business model (‘hold to sell’) and classified at FVPL.

Factoring of trade debtors

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