Factoring with recourse

Factoring with recourse – This is an illustration of how derecognition is applied in practice. The objective is to present the mechanics of applying the IFRS 9 requirements for derecognition of financial assets, starting with an analysis of the transaction using the flowchart [IFRS 9 B3.2.1], and culminating with the initial and subsequent accounting entries for both the transferor and transferee.

Background and assumptions

Entity J enters into an agreement to assign its portfolio of €20 million trade receivables with recourse to factor K. The receivables have 90-day terms and are subject to normal warranties on the existence of the receivables at the date of the transfer (for example, if a customer returns the goods purchased because they are faulty, the receivable does not exist; J will pay to K the face amount of the receivable plus interest).

K agrees to pay J an initial amount of €16 million in cash for the rights to the cash flows from the receivables. Once the receivables have been repaid, K will pay a further sum to J calculated as the balance of €4 million less interest on the €16 million initial payment until the date debtors pay and less any defaults (defined as any debts that remain unpaid after 120 days). As J continues to service the receivables, the debtors have not been notified that their receivables have been transferred. J also receives a fee of 0.2% of the notional amount of each receivables transferred for servicing the receivables.

Additional information:

• Fair value of portfolio of trade receivables on date of transfer – €19.5 million
• Carrying value of portfolio of trade receivables on date of transfer – €20 million
• The servicing fee is expected to adequately compensate entity J for servicing the receivables
• The receivables were classified as at amortised cost
  

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Analysis using the flowchart [IFRS 9 B3.2.1]

Step 1 Consolidate all subsidiaries

This step is not applicable in this example.

Step 2 Determine whether the derecognition model should be applied to part of a financial asset (or a group of similar financial assets) or a financial asset (or a group of similar financial assets) in its entirety.

The financial instruments being transferred have similar characteristics. They are all trade receivables, have similar credit ratings and mature at approximately the same date (90 days).

They should be assessed as a group of similar financial assets

Step 3 Have the rights to the cash flows expired?

No, the portfolio of receivables has not yet reached maturity so the rights to the cash flows still exist.

Step 4 Is there a transfer?

Yes, entity J has assigned the rights to the cash flows from the receivables to factor K; therefore there has been a transfer under IFRS 9 3.2.4 (a).

Although J has provided normal warranties, these relate to business risks of the underlying transaction, which affect the existence of the receivable rather than to the financial risks associated with the receivables themselves and do not prohibit the transfer of rights to cash flows.

In addition, although the debtors have not been notified that their receivables have been transferred, this does not preclude this transaction meeting the definition of a transfer, as J is only servicing the receivables.

Step 5 Risks and rewards analysis

Entity J has retained the credit and late payment risk as the expected losses/variability is such that the likelihood of losses exceeding the €4 million withheld is remote. J has therefore retained substantially all the risks and rewards and should continue to recognise the receivables.

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Transferor’s accounting

On the date of the transfer

As a result of the failed derecognition, entity J continues to recognise the receivables. J also recognises a financial liability for the consideration received for the transferred asset from factor K.

Accounting entries on the date of the transfer

(in € thousands) Factoring with recourse	DR	CR
Cash Factoring with recourse	16,000
Loans from factor K Factoring with recourse		16,000

To recognise the transfer as a collateralised borrowing. Factoring with recourse

Subsequent accounting Factoring with recourse

Subsequently, entity J will continue to account for the transferred asset as receivables at amortised cost, subject to impairment testing. J will account for the liability to factor K at amortised cost and accrue interest until the date receivables pay using the effective interest method. Assume that €19 million pay in 90 days and the other €1 million remains outstanding after 120 days. Interest is charged by the factor at 10%.

On day 90 Factoring with recourse

(in € thousands) Factoring with recourse	DR	CR
Interest expense Factoring with recourse	400
Loans from factor K Factoring with recourse		400

To accrue interest on the loan from factor K of €16 million (10% * 16m * 90/360 = 400).

On day 120 Factoring with recourse

(in € thousands) Factoring with recourse	DR	CR
Cash Factoring with recourse	19,000
Receivables Factoring with recourse		19,000
Cash		19,000
Loans from K	16,400
Receivable from K Factoring with recourse	2,600

To pay cash to the factor when received, remove the liability and set up a receivable from factor for the deferred purchase consideration still to be received.

	(in € millions)
Cash received from debtors	19
Less interest	0.400
Less upfront payment	16
Additional cash received from factor	2.6

Note: In reality, the cash probably does not move in a gross basis, as the transferor would normally settle the net amount. This done here to bring more clarity to the case.

The entries would be as follows:

On day 120

(in € thousands)	DR	CR
Cash	2,600
Receivable from K		2,600
Impairment	1,000
Receivables		1,000

To record the settlement of the receivables from Factor K, as at day 120 the relationship with K ceases, entity J also needs to record impairment on the remaining €1,000 of receivables if it has not already.

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Transferee’s accounting

As the transfer does not qualify for derecognition, the transferee K does not recognise the transferred receivables as their assets. K derecognises the cash or other consideration paid and recognises a receivable from the transferor J.

On the date of the transfer

(in € thousands)	DR	CR
Loan to company J	16,000
Cash		16,000

To recognise the transfer as a collateralised lending.

Subsequent accounting

Subsequently, factor K will account for this loan at amortised cost using the effective interest method unless designated as at fair value through profit or loss.

On day 90

(in € thousands) Factoring with recourse	DR	CR
Loan to J	400
Interest income		400
Cash Factoring with recourse	19,000
Loan to J Factoring with recourse		16,400
Loan from J Factoring with recourse		2,600

To accrue interest on the loan to entity J and extinguish the loan to J as €19 million of receivables have been paid.

When factor K makes the additional payment to J, the entries would be as follows:

On day 120

(in € thousands) Factoring with recourse	DR	CR
Cash Factoring with recourse		2,600
Loan from J Factoring with recourse	2,600

To record the settlement of the loan with J. Factoring with recourse

Factoring with recourse