FACTORING
A financing method in which a business owner sells accounts receivable at a discount to a third-party funding source to raise. It is usually done either on a with recourse and without recourse.
Factoring Without Recourse
Factoring without recourse is a form of factoring, under which the bank assumes the risk of debtor’s failure to pay for the goods/services delivered. It is a transfer of financial assets that meets the criteria for derecognition. It is treated as a sale and not as a secured borrowing.
Factoring With Recourse
Factoring with recourse is a form of factoring, in which the transferor guarantees payment to the factor in the event the debtor fails to pay. It is a transfer of asset where the transferor neither transfers nor retains substantially all the risks and rewards of ownership of the financial asset.
Factor’s holdback – the seller is responsible for any reduction in the collection of the receivables due to sales returns and discounts.
Casual basis – service fees and interest charges is recorded as “loss on sale of receivables”.
Regular means of financing – service fees and interest charges as regular expenses.
Sample Problem 1: (Without Recourse)
DJ Company factored P 4,000,000 of accounts receivable to Padilla Financing Corp.on a without recourse basis on October 1, 2013. Padilla charged a 5% service fee and retained a 10% holdback to cover expected sales returns. In addition, Padilla charged a 12% interest computed on a weighted average time to maturity of the receivables of 73 days based on 365 days.
Entries: (casual basis)
Cash on hand 3,304,000
Receivable from factor 400,000
Loss on sale of receivable 296,000
Accounts receivable 4,000,000
(regular means of financing)
Cash on hand 3,304,000
Receivable from factor 400,000
Service charge 200,000
Interest expense 96,000
Accounts receivable 4,000,000
Cost of factoring for DJ Company is 296,000 equal to the service and interest charges (200,000 + 96,000).
Sample 2: (With Recourse)
Using the same information in Sample Problem 1 except that DJ Company sold the receivables on a with recourse basis. DJ Company determines that the recourse obligation has a fair value of 50,000.
Entries: (casual basis)
Cash on hand 3,304,000
Receivable from factor 400,000
Loss on sale of receivable 346,000
Accounts receivable 4,000,000
Liability for recourse obligation 50,000
(regular means of financing)
Cash on hand 3,304,000
Receivable from factor 400,000
Commission expense 200,000
Interest expense 96,000
Loss on recourse obligation 50,000
Accounts receivable 4,000,000
Liability for recourse obligation 50,000
Notice: Whether the factoring is casual or as regular means of financing, the cost of factoring is the same.
Sample Problem 3: (Settlement of Factor’s Holdback)
Use the same information in the previous samples. Assume further that all of the receivables were collected except that total sales returns was 40,000.
Entries: (without recourse)
Cash on hand (squeeze) 360,000
Sales returns 40,000
Receivable from factor 400,000
(with recourse)
Cash on hand (squeeze) 360,000
Sales returns 40,000
Receivable from factor 400,000
Recourse obligation 50,000
Gain on recourse obligation 50,000