Factoring of accounts receivables
As a result of a factoring transaction, the company receives cash in advance instead of waiting for the collection. This is helpful since companies are able to realize assets immediately, however the disadvantage is that the selling price of the accounts receivable are normally lower than the face value. Once the accounts receivable have been sold to a factor, the customers are typically informed and the subsequent payments are made directly to the factor.
There are generally two types of factoring arrangements:
Factoring without recourse
When accounts receivables are sold to a factor without recourse, it means that the factor bears the risk of credit losses on the receivables. If any of the receivables sold are proven to be uncollectible, the factor will not be able to recover any amounts from the company (i.e., the seller of the said accounts receivables).
In this case, there is complete derecognition of the accounts receivables sold. The following simplified journal entry is presented to show the impact of factoring without recourse on the financial statements:
| Account | Debit | Credit | Financial statement element |
| Cash | XX | Asset | |
| Factoring fees | XX | Expense | |
| Interest cost | XX | Expense | |
| Accounts receivables | XX | Asset | |
| To record sale of accounts receivables to a factor | |||
In the journal entry, the accounts receivables are derecognized in the balance sheet and cash is received net of the cost of factoring and interest costs.
The factor would typically charge factoring fees for providing the services and also interest costs for providing cash to the company in advance of the maturity of the accounts receivables. These costs are deducted from the face value of the accounts receivables sold to determine the cash proceeds from the factor (the fee and interest are sometimes combined into a single loss on sale of receivables line instead of being shown separately).
When receivables are sold, the company also removes (debits) any allowance for credit losses related to the sold receivables, so the loss on sale is measured against their net carrying amount rather than their gross face value. Bad debt expense already recognized in earlier periods is not reversed.
Factoring with recourse
This is the opposite of factoring without recourse. This means that the contractual relationship with the factor does not end with the sale of the accounts receivable because the risk of credit losses on the receivables is still borne by the company which sold the receivables.
If the transfer meets the U.S. GAAP sale conditions (the company surrenders control over the receivables), the receivable is fully derecognized, and the journal entry also recognizes a “recourse liability” account, which serves as an allowance for estimated uncollectible balances related to the sold receivables and increases the loss recognized on the sale. If those conditions are not met, the transfer is accounted for as a secured borrowing instead: the receivables stay on the company’s books, and the cash received is recorded as a liability rather than as sale proceeds.
The recourse liability is measured at the estimated fair value of the recourse obligation, which depends mainly on the expected credit losses on the sold receivables - conceptually similar to estimating the allowance for credit losses, covered in a later chapter on subsequent measurement of accounts receivables, except that the “recourse liability” account is a liability account and not a contra-asset account.
Example: Factoring with and without recourse
A company factors $100,000 of receivables, paying a 2% fee ($2,000) plus $1,500 interest, for net cash proceeds of $96,500. Without recourse:
Account Debit Credit Cash $96,500 Factoring fee expense $2,000 Interest cost $1,500 Accounts receivable $100,000 With recourse: the company also expects $20,000 of the receivables to become uncollectible. The entry is the same as above, plus:
Account Debit Credit Loss on sale of receivables $20,000 Recourse liability $20,000 Answer: Cash proceeds are $96,500 either way; the recourse liability raises the total loss recognized from $3,500 to $23,500.