6.5 Factoring of Receivables and Derecognition of Financial Assets
Key Takeaways
- A financial asset is derecognised only when the contractual rights to its cash flows expire or when it is transferred and substantially all the risks and rewards of ownership pass to the transferee.
- Factoring without recourse normally transfers the credit risk, so the receivables are derecognised and the difference between the carrying amount and the proceeds is charged to profit or loss.
- Factoring with recourse leaves the irrecoverable-debt risk with the seller, so the receivables stay on the statement of financial position and the cash received is recognised as a secured borrowing.
- Where risks and rewards are neither transferred nor retained, derecognition depends on whether the transferor has retained control of the asset.
- The derecognition decision changes receivables days, the current ratio and gearing, so an exam scenario that misclassifies a with-recourse factoring flatters every liquidity ratio in the answer.
6.5 Factoring of Receivables and Derecognition of Financial Assets
Why this earns marks: Factoring is one of the very few items the FR study guide names as a standalone learning outcome — "explain and account for the factoring of receivables". It is also the single most common way an exam scenario creates an apparent liquidity improvement that is not real. Get the derecognition decision right and the ratio commentary in Section C writes itself.
1. The Derecognition Framework in IFRS 9
An entity derecognises a financial asset when, and only when:
- The contractual rights to the cash flows from the financial asset expire — a receivable is settled, a bond matures; or
- It transfers the financial asset and the transfer qualifies for derecognition.
The second route is the one factoring uses, and IFRS 9 tests it with a decision sequence:
Has the entity TRANSFERRED the contractual rights to
receive the cash flows (or assumed a pass-through obligation)?
|
+---------------+----------------+
| NO | YES
v v
CONTINUE to recognise Has it transferred substantially ALL
the asset in full the RISKS AND REWARDS of ownership?
|
+---------------------+---------------------+
| YES | NO, it RETAINED | NEITHER
| | substantially all | transferred
v v | nor retained
DERECOGNISE CONTINUE to recognise v
the asset in full the asset, and recognise Has it retained
a FINANCIAL LIABILITY CONTROL of the asset?
for the consideration |
received +------+------+
| NO | YES
v v
DERECOGNISE Continue to
in full recognise to the
extent of CONTINUING
INVOLVEMENT
The risks and rewards being tested for a trade receivable are principally:
- Credit risk — the risk that the customer does not pay at all;
- Late payment or slow payment risk — the risk that the cash arrives later than expected, which in a factoring arrangement usually surfaces as additional interest;
- Any residual exposure the seller retains, such as a guarantee of a minimum collection percentage.
2. What Factoring Actually Is
Factoring is the sale of trade receivables to a finance company (the factor) in exchange for immediate cash, typically a percentage of face value, with the balance paid over when the customers settle. Entities use it to accelerate the cash conversion cycle, to outsource the credit control function, or both.
Three commercial features usually appear in an exam scenario, and each one matters to the accounting:
| Feature | What to look for in the scenario | Why it matters |
|---|---|---|
| Recourse | Does the factor have the right to reclaim from the seller amounts that customers fail to pay? | Recourse means credit risk has been retained — the single most decisive fact |
| Administration fee | A percentage of the receivables factored, charged for running the sales ledger | An expense either way; presented in operating expenses |
| Finance charge | Interest charged on the cash advanced, often monthly until the customer pays | In a with-recourse arrangement this is unmistakably a borrowing cost |
3. Factoring Without Recourse
The factor buys the receivables outright and bears the loss if a customer defaults. Substantially all the risks and rewards of ownership have been transferred.
Treatment: derecognise the receivables. The difference between the carrying amount given up and the consideration received is recognised in profit or loss — in substance the cost of selling the debts and of the credit protection obtained.
Dr Cash (proceeds received)
Dr Loss on factoring / administration expense (the shortfall)
Cr Trade receivables (carrying amount derecognised)
[!TIP] Presentation of the charge. The expense is an operating cost of selling the receivables and running the ledger, not a finance cost, because there is no borrowing. Under IFRS 18 it therefore sits in the operating category, not the financing category.
4. Factoring With Recourse
The factor advances cash but may reclaim from the seller any amount a customer fails to pay. The seller has retained substantially all the risks and rewards, most importantly credit risk.
Treatment: do not derecognise. The receivables stay on the statement of financial position at their carrying amount and the cash received is recognised as a financial liability — in substance a secured borrowing with the receivables as collateral. The finance charge is accrued as a finance cost, which under IFRS 18 falls in the financing category.
On receipt of the advance:
Dr Cash (advance received)
Cr Loan from factor (financial liability)
As customers settle and the factor charges interest:
Dr Loan from factor (amounts collected by the factor)
Dr Finance cost (interest charged on the advance)
Dr Administration expense (the factor's service fee)
Cr Trade receivables (as customers pay)
Cr Cash / Loan from factor (settlement of charges)
Summary comparison
| Without recourse | With recourse | |
|---|---|---|
| Credit risk | Passes to factor | Retained by seller |
| Receivables | Derecognised | Remain recognised |
| Cash received | Consideration for a sale | Financial liability (borrowing) |
| Charge to profit or loss | Loss on sale / admin expense (operating) | Finance cost (financing) + admin expense (operating) |
| Effect on gearing | None | Increases — a new liability appears |
| Effect on receivables days | Falls sharply | Unchanged |
| Effect on the current ratio | Depends on the discount suffered | Typically falls — current liabilities rise |
5. Worked Example: The Same Cash, Two Different Balance Sheets
Scenario
Ambleside Co has trade receivables of $900,000 at 30 November 20X6. On 1 December 20X6 it factors $600,000 of those receivables. The factor immediately advances 80% of the face value, charges an administration fee of 1.5% of the receivables factored, and charges interest of 1% per month on the advance outstanding. By 31 December 20X6 customers have paid the factor $400,000.
Ambleside's other relevant figures at 31 December 20X6, before accounting for the factoring, are: inventories $310,000, cash $120,000, trade payables $540,000, other current liabilities $160,000, equity $2,400,000, long-term borrowings $800,000. Revenue for the year was $5,400,000.
Advance received on 1 December: $600,000 x 80% = $480,000
Administration fee: $600,000 x 1.5% = $9,000
Interest for December: $480,000 x 1% = $4,800
Case A — the arrangement is without recourse
Ambleside derecognises the $600,000 of receivables. It has received $480,000 now and is entitled to the remaining $120,000 less the fees as customers settle.
Dr Cash $480,000
Dr Other receivable from factor $106,200 ($120,000 - $9,000 - $4,800)
Dr Administration expense (operating) $9,000
Dr Discount on sale of receivables (operating) $4,800
Cr Trade receivables $600,000
Note that in a genuine sale there is no borrowing, so the 1% monthly charge is
part of the discount suffered on selling the debts, not a finance cost. Both
charges therefore sit in the IFRS 18 operating category.
| Ratio at 31 December 20X6 | Calculation | Result |
|---|---|---|
| Trade receivables | $900,000 - $600,000 | $300,000 |
| Receivables days | ($300,000 / $5,400,000) x 365 | 20.3 days |
| Current assets | $300,000 + $106,200 + $310,000 + $120,000 + $480,000 | $1,316,200 |
| Current liabilities | $540,000 + $160,000 | $700,000 |
| Current ratio | $1,316,200 / $700,000 | 1.88 : 1 |
| Gearing (debt / equity) | $800,000 / $2,400,000 | 33.3% |
Case B — the arrangement is with recourse
Ambleside retains the credit risk, so nothing is derecognised.
Dr Cash $480,000
Cr Loan from factor (current liability) $480,000
Dr Administration expense (operating) $9,000
Dr Finance cost (financing) $4,800
Cr Loan from factor / Cash $13,800
As customers pay the factor $400,000 in December:
Dr Loan from factor $400,000
Cr Trade receivables $400,000
| Ratio at 31 December 20X6 | Calculation | Result |
|---|---|---|
| Trade receivables | $900,000 - $400,000 collected | $500,000 |
| Receivables days | ($500,000 / $5,400,000) x 365 | 33.8 days |
| Loan from factor | $480,000 - $400,000 + $13,800 charged | $93,800 |
| Current assets | $500,000 + $310,000 + $120,000 + $480,000 | $1,410,000 |
| Current liabilities | $540,000 + $160,000 + $93,800 | $793,800 |
| Current ratio | $1,410,000 / $793,800 | 1.78 : 1 |
| Gearing (debt / equity) | ($800,000 + $93,800) / $2,400,000 | 37.2% |
The interpretation point
The cash position is identical in both cases. Yet Case A reports receivables days 13.5 days shorter, a stronger current ratio and unchanged gearing, while Case B reports a visible new borrowing. A Section C commentary that praises Ambleside for "a dramatic improvement in credit control" without asking whether the factoring was with or without recourse has missed the substance of the transaction entirely.
6. Common Exam Traps
[!WARNING] Trap 1: Derecognising because cash has been received. Cash receipt proves nothing about derecognition. Find the recourse clause first; it decides the entire treatment.
[!WARNING] Trap 2: Netting the factor loan against receivables. Where the arrangement is with recourse, the receivables and the loan from the factor are separate assets and liabilities. Offsetting them is prohibited unless the strict IAS 32 offsetting criteria are met, which they are not here.
[!WARNING] Trap 3: Classifying the with-recourse interest as an administration expense. Interest charged on the advance is a finance cost under IFRS 18's financing category. Only the ledger administration fee is an operating expense.
[!TIP] Watch for the partial-risk scenario. A factoring arrangement in which the seller guarantees only the first 5% of losses has transferred most, but not all, of the credit risk. This is the "neither transferred nor retained" branch, where derecognition depends on control and, if control is retained, the asset is recognised to the extent of the continuing involvement. FR scenarios usually present the clean with-or-without recourse cases, but the guarantee wording is worth reading carefully.
Grasmere Co factors $400,000 of trade receivables. Under the agreement the factor advances 85% of face value immediately, charges a monthly finance charge on the balance advanced, and retains the right to recover from Grasmere the full amount of any receivable that remains unpaid after 120 days. How should Grasmere account for the arrangement?
Coniston Co has revenue of $7,300,000 and trade receivables of $1,000,000 immediately before it factors $600,000 of those receivables without recourse on the final day of its reporting period. Which statement best describes the effect of the transaction on Coniston's reported position and on the analysis of it?
Which of the following is the correct treatment of the charges arising on a with-recourse factoring arrangement in a statement of profit or loss prepared under IFRS 18?