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Factoring of Accounts Receivable

Moneyzine Editor
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Moneyzine Editor
2 mins
January 17th, 2024
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Factoring of Accounts Receivable

Definition

The financial accounting term factoring refers to the process whereby a company sells its accounts receivable to another company. When accounts receivable is sold to a factor, the purchasing company assumes responsibility for collection of the money owed.

Explanation

In the normal course of business, customers are constantly making purchases on credit and remitting payments. Factoring receivables to another party allows companies to reduce the sales to cash revenue cycle time. In addition to factoring, disposition of accounts receivable can also take place through what is known as pledging, or assignment.

The factoring process involves an agreement with a factor, which is a company that purchases receivables for a fee, and then collects the money owed directly from customers. Once sold, the receivables are removed from the seller's books. Generally, there are two approaches to factoring:

  • Transfer with Recourse: when sold with recourse, the seller promises to buy back any receivables that are not collected by the purchaser; essentially guaranteeing payment.

  • Transfer without Recourse: when sold without recourse, the purchaser assumes the risk of non-payment.

Companies selling receivables will create what's called a holdback account. This is used to absorb the credit losses that might occur under a sale with recourse agreement or the cost of sales discounts and returns under an agreement without recourse.

Example

Company A would like to transfer $100,000 of receivables to First Factors Collection Group. Company A agrees to sell its receivables at a 5% discount, and will establish an account at 2% for sales discounts and returns customers may request when First Factors attempts to collect money owed.

The journal entries for Company A would be the same regardless if the agreement were with recourse or without. The holdback account (Due from Factor), would merely serve a different purpose under each arrangement:

Debit

Credit

Cash

$93,000

Due from Factor (sales discounts, returns)

$2,000

Loss of Sale of Receivables

$5,000

Accounts Receivable

$100,000

Related Terms

  • Balance Sheet
    Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
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  • Current Assets
    The financial accounting term current assets is generally defined as cash and other assets that can be converted into cash within one year or one operating cycle, whichever is longer. Current assets are a subcategory of assets, which appear on a company's balance sheet.
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  • Assignment of Accounts Receivable
    The financial accounting term assignment of accounts receivable refers to the process whereby a company borrows cash from a lender, and uses the receivable as collateral on the loan. When accounts receivable is assigned, the terms of the agreement should be noted in the company's financial statements.
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  • Disposition of Accounts Receivable
    The financial accounting term disposition of accounts receivable is used to describe several approaches companies can take to accelerate the receipt of cash from receivables. The two most common methods include factoring and assignment; whereby the company transfers receivables to another party in exchange for cash.
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  • Allowance for Doubtful Accounts
    The term allowance for doubtful accounts refers to the contra asset to accounts receivable. Allowance for doubtful accounts represents the portion of accounts receivable the company does not expect to collect from customers.
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  • The term special allowance accounts refers to a contra asset to accounts receivable that ensures the amount appearing on the balance sheet is stated in terms of net realizable value. Special allowance accounts are required to match anticipated and real expenses with the corresponding sales revenues.
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