Factoring of trade debtors is by far the most common transaction entered into by non-financial entities that requires assessment against the derecognition criteria. Surprisingly, IFRS 9 does not mention it in its examples. Factoring of trade debtors can serve as a useful example to illustrate derecognition requirements.
Entity A enters into a factoring agreement and sells its portfolio of trade debtors to the Factor. The face value and carrying amount of those debtors are €1 million and the selling price is €0.9 million. After the sale, Entity A absorbs first 1.8% of credit losses of the whole portfolio and the rest is absorbed by the Factor. The average credit loss on similar debtors in the past amounts to 2% with a standard deviation of 0.2%.
First, Entity A determines that is has transferred its rights to receive the cash flows under paragraph IFRS 9 3.2.4 (a). Next, Entity A needs to assess whether it has transferred substantially all risks and rewards under paragraph IFRS 9 3.2.6 (a). In doing this analysis, Entity A calculates expected variability before and after the transfer by modeling different scenarios of credit losses with assigned probabilities based on reasonable and supportable information about past events, current conditions and forecasts of future economic conditions. Discounting in this example is ignored for the sake of simplicity.
The variability before and after the transfer is summarised in the following tables:
Before the transfer:
After the transfer (credit loss absorbed up to 1.8%):
Of the original variability of €1,731, Entity A transferred €1,636 and retained €95 (95%/5%, no specific threshold given in IFRS 9). Therefore, Entity A concludes that it has transferred substantially all the exposure with the variability in the amounts and timing of the net cash flows of the transferred asset. As a result, substantially all risks and rewards have been transferred and trade debtors should be derecognised.
As a result of the transaction, Entity A derecognises trade debtors and recognises a one-off derecognition loss in PNL under paragraph IFRS 9 3.2.12. Additionally, Entity A needs to recognise retained credit risk as a liability (IFRS 9 3.2.6 (a)). Accounting entries made by Entity A are as follows:
Derecognition of trade debtors
Provision for retained credit risk (liability not netted with trade debtors)
Derecognition loss (PNL)
IFRS 9 is silent on the PNL line item in which the derecognition gain/loss should be presented. The classification in PNL should be consistent with the classification of proceeds in the statement of cash flows.