Factoring With Late Payment Risk Retained – FAQ | IFRS

Factoring with late payment risk retained

This is an illustration of how derecognition is applied in practice. The objective is to present the mechanics of applying the IFRS 9 requirements for derecognition of financial assets, starting with an analysis of the transaction using the flowchart [IFRS 9 B3.2.1], and culminating with the initial and subsequent accounting entries for both the transferor and transferee.

Background and assumptions

Entity L enters into an agreement on 1 January 20X1 to assign its portfolio of €20 million trade receivables to factor M. M pays L €19.5 million in cash for the rights to the cash flows from the receivables. As M is a banking subsidiary of an insurance company, it assumes the default risk. The receivables have 60-day terms and are subject to normal warranties on the existence of the receivables at the date of the transfer (for example, if a customer returns the goods purchased because they are faulty – the receivable does not exist – L will pay M the face amount of the receivable). The debtors have not been notified that their receivables have been transferred. L will pay interest (at Euribor set at the date of transfer + 50bps) to M should any of the receivables pay late for up to 210 days after their due date. After 210 days, the receivables will be considered defaulted, and the factor will suffer any further loss. Historically, an average of 30% of customers pay late, and an additional 1.25% of customers default.

L has determined that both credit risk and slow-payment risk are significant risks of its trade receivables. L has performed an analysis that shows that some significant risk has been transferred and some significant risk has been retained.

Note that continuing involvement is a unique accounting model for which little guidance is provided in IAS 39. There may therefore be other acceptable ways to account for the following transaction.

Additional information:

  • Fair value of portfolio of trade receivables on date of transfer – €19.35 million
  • Carrying value of portfolio of trade receivables on date of transfer – €20 million
  • Fair value of late payment guarantee on date of transfer – €0.15 million
  • 270 day Euribor on date of transfer – 3.3%
  • L continues to service the receivables and is adequately compensated for doing so

Analysis using the flowchart [IFRS 9 B3.2.1]

Step 1 Consolidate all subsidiaries

This step is not applicable in this example.

Step 2 Determine whether the derecognition model should be applied to part of a financial asset (or a group of similar financial assets) or a financial asset (or a group of similar financial assets) in its entirety.

The financial instruments being transferred have similar characteristics. The trade receivables have similar credit ratings and mature at approximately the same date (60 days). They should be assessed as a group of similar financial assets.

Step 3 Have the rights to the cash flows expired?

No, the portfolio of receivables has not yet reached maturity so the rights to the cash flows still exist.

Step 4 Is there a transfer?

Yes, entity L has assigned the rights to the cash flows from the receivables to factor M; therefore there has been a transfer under IFRS 9 3.2.4 (a). Although L has provided normal warranties, these relate to business risks of the underlying transaction, which affect the existence of the receivable rather than the financial risks associated with the receivable itself and do not prohibit a transfer of rights to cash flows. In addition, although the debtors have not been notified that their receivables have been transferred, this does not preclude this transaction meeting the definition of a transfer, as L is only servicing the receivables and has no rights to cash flows from them. Therefore L has transferred its rights to the cash flows to M.

Step 5 Risks and rewards analysis

Before the transaction, L was exposed to all the risks of the receivables, both credit default risk and late payment risk. After the transaction, L has only retained the late-payment risk up to 210 days.

The credit risk and the slow-payment risk beyond 210 days have been transferred to the factor.

Therefore, according to L’s analysis, it has neither retained nor transferred substantially all the risks and rewards relating to the receivables.

Step 6 Control

Factor M does not have the practical ability to sell the receivables unilaterally. There is no market in trade receivables, and should M sell the receivables, it would have to do so with the attached late-payment guarantee. That guarantee as well as the servicing is an additional restriction, hence L still controls the receivables. Therefore L will continue to recognise the receivables to the extent of its continuing involvement.

Transferor’s accounting

On the date of the transfer

As entity L has neither retained nor transferred substantially all the risks and rewards of ownership of the receivables, and factor M does not have the practical ability to sell the receivables, L should continue to recognise the receivables to the extent of its continuing involvement. The extent of L’s continuing involvement is the extent to which it is exposed to changes in the value of the receivables, which in this case is the late-payment guarantee. The continuing involvement asset is the lower of the amount of the receivables and the maximum amount of consideration received that L could be required to repay. The associated liability will be the amount of the continuing involvement asset plus the fair value of the late-payment guarantee (in this case, €150,000). This results in the net position on the balance sheet of the continuing involvement asset and liability being the fair value of the late payment guarantee.

The continuing involvement asset is calculated as follows:

Amount of receivables

20,000,000

– Interest rate

3.30%

– Number of days /360

210/360

‘= Continuing involvement valuation

385,000

Accounting entries on the date of the transfer (1 January 20X1)

(in €)

DR

CR

Cash

19,500,000

Receivables

20,000,000

Continuing involvement asset

385,000

Continuing involvement liability

(the guaranteed amount + FV of guarantee of €150k)

535,000

Loss on transfer

650,000

To recognise entity L’s continuing involvement in the form of a late-payment guarantee.

Subsequent accounting

Subsequently, over the next 270 days as the receivables repay, the continuing involvement asset and liability will decrease similarly. In addition, the initial fair value of the guarantee will be amortised in profit and loss. An impairment charge on the asset will be taken if a payout is required under the guarantee.

For example, assume entity L prepares an interim set of financial statements at 30 June 20X1 and at that time 20% of receivables still have not paid (the remaining 80% paid within 60 days). The journal entries for the transaction under continuing involvement would be as follows:

(in €) Factoring with late payment risk retained

DR

CR

Continuing involvement liability Factoring with late payment risk retained

308,000

Continuing involvement asset Factoring with late payment risk retained

To decrease the continuing involvement asset and liability to reflect that 80% paid on time; therefore no payment will be required under the late payment guarantee (80% * 443,333 = 354,667)

308,000

Cash paid out under late payment guarantee as late for 120 days now (20,000,000* 20% *3.8%*120/360)

44,000

Continuing involvement liability Factoring with late payment risk retained

To recognise the payment made under late payment guarantee

44,000

Other income – amortisation of guarantee fee

(4 months/7 months of 20% of 150,000=17,143) + (80% of 150,000 = 120,000) in full as has been repaid)

137,143

Continuing involvement liability Factoring with late payment risk retained

To amortise the guarantee fee Factoring with late payment risk retained

137,143

Impairment charge in profit and loss Factoring with late payment risk retained

44,000

Continuing involvement asset Factoring with late payment risk retained

To impair the asset to reflect the payout under the late payment

guarantee

44,000

After these entries have been made, the resulting continuing involvement asset is €33,000. This represents the maximum remaining payout on the 20% that has not yet paid. The resulting continuing involvement liability is € €45,857. This represents the €33,000 for the 20% that has not yet paid + remaining fee of €12,857 yet to be amortised.

Note: if the guarantee fee is insufficient to cover the losses, an additional provision would need to be recognised in accordance with IAS 37, ‘Impairment of assets’.

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