Factoring accounts receivable refers to selling its accounts receivable (invoices) to a third party (called a factor) at a discount in exchange for immediate cash. This is commonly done to improve liquidity without waiting for customers to pay their invoices. There are two main types of factoring: with recourse and without recourse. The journal entries for both types differ slightly.
1. Factoring with Recourse
In this case, if the factor cannot collect the receivables, the company is still responsible for any unpaid balances. This involves contingent liability.
Example:
- Accounts Receivable: $10,000
- Cash Received from Factor: $9,000 (due to a discount of $1,000)
- Factoring Fee: $1,000
Journal Entry for Factoring with Recourse:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 09/06/2024 | Cash A/c Debit | 9,000 | |
| 09/06/2024 | Factoring Expense (Fee) A/c Debit | 1,000 | |
| 09/06/2024 | To Accounts Receivable A/c | 10,000 |
Explanation:
- Cash will be debited for the amount received from the factor ($9,000).
- Factoring expenses will be debited to account for the discount/fee charged by the factor ($1,000).
- Accounts Receivable will credited to remove the receivables sold to the factor from the company’s books.
If the factor is unable to collect a specific receivable, the company would recognize a liability for the amount of the receivable that wasn’t paid.
Journal Entry for Unpaid Receivable (if the customer doesn’t pay):
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 09/06/2024 | Accounts Receivable A/c Debit | 500 | |
| 09/06/2024 | To Liability to Factor A/c | 500 |
Explanation:
- Accounts Receivable will debited again because the factor returned the unpaid receivable.
- Liability to Factor will credited to show the amount owed back to the factor.
2. Factoring Without Recourse
In this case, the factor assumes all the risk of collection, and the company is not responsible for unpaid receivables. Once the receivables are sold, they are permanently removed from the company’s balance sheet.
Example:
- Accounts Receivable: $10,000
- Cash Received from Factor: $9,000 (due to a discount of $1,000)
- Factoring Fee: $1,000
Journal Entry for Factoring Without Recourse:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 09/06/2024 | Cash A/c Debit | 9,000 | |
| 09/06/2024 | Factoring Expense (Fee) A/c Debit | 1,000 | |
| 09/06/2024 | To Accounts Receivable A/c | 10,000 |
Explanation:
- The entry is the same as with recourse, but in this case, the company has no obligation to pay back the factor if the receivables aren’t collected.
3. Advance Payments on Factored Receivables
Sometimes the factor will be only advance a portion of the receivables (e.g., 80%) and will pay the remainder after the customers pay the receivables.
Example:
- Accounts Receivable: $10,000
- Cash Received from Factor (80%): $8,000
- Factoring Fee: $1,000
- The remaining amount ($2,000) is due when the customers pay the receivable.
Journal Entry at the Time of Advance:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 09/06/2024 | Cash A/c Debit | 8,000 | |
| 09/06/2024 | Factoring Expense (Fee) A/c Debit | 1,000 | |
| 09/06/2024 | Factored Receivable (Due) A/c Debit | 1,000 | |
| 09/06/2024 | To Accounts Receivable A/c | 10,000 |
Journal Entry When Remaining Amount is Paid:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 09/06/2024 | Cash A/c Debit | 2,000 | |
| 09/06/2024 | To Factored Receivable (Due) A/c | 2,000 |
Conclusion: Factoring is an effective way for companies to improve their cash flow. The journal entries for factoring accounts receivable is vary depending on whether it’s with recourse, without recourse, or if there’s an advance involved. In all cases, the company records the cash received, reduces its accounts receivable, and accounts for the factoring fee.