2. Accounting for Factoring - Purpose
The purpose of this presentation is to provide a simple “how to”
guide to accounting for factoring arrangements.
• Many companies that may be tight on cash choose to factor
their accounts receivable in order to bring in cash more
quickly.
• Many companies are challenged by how to record these
complex entries.
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Scenario Assumptions
Let’s assume that XYZ Company enters into a factoring arrangement with a bank or some
kind of financial institution that we’ll call “First McLean Bank.”
First McLean Bank offers to advance 85% of the valid accounts receivables.
XYZ factors $10,000 of invoices with the Bank
The factoring fee is 3%
Funds transfer fee is $20 from First Mclean Bank to XYX’s commercial checking account.
Assume that the bank transfer fees are netted against the advance received.
Interest on outstanding advances is calculated at 2% monthly.
Receivables are assigned to First McLean Bank. That means customers pay First Mclean, not XYX.
* We must create an account for “Factoring advances” in our Chart of Accounts. This can be done within the Current
Asset section of the balance sheet as a “contra asset” or it can be created within the liability section as a current liability.
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Initial Credit Sale
Factoring only happens when there are credit sales and
collection against accounts receivables is expected.
Assuming XYX invoiced customers for $10,000 on credit, we
would have initially recorded the following entry:
Debit Accounts Receivable $10,000
Credit Sales $10,000
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Step 1: Factoring Advance
XYZ Co. decides to factor the $10,000 of invoices with First Mclean Bank. The advance rate is 85%,
the factoring fee is 3%, and the fee for the bank transfer (i.e. wire or ACH) is $20. The entry to record
the cash received and the fees is:
Debit Cash $8,480 => (85% * $10,000 less the $20 bank
fee)
Debit Factoring Fee $ 300 => ( 3% * $10,000)
Debit Bank Transfer fee $ 20
Credit Factoring Advance $8,800
* Notice that Accounts Receivable is not affected. So what happens to the $1,200 difference between
the value of the invoices factored and the total advance? That is the “escrow reserve” held by the
factoring company. First Mclean Bank’s books will show a “reserve account for $1,200. We can
calculate the cumulative reserve in XYX’s books by calculating the difference between total factored
Accounts Receivable ($10,000) and the Factoring Advance ($8,800), or $1,200.
6. Factoring Advance- Recording of Cash
It’s Important to note that the Advance is not a payment of
receivables. It is a loan. Accounts Receivable is not affected
by the factoring advance.
Do not post factoring advances against outstanding accounts
receivable!
7. Step 2 – Recording of Interest Expense
Most factoring agreements include periodic interest charges
calculated upon outstanding factoring advances. Let’s assume that
after one month, the entire balance of $10,000 remains outstanding.
First Mclean Bank charges 2% monthly interest on outstanding
advances. In a previous slide (“Step 1”) we determined the factoring
advances was $8,800. The journal entry would be:
Debit Interest expense $176 => (2% * $8,800)
Credit Factoring Advance account $176
8. Step 3 Payment of Factored Receivables
Let’s assume now that the customer(s) pay the $10,000 balance
in full. Since the receivables were assigned to the factoring
company, the $10,000 cash is received by First Mclean Bank,
not XYZ. Cash at XYZ company is unaffected! The offset to
receivables is a reduction in the advance! The entry is
Factoring Advance $10,000
Accounts Receivable $10,000
9. Step 4 Return of Escrow Reserve
Now assume that after one month, the entire $10,000 accounts receivable balance is
paid by customers to the factoring company. The factoring advance is now $8,976
($8,800 initial advance + $176 1st month’s interest). When the receivables were paid, we
debited a factoring liability account for $10,000. After customer payment, the reserve
balance is negative $1,024 ($8,976-$10,000). That means that the First McLean Bank
now owes XYZ Co $1,024! First Mclean Bank will now zero out the “escrow reserve” and
record the balance of funds received in a “cash reserve” account. The “escrow account”
is now $0.
So how does the Factoring Advance account in XYX’s books return to 0? It happens
when First Mclean Bank returns the funds to XYZ Co. Remember, there will likely be
another bank fee for the funds transfer. The entry for the return of reserve funds is:
Debit Cash $1,004
Debit Bank Transfer fee $ 20
Credit Factoring Advance $1,024
10. Summary
Now we are back to where we started, with the return of the reserve:
XYZ’s factoring advance account is =>$0
The Bank’s escrow reserve account is = > $0
The Bank’s cash reserve account is => $0
With each new factoring of receivables, we restart the process
and repeat steps 1-4.
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END
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