Assigned and factoring Accounts Receivable

Assignment Financing

• Definition: A method where a company uses its accounts receivable as collateral to borrow money.

• Process:

  • Company assigns accounts receivable to a lender as collateral.

  • If the company defaults on the loan, the lender takes control of the assigned accounts receivable.

• Fees:

  • Finance charge and interest rate are applicable based on how long it takes to pay back the loan.

  • Companies seek assignment financing to improve liquidity and ensure immediate cash flows.

Factoring

• Definition: The sale of accounts receivable to another company or financial institution, known as a factor.

• Purpose: Companies sell their accounts receivable to obtain immediate cash rather than waiting for customers to pay.

• Mechanics of Factoring:

  • A selling company receives cash upfront but at a discount; the factoring company deducts a commission.

  • The factor retains a portion of the accounts receivable to cover potential losses (bad debts).

Differences Between Assignment and Factoring

• Assignment:

  • Using accounts receivable as collateral for a loan.

  • Borrowed money calculated based on a percentage of assigned accounts receivable, less any fees.

  • Interest is calculated on the borrowed amount.

• Factoring:

  • Selling accounts receivable to a factor.

  • The entire accounts receivable amount reduces, and the factor provides a percentage of the total, holding back some as security.

  • Commission charged as an expense.

Accounting Entries

Assignment Accounting

• Initial Entry:

  • Debit: Assigned Accounts Receivable (for the amount assigned)

  • Credit: Note Payable (for the amount of cash received minus any service fees)

• Interest Entry:

  • Calculate interest using: Interest = Principal × Rate × Time/12

  • Debit: Interest Expense

  • Credit: Cash (upon repayment)

• Cash Collection:

  • When a payment is received:

    • Debit: Cash (for amount collected)

    • Credit: Assigned Accounts Receivable (for the amount paid off)

Factoring Accounting

• Initial Entry:

  • Debit: Factoring Expense (for commission amount)

  • Debit: Receivable from Factor (the amount retained by the factor)

  • Credit: Accounts Receivable (total value factored)

  • Credit: Cash (the amount received after factoring fees)

Examples and Scenarios

• Assignment Example:

  • Company assigns 60% of accounts receivable to a lender, with a lender advancing 80% after service charge and interest.

  • Interest noted after every period, calculating based on outstanding principal.

• Factoring Example:

  • A company sells $2,450,000 worth of accounts receivable at a 15% commission.

  • The company retains 4% of the amount factored as security.

Key Points to Remember

• Always calculate interest on the amount borrowed, not on the total accounts receivable.

• When factoring, use the gross amount for calculating commission fees and maintain a balance in your accounting entries.

• The accounting treatment for factoring can sometimes differ based on whether it’s the first instance of factoring or subsequent instances, with terminology slightly varying between 'factoring expense' and 'loss on factoring' based on context.

In the context of factoring, the factor is a financial institution or company that purchases accounts receivable from another company, providing immediate cash in exchange for the right to collect payments from customers. The factor typically charges a commission and retains a portion of the receivable to cover potential losses (bad debts). This allows the selling company to improve cash flow and liquidity without waiting for customers to pay their invoices.