Accounts Receivables | External Financial Reporting Decision | Section A CMA USA Part 1 | Episode 12

Introduction

This tutorial provides a comprehensive guide on factoring in accounts receivables, including the differences between factoring with and without recourse. Understanding these concepts is crucial for financial reporting and decision-making, especially for those studying for the CMA USA exam.

Step 1: Understand Factoring in Accounts Receivables

Factoring is a financial transaction in which a business sells its accounts receivables to a third party (the factor) at a discount. This allows businesses to receive immediate cash flow instead of waiting for customers to pay their invoices.

Key Points:

• Immediate Cash Flow: Businesses can improve liquidity by selling receivables.
• Risk Transfer: Depending on the type of factoring, the risk of non-payment may be transferred to the factor.

Step 2: Differentiate Between Factoring With and Without Recourse

Factoring can be classified into two main types: with recourse and without recourse. Understanding these distinctions is important for accounting and financial reporting.

Factoring With Recourse:

• The seller retains the risk of non-payment.
• If the customer defaults, the business must buy back the receivable from the factor.
• Typically results in lower fees compared to without recourse.

Factoring Without Recourse:

• The factor assumes the risk of non-payment.
• The seller is not liable if the customer defaults.
• Generally incurs higher fees due to the increased risk for the factor.

Step 3: Record Journal Entries for Factoring

Recording the journal entries for factoring is essential for accurate financial reporting. Here’s how to do it based on the type of factoring.

Journal Entry for Factoring With Recourse:

1. Record the Sale of Receivables:

   • Debit Cash (amount received)
   • Debit Loss on Sale of Receivables (if any)
   • Credit Accounts Receivable (total amount sold)

   Example:

   Debit: Cash $8,000
   Debit: Loss on Sale of Receivables $2,000
   Credit: Accounts Receivable $10,000
   

2. If the Customer Defaults:

   • Debit Accounts Receivable (amount to be repaid to factor)
   • Credit Cash (amount paid to factor)

   Example:

   Debit: Accounts Receivable $10,000
   Credit: Cash $10,000
   

Journal Entry for Factoring Without Recourse:

1. Record the Sale of Receivables:

   • Debit Cash (amount received)
   • Debit Loss on Sale of Receivables (if any)
   • Credit Accounts Receivable (total amount sold)

   Example:

   Debit: Cash $8,000
   Debit: Loss on Sale of Receivables $2,000
   Credit: Accounts Receivable $10,000
   

Conclusion

This tutorial covered the essential aspects of factoring in accounts receivables, including its definition, the differences between with and without recourse, and how to record journal entries properly. Understanding these principles is vital for effective financial decision-making and reporting. For further practice, explore the provided links for notes and multiple-choice questions to reinforce your learning.