Since my post about Receivable Factoring Guide, many of you asked me a typical question; “what is journal entry for factoring of accounts receivable?” To sum-up the factoring mechanism; when factoring accounts receivable, the receivables are sold to a finance company. The factor buys the accounts receivable at a discount from face value, typically at a discount of 6 percent. Customers are usually notified. The factoring arrangement is usually without recourse, where the risk of un-collectibility of the customer’s account rests with the financing institution. Billing and collection is typically done by the factor. The factor charges a commission ranging from 3/4 percent to 11/2 percent of the net receivables acquired.

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The Journal Entry is:

[Debit]. Cash (proceeds)
[Debit]. Loss on sale of receivables
[Debit]. Due from factor (*)
[Credit]. Accounts receivable (face amount of receivables)

Note: (*) proceeds kept by factor to cover possible adjustments such as sales discounts, sales returns and allowances.

Factoring is usually a continual process. The seller of merchandise receives orders and transmits them to the factor for acceptance; if approved, the goods are shipped; the factor advances the money to the seller; the buyers pay the factor when payment is due, and the factor periodically remits any excess reserve to the seller of the goods. There is a continual circular flow of goods and money among the seller, the buyers, and the factor. Once the agreement is in effect, funds from this source are spontaneous

Factoring is usually a continual process. The seller of merchandise receives orders and transmits them to the factor for acceptance; if approved, the goods are shipped; the factor advances the money to the seller; the buyers pay the factor when payment is due, and the factor periodically remits any excess reserve to the seller of the goods. There is a continual circular flow of goods and money among the seller, the buyers, and the factor. Once the agreement is in effect, funds from this source are spontaneous.

Case Example:

Royal Bali Cemerlang factors $200,000 of accounts receivable. There is a 4 percent finance charge. The factor retains 6 percent of the accounts receivable. Appropriate journal entries are:

[Debit]. Cash = $180,000
[Debit]. Loss on sale of receivables (4% × $200,000) = $8,000
[Debit]. Due from factor (6% × $200,000) = $12,000
[Credit]. Accounts receivable = $200,000

 

Factors provide a dependable source of income for small manufacturers and service businesses.

One more case example:

You need $100,000 and are considering a factoring arrangement. The factor is willing to buy the accounts receivable and advance the invoice amount less a 4 percent factoring commission on the receivables purchased. Sales are on 30-day terms.A14 percent interest rate will be charged on the total invoice price and deducted in advance. With the factoring arrangement, the credit department will be eliminated, reducing monthly credit expenses by $1,500. Also, bad debt losses of 8 percent on the factored amount will be avoided. To net $100,000, the amount of accounts receivable to be factored is:

Account Receivable Factoring 

The effective interest rate on the factoring arrangement is:

0.14/0.82 = 17.07%

 

The annual total dollar factoring cost is:

 

Interest (0.14 × $121,951) = $17,073
Factoring (0.04 × $121,951) = 4,878
————————————————– (+)
Total cost = $21,951

 

Hope this post explains what journal entry for factoring of account receivable is.