This site uses cookies to provide you with a more responsive and personalised service. By using this site you agree to our use of cookies. Please read our privacy policy for more information on the cookies we use and how to delete or block them.
Article:

Debt factoring of trade receivables under IFRS 9

15 May 2018

In this article, we take a closer look at how debt factoring could result in trade receivables being measured at fair value rather than amortised cost under IFRS 9.

 

Accounting for factoring arrangements

Debt factoring, or invoice discounting, is a widely used method of financing for many entities. It typically involves the sale of trade receivables (at a discount) to a factoring company in exchange for the rights to cash collected from those receivables. Some factoring arrangements transfer substantially all the risk and rewards of the receivables, resulting in an accounting derecognition by the seller, whereas others do not. This derecognition analysis can be complex and has been the main accounting issue posed by factoring arrangements under IAS 39.

This will continue to be the case under IFRS 9 as the derecognition requirements are unchanged. However, IFRS 9 also introduces another issue because, under the new classification model for financial assets, factoring can affect how the trade receivables are classified and measured.  

 

How factoring interacts with the new classification model

Under IFRS 9, a financial asset is classified based on two criteria:

  1. The business model within which it is held (see June 2017 edition of Business Edge)
  2. Whether its contractual cash flows meet the solely payments of principal and interest (SPPI) test.

Under IFRS 9, an accounting derecognition is considered a sale for the purposes of assessing the business model; consequently, factoring that results in derecognition must be taken into account as part of the assessment (see October 2017 edition of Business Edge).

This means that entities that factor some or all of their trade receivables may be unable to conclude that those receivables are part of a ‘hold to collect’ business model which would preclude amortised cost classification (even if the SPPI test is met). This means that classification at Fair Value through Other Comprehensive Income (FVOCI) or at Fair Value through Profit or Loss (FVPL) may be required.
 

BUSINESS MODEL

Hold to collect

Hold to collect and sell

Other

CASH FLOW TYPE

SPPI

Amortised cost

FVOCI

FVPL

Other

FVPL

FVPL

FVPL

 

 

 

 

 


The examples below illustrate some common scenarios that could arise.   

1 – Mixed portfolio

Company A holds a portfolio of trade receivables which meet the SPPI test and are either held to collect their cash flows or are subject to factoring arrangements that result in derecognition. In the past, factoring has been frequent and significant in value but this depends on the day to day liquidity needs. At initial recognition, it is not known which receivables will be subject to factoring.

In this example, the portfolio of trade receivables is likely to fail the ‘hold to collect’ test and instead meet the ‘hold to collect and sell’ criteria. This is because cash flows are being generated through a combination of collection and sales (by factoring) and it is not known at initial recognition which receivables will be factored. This would result in a FVOCI classification meaning that Company A would be required to maintain both fair value and amortised cost (including Expected Credit Losses) accounting records.

2 - Segregated portfolio

Company B holds a portfolio of trade receivables which meet the SPPI test. The trade receivables relate to customers in two different countries; Country X receivables are held to collect their cash flows whereas Country Y receivables are always subject to factoring arrangements (as payment terms in that region are much longer than average). The factoring arrangement results in derecognition.

Here it seems likely that Company B will in a position to segregate its portfolio and apply different business models to each sub-portfolio. Country X receivables would be in a ‘hold to collect’ business model and classified at amortised cost whereas Country Y receivables would be in an ‘other’ business model (‘hold to sell’) and classified at FVPL.

 

What is the effect on the business model if the factoring arrangement does not result in derecognition?

Some factoring arrangements do not result in an accounting derecognition, eg if the seller legally transfers the rights to the cash flows to a factoring company but retains the bad debt risk by providing a guarantee. Whether legal form sales of this nature should be taken into account when assessing the business model is not specifically addressed in IFRS 9 and consequently, this is likely to be an area of judgment and accounting policy choice. This is because the arrangement changes how the seller generates cash flows, ie the seller receives a cash payment immediately from the factor, with the factor being entitled to the contractual cash flows from the receivables.

This means that when assessing the business model, some entities will choose to include legal form sales under which the rights to cash flows from the trade receivables have been transferred to another party, whereas other entities will choose to only include sales that meet the accounting derecognition requirements.

 

What action is needed?

Businesses that use debt factoring should take the following steps in order to determine whether their trade receivables should be measured at fair value or amortised cost:

  1. Identify those factoring arrangements that do result in an accounting derecognition which are required to be considered when assessing the business model
  2. Identify those factoring arrangements that involve a legal form sale but do not result in an accounting derecognition and exercise judgment in making an accounting policy choice as to whether they are to be taken into account in the business model assessment
  3. Consider whether it is possible to segregate portfolios into more than one business model (similar to Example 2 above).

Finally, entities should be aware that a similar issue arises in the context of securitisation structures. This is because, in many cases, these structures also involve an entity transferring the rights to cash flows arising from a group of receivables to another entity which may, or may not, result in the seller achieving an accounting derecognition. If both entities form part of the same consolidated group, this could result in the business model at an individual entity level being different from the business model at consolidated group level (ie FVPL in the originator’s books as opposed to amortised cost in both the securitisation vehicle and the group’s books).

For help and advice on IFRS 9 please get in touch with your usual BDO contact or Dan Taylor.

Read more on IFRS 9:

Assessing for Significant Increases in Credit Risk under IFRS 9

Hedge Accounting Documentation

Issued financial guarantees

Hedge Accounting - policy choices available on transition

Solely Payments of Principal and Interest

Business Models

The new expected credit loss model

Modifications of financial liabilities

Classification of financial assets

Hedge effectiveness thresholds

Impairment and the simplified approach

Available For Sale Financial Assets
 

Business Edge Index