... risk management and accounting
Factoring has been used as an instrument to manage liquidity and credit risks at many entities for some time now. Nevertheless, there are always questions when factored receivables are to be recognised according to international accounting rules, especially in terms of classification and measurement. With the introduction of IFRS 9, the new financial instrument standard for recognising financial instruments, accounting has become even more complicated from this year and entities must now scrutinise their existing processes and methods. In this article, we look at a selection of practical issues and show why central monitoring of factoring transactions makes sense.
First, a general classification and definition of factoring as part of credit risk management is helpful, which typically involves a distinction between four approaches:
The general effects and, thus, also the advantages of factoring and similar models are well known, with a number of design options existing in practice. The basic idea is to transfer an entity's trade receivables to a purchaser of receivables. In return, the purchasing entity receives a consideration for providing immediate liquidity and for the transfer of risk, or rather retains a safety margin. The selling entity thereby benefits in general from reduced credit risk and accelerated receipt of payment, because there is no need to monitor customers' observance of their payment terms. In practice, besides the sale of individual receivables and receivables portfolios (e.g. via factoring), securitised transactions (e.g. via asset-backed securities or ABS) have also established themselves, which involve a pool of receivables being transferred to a special purpose vehicle which, in turn, is refinanced through the issuance of securities.
The following requirements are paramount for the accounting of receivables under international financial reporting (IFRS):Accounting matter/point in time
|Accounting matter/point in time||Requirement of IFRS 9|
|Initial recognition and subsequent measurement of the customer receivable (prior to sale)||Assessment of cash flow characteristics and determination of business model (new)|
|Derecognition of customer receivable (upon sale or settlement)||Evaluation of the transfer of risks and rewards arising from the sale (unchanged)|
The financial reporting of the sales transaction under IFRS 9, i.e. the criteria for assessing the risks and rewards that remain with the entity, were taken from IAS 39 and, thus, are not addressed further here. However, it is important to note that the transfer of the significant risks and rewards to the purchaser of the receivables can lead to the receivable being derecognised. Accounting optimisation of working capital is often another important objective of the factoring programmes. If significant risks and rewards remain at the entity, i.e. it largely retains the credit risk, then the receivable remains fully or at least proportionately in the entity's books. Furthermore, in the case of securitised transactions, any consolidation of the special purpose vehicle pursuant to IFRS 10 must be examined.
In this respect, IFRS 9 completely revises the manner in which entities classify and measure receivables, which is addressed in greater detail later on. This is also relevant for factored receivables that are derecognised, as this derecognition generally does not occur immediately in practice.
While the characteristics of the contractual cash flows are crucial for classification according to IFRS 9, the business model in which the entity manages the receivables is also decisive. Trade receivables are held by entities with the primary goal of collecting the contractual cash flows and, thus, are typically to be assigned to the "hold to collect" business model. This enables measurement at amortised cost (with the assumption that the cash flow characteristics are adhered to, which for simple trade receivables is generally the case in practice).
However, if receivables are sold within the scope of factoring or ABS transactions and (later) derecognised, the business model is no longer (only) to collect contractual cash flows upon maturity of the receivables, as assignment/sale is key for the matter of control. Thus, factoring in the context of a factoring programme is typically based on a liquidity management objective, meaning that assigning assets to a "hold to collect" business model no longer appears appropriate. The assets are measured at fair value in this case.
Furthermore, it may be necessary to break down the portfolio of receivables into different sub-portfolios if they are held within different business models. This would be the case, for example, if the factoring programme selected receivables according to specific criteria, such as currency or rating. The receivables remaining outside the programme will continue to be assigned to the "hold to collect" business model and are to be recognised at amortised cost.
If a factoring programme has not been set up centrally but instead is operated only by a subsidiary, for group accounting purposes, the business model must still be determined by key management personnel within the meaning of IAS 24. In trade relations with countries such as China, export financing through letters of credit (L/C), forfaiting and similar structures is very popular because the exporter is guaranteed an up-front payment through the sale of receivables (with a certain markdown). For cases that may affect significant amounts of receivables at international groups, also, a precise assessment must be made regarding which business model to determine specifically in order to ensure proper classification of the financial instruments in the financial statements.
IFRS 9 has not made accounting for factoring and the underlying receivables any easier. The relevant requirements and the determination of business model should be centrally stipulated and coordinated in order to ensure accurate presentation in the IFRS consolidated financial statements. This means firstly creating group-wide transparency concerning the corresponding programmes and sales activities – even if local units operate largely independently – and then establishing consistent accounting policies, processes and documentation.
Source: KPMG Corporate Treasury News, Edition 85, October 2018
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