Factoring in its various forms is not new, whether in the context of regular bilateral factoring agreements, reverse factoring or structured transactions using special purpose vehicles in asset-backed securities or asset-backed commercial paper transactions. However, in times of a pandemic and persistent uncertainties, factoring agreements take on a special significance as a way of procuring liquidity. For many companies, the adage "cash is king" once again applies. Factoring is an excellent way of easing a liquidity crunch by selling and prefinancing customer receivables. 

But there are a few stumbling blocks to avoid when it comes to signing a new factoring agreement. To achieve a contract that is acceptable to all parties, an early involvement of the accounting and legal departments is of the essence. The treasury department generally focuses on the advantages of the agreed financing terms and conditions. But since the accounting treatment of the factoring transaction depends heavily on how the contract is drawn up, accounting should be involved well before the contract is signed. Essentially, the question is whether the sold receivables may be derecognized from the balance sheet or whether they just serve as collateral for the financing received from the bank. As a result, the structure of a factoring agreement can have a considerable impact on the balance sheet total, and accordingly also on the equity ratio. Particularly in the case of leveraged companies, which have to comply with certain covenants imposed by the financing banks, the issue of recognizing a new factoring agreement in the balance sheet may actually become more important and override the purely economic consideration of the contractual terms.

The issue of derecognizing sold receivables is usually complex and can only be assessed by looking at the individual circumstances and the terms of the relevant contract. Often, the devil is in the details. IFRS 9.B3.2.1 provides a basic method for the accounting process.

The key issues are the transfer of

  1. the right to collect the cash flows from the receivables sold,
  2. the significant risks and rewards,
  3. the right of disposal.

In most cases, items 1 and 3 can be covered by wording a contract clearly. It is at this point that it is worth seeking the advice of experts before the contract is signed, in order to avert any unpleasant surprises and to prevent contractual clauses that could stand in the way of a derecognition in the balance sheet that could have easily been avoided. The transfer of significant risks and rewards, by contrast, more strongly impacts the economic aspect of the factoring agreement. Relevant aspects are, for example, the debtor default risk, foreign currency risks and the risk of late payments. In any event, the contract must be drafted in such a way as to ensure that not all risks and rewards remain with the seller in substance. If this is ensured, it is possible that the transfer of the right of disposal will result in a derecognition for accounting purposes, even if the majority of the risks and rewards have not been transferred. The transfer of risks and rewards should be assessed based on the variability of cash flows, which usually requires appropriate modeling. 

If you are looking for support in negotiating new factoring agreements or would like to optimize the processing of sold receivables, please contact our accounting and valuation experts in the Finance and Treasury Management team.

Source: KPMG Corporate Treasury News, Edition 111, May 2021