Reserves and retentions held back from factoring clients · IFRS 9 / IAS 32

In plain words

A factoring company usually pays most of an invoice upfront and keeps the rest back until the customer pays. If the factor bought the invoices, the amount kept back is money it owes the business. If the factor only lent money against the invoices, it records just the loan and owes nothing extra yet. The amount owed to the business is not netted against money owed by the business's customers.

Why it matters

Factors rarely pay 100% of the invoice price upfront. They advance a percentage and hold back the rest as a reserve or retention, paid to the client when debtors pay, after deducting charges, credit notes and disputed amounts. How that reserve is recorded depends on what the factor has recognised. If it bought the receivables, the reserve is usually deferred purchase price owed to the client and is a financial liability. If it holds a recourse loan to the client, there is no reserve liability at all, because the factor has recognised only the amount advanced. Factors often get this wrong by grossing up assets and liabilities, or by netting the reserve against receivables owed by different counterparties, which distorts total assets, leverage and concentration figures.

Diagnostic questions

Has the factor recognised the full invoices as purchased receivables, or only the amount advanced as a loan to the client? Under the contract, what can be deducted from the reserve: discount charges, fees, credit notes, disputed invoices, unpaid invoices? Does the reserve absorb debtor credit losses, so that it is in effect a first-loss piece retained by the client, which may affect whether the client derecognised at all? Does the factor have a legally enforceable right to set off the reserve against amounts owed by the same client, and does it intend to settle net? When is the reserve released: invoice by invoice on collection, periodically, or at the end of the facility?

Recognition

Start from the conclusion in BANK-074 on what the factor has recognised.
Purchased receivables: recognise the receivables at the purchase price and the unpaid part of the price as a financial liability to the client (reserve or deferred purchase price), since the factor has a contractual obligation to pay it.
Recourse loan: recognise only the cash advanced as a loan to the client; do not recognise the full invoices or a reserve liability. When collections from debtors exceed the loan and charges, the excess is cash held for the client and becomes a liability at that point.
Reduce the reserve liability for deductions the contract allows, such as credit notes and dilutions the client must bear, with a corresponding reduction in the purchased receivables or a claim on the client.
Do not offset the reserve liability (owed to the client) against purchased receivables (owed by debtors), because the counterparties differ.
Offset the reserve against a recognised receivable from the same client only if the factor has a currently legally enforceable right of set-off and intends to settle net or simultaneously.
Derecognise the reserve liability when it is paid to the client or otherwise extinguished under the contract.

Measurement

The reserve liability is a financial liability measured at amortised cost, which for short-dated reserves is the amount contractually payable to the client, reduced by deductions the contract permits. Where the reserve is payable only if and when debtors pay and absorbs debtor losses, it is a sign that the client may have retained credit risk; if derecognition is still achieved, the liability reflects the amount expected to be payable under the contract. Release is measured at the amount paid, and any difference between the liability and the amount paid is recognised in profit or loss.

Presentation & disclosure

Disclose: (1) the policy for reserves and retentions and the basis on which they are recognised; (2) the carrying amount of reserves owed to clients, presented separately from purchased receivables; (3) any amounts offset and the related offsetting disclosures; (4) the role of reserves as credit enhancement in measuring ECL on client exposures; (5) liquidity disclosures for reserves payable on collection.

Common mistakes

Recognising the full face value of invoices and a reserve liability under recourse factoring, inflating total assets and liabilities
netting reserves owed to clients against receivables owed by debtors
treating the reserve as income or as a provision
releasing reserves without first deducting credit notes and disputes the client must bear
ignoring that a reserve absorbing debtor losses may mean the client has not transferred substantially all credit risk
omitting reserves from liquidity analyses

Simple example

A Cairo factoring company buys EGP 20,000,000 of invoices without recourse for credit risk; the client remains liable for credit notes and disputes, and the transfer qualifies for derecognition by the client. The purchase price is EGP 19,600,000 (face value less a discount of EGP 400,000). The factor pays 80% of face value (EGP 16,000,000) now and holds the rest as a reserve.
Reserve = 19,600,000 - 16,000,000 = EGP 3,600,000.
Journal entry at purchase:
Dr Purchased receivables 19,600,000
Cr Cash 16,000,000
Cr Reserve payable to client 3,600,000
Shortly after purchase, before any discount has accreted, the client issues a credit note of EGP 500,000 on one invoice. The carrying amount of that invoice in the factor's books is EGP 490,000 (its share of the discount being EGP 10,000), and the contract lets the factor deduct the full face value from the reserve:
Dr Reserve payable to client 500,000
Cr Purchased receivables 490,000
Cr Interest income - discount 10,000
When the remaining invoices of EGP 19,500,000 are collected, the factor releases the reserve balance of EGP 3,100,000 to the client:
Dr Reserve payable to client 3,100,000
Cr Cash 3,100,000
(Under a full-recourse facility, the factor would recognise only a loan of EGP 16,000,000 to the client, with no purchased receivables and no reserve liability.)

Professional judgment

Judgment is needed where the reserve both settles deferred price and absorbs debtor losses: the factor must consider whether the client has retained so much credit risk that the transfer fails derecognition, in which case the analysis in BANK-074 changes the whole picture. Offsetting requires legal analysis of the set-off right in the normal course of business and on insolvency of the client. The pattern of releases, and whether reserves are pooled across invoices, also affects whether reserves are an effective credit enhancement on client exposures.

Source basis

IFRS 9 / IAS 32 · Financial Instruments / Financial Instruments: Presentation

Paragraph references

IAS 32.42IAS 32.AG38B–AG38DIFRS 9.3.3.1IFRS 9.3.2.6

Verified against the official standard texts used in the IFRS Expert skill.

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Educational and navigation content only. Not professional advice. Does not reproduce official IFRS/IAS text. Consult the authoritative standards and qualified professionals; professional judgment may still be required.