What Are Accounts Receivable (A/R) Discounted?

Accounts receivable discounted refers the selling of unpaid outstanding invoices for a cash amount that is less than face value of those invoices. It is an accounting tactic that discounts the value of accounts receivable (AR) on a company's balance sheet in return for cash balances.

Key Takeaways

  • Accounts receivable discounted refers the selling of unpaid outstanding invoices for a cash amount that is less than face value of those invoices.
  • The buyer of the accounts receivable discounted is referred to as a "factor".
  • Accounts receivable are often sold at a discount in order to raise cash quickly and to reduce the risk that debtors will fail to pay in full.

Understanding Accounts Receivable Discounted

Accounts receivable (AR) is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivables are listed on the balance sheet as a current asset. AR is any amount of money owed by customers for purchases made on credit.

Accounts receivable discounted takes outstanding invoices that represent money owed to a creditor (such as a firm) and seeks to sell those uncollected amounts to a buyer for less than face value, typically to quickly raise capital and improve cash flow. The buying firm - also referred to as a "factor" - purchases the financial obligations at a discounted rate providing the selling firm with immediate cash. However, the sale is often undertaken without recourse, meaning that the factor assumes full responsibility for collecting the money owed in order to recoup its financial layout for the account. The vendor/debtor who owed the selling firm money per the receivable would direct its payment to the factor who purchased the financial obligation.

Accounts receivable are often sold at a discount in order to mitigate the risk that the debtor will not satisfy the obligation. The discount arises because the factor assumes the underlying risk of the receivables and must be compensated for the delayed inflow of funds.

Previously only large firms that could meet minimum threshold requirements could enter into a relationship with a factoring firm (typically a large bank) to sell their receivables and obtain much-needed cash, and often with recourse. Today, medium- and small-sized firms operating in virtually all industries (i.e., IT firms, manufacturers, even hospitals) can find ways to sell their A/Rs for a discounted rate to individual factoring firms or through factoring broker intermediaries.

Allowance for Doubtful Accounts

Some debts owed to a firm that are listed as accounts receivable cannot be sold or will not be paid back in part or in full. Under U.S. generally accepted accounting principles (GAAP), expenses must be recognized in the same accounting period that the related revenue is earned, rather than when payment is made. Therefore, companies must estimate a dollar amount for uncollectible accounts using the allowance method.

This estimate for bad debt losses is recorded as both a bad debt expense on the income statement and displayed in a contra account below accounts receivable on the balance sheet, often called the allowance for doubtful accounts. The net of accounts receivable and the allowance for doubtful account displays the reduced value of accounts receivable that is expected to be collectible. Businesses retain the right to collect funds even if they are in the allowance account. This allowance can accumulate across accounting periods and will be adjusted periodically based on the balance in the account and receivables outstanding that are expected to be uncollectible.