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CA Intermediate · Financial Management and Strategic Management · Financing of Working Capital

Mehta Textiles sells goods on credit and has entered into a non-recourse factoring arrangement with a factor for its receivables. A customer approved by the factor becomes insolvent and fails to pay. Who bears the loss on this debt?

The factor bears the loss. Under non-recourse factoring the factor takes over the credit risk on receivables it has approved, so when an approved customer becomes insolvent it cannot recover the advance from the client. Only under recourse factoring would the seller bear the loss.

  1. AMehta Textiles, because the factor can recover the advance from it
  2. BThe factor, because it has no right of recourse against the client for approved debtsCorrect
  3. CThe customer's bankers, who must pay on its behalf
  4. DThe loss is shared equally by Mehta Textiles and the factor

Explanation

In non-recourse factoring the factor buys approved receivables and takes on the credit risk. If an approved customer defaults through insolvency, the factor absorbs the loss and cannot claim it back from the client. The option naming Mehta Textiles describes recourse factoring, which is the wrong type here.

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