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IAI Actuarial Core Principles · Business Finance · Financial instruments issued or used by companies

Under a factoring arrangement with recourse, Kaveri Textiles sells its trade receivables to a factor. Which statement is correct?

With recourse factoring, Kaveri must repay the factor for any invoices customers fail to pay, so bad debt risk stays with Kaveri. Only non-recourse factoring passes credit risk to the factor, and in either case the arrangement reduces administration costs but does not remove them.

  1. AThe factor bears the bad debt risk and Kaveri has no further exposure
  2. BKaveri must repay the factor for any invoices that the customers fail to payCorrect
  3. CKaveri's customers are never aware of the arrangement
  4. DThe arrangement always reduces Kaveri's administration costs to zero
  5. Recourse factoring is the same as invoice discounting without any credit risk transfer to the firm

Explanation

With recourse, the credit risk stays with the seller: if a customer defaults, the factor can claim the amount back from Kaveri. Non-recourse factoring transfers bad debt risk to the factor. Customers are usually aware in factoring, and costs are reduced but not eliminated.

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