Factoring: Challenges of quantitative derecognition analysis according to IFRS and HGB

Factoring programmes offer companies the opportunity to sell their receivables to third parties and thereby improve their liquidity. Both IFRS and HGB regulate whether receivables sold may be derecognised by the seller. In addition to many qualitative requirements, which have already been discussed in detail in previous publications of this newsletter1, this article will focus explicitly on a quantitative aspect of the assessment of derecognition in connection with retained credit risks under IFRS and HGB.

According to IFRS, it must be clarified whether and to what extent risks and opportunities are transferred. To this end, the receivables portfolio must be analysed before and after the transaction. Possible risks such as the credit default risk, the risk of delayed payments or a foreign currency risk must be analysed. The decisive factor here is the variability of the net cash flows from the transferred asset in terms of amount and timing. If it is determined that essentially all risks and rewards have been transferred, the criterion of derecognition is met. If some or all of the risks are retained, the receivables sold may only be derecognised in part or not at all.²

The requirements of the HGB differ from those of IFRS, as the focus here is not on the variability of cash flows, but on the appropriateness of a discount to cover credit risks. A discount is deemed appropriate if it is customary in the market and sufficient to cover the expected actual defaults on the receivables sold. It can be derecognised if the discount is not unreasonably high.3

In practice, the structure of the retention of credit risks plays a decisive role in assessing the ability to derecognise receivables sold, both under IFRS and HGB. The seller can retain credit risks for the transferred receivables to varying degrees. In practice, for example, the following arrangements exist:

• First loss guarantee: The seller assumes a default guarantee up to a certain amount ("first loss"). This means that the seller is liable for a fixed portion of the expected bad debt losses.
• Guarantee account with variable retention: A portion of the purchase price (as a percentage of the nominal value of the receivables) is initially retained and paid into a guarantee account. The purchaser can use this account to cover payment defaults. After a certain period, the remaining amount is paid out to the seller as the subsequent purchase price.

With regard to an entire portfolio of receivables sold, both forms act as a percentage discount to cover credit risks or determine the level of risk retained by the seller. The final purchase price depends on the actual defaults that occur.

In order to fulfil the requirements of both accounting standards, the seller must carry out a quantitative analysis based on the receivables portfolios actually sold. The relevant requirements are defined in both standards. Under IFRS, there is an application example in IDW RS HFA 48, but its application is not mandatory4. To measure the extent to which credit risks are transferred, the present values of forecast cash flows are weighted taking into account expected credit losses for various scenarios with probabilities of occurrence before and after the transaction. The variability is then calculated using the standard deviation before and after the transaction. A non-mandatory example of the evaluation of variability before and after the transaction can be the use of ratios. A ratio below 10% indicates that essentially all credit risks associated with the financial asset have been transferred, so that derecognition is possible. If the ratio is above 90%, the material credit risks have been retained, which means that derecognition is not possible. Between 10% and 90%, neither a complete transfer nor a complete retention of the risks and rewards can be assumed.

The requirements under HGB are much less specific. According to IDW RS HFA 8, the appropriateness of the retained credit risk is deemed to be given if the discount does not exceed the actual expected defaults of the portfolio, taking into account an allowance for the risk of unexpected losses. However, there is no precise definition of the term "unexpected loss".

In practice, both IFRS and HGB often raise the question of how to implement such an analysis in terms of input and methodology for a real portfolio of receivables. Both approaches are initially based on information about the expected default risk of the portfolio at the level of the individual debtors. One challenge is often the availability of internal and external data on debtor-specific default probabilities (e.g. derived from maturity-specific CDS spreads or based on historical defaults). If this information is available, a statement can be made about the expected probability of default.

However, this alone is not sufficient to obtain the required decision measure of the quantitative analysis, which represents a second challenge. Under IFRS, the relevant criterion is the variability of expected credit losses before and after the transaction. Therefore, mathematical-statistical methods should be used to determine a loss distribution for different scenarios with probabilities of occurrence (e.g. Monte Carlo simulation). The variability (e.g. standard deviation) before and after the transaction can then be determined.

In addition to the expected default risk, the HGB also requires unexpected risk to be taken into account. There are no specific requirements for this, but experts recommend also using a loss distribution and a suitable statistical measure to determine the uncertainty (e.g. standard deviation or value at risk).⁵

The assessment of the ability to derecognise receivables in factoring transactions under both IFRS and HGB depends crucially on the extent to which credit risks are retained or transferred by the seller. While IFRS requires a detailed analysis of the variability of cash flows, HGB focuses on the appropriateness of the discount to cover default risks. The practical implementation of a reliable quantitative analysis is a challenge, particularly due to the availability of default data and the need for statistical modelling. Our finance and treasury management experts will be happy to provide you with a practical exchange and further discussion.

Those: KPMG Corporate Treasury News, Ausgabe 153, April 2024
Authors:
Robert Abendroth, Partner, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Jan Frederik Richter, Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG

1 Vgl. KPMG Corporate Treasury News, Ausgabe 137 und Ausgabe 135
2 Vgl. IDW RS HFA 48 Tz. 73 ff.
3 Vgl. IDW RS HFA 8 Tz. 20 ff.
4 Vgl. IDW RS HFA 48 Tz. 81 ff.
5 Vgl. Rimmelspacher/Meyer/Girlich, WPg 2019, S. 1147 ff.