FRS 5 - Reporting the substance of transactions - requires that a reporting entity's financial statements should report the substance of the transactions into which it has entered.

You are the management accountant of S Ltd. During the most recent financial year (ended 31 August 1998), the company has entered into a debt factoring arrangement with F plc. The main terms of the agreement are as follows:
1 On the first day of every month S Ltd transfers (by assignment) all its trade debts to \(\mathrm{F}\) plc, subject to credit approval by F plc for each debt transferred by S Ltd.
2 At the time of transfer of the debtors to F plc, S Ltd receives a payment from F plc of \(70 \%\) of the gross amount of the transferred debts. The payment is debited by F plc to a factoring account which is maintained in the books of \(F\) plc.
3 Following transfer of the debts, F plc collects payments from debtors and performs any necessary follow-up work.
4 After collection by \(\mathrm{F}\) plc, the cash received from the debtor is credited to the factoring account in the books of \(\mathrm{F}\) plc.
5 F plc handles all aspects of the collection of the debts of S Ltd in return for a monthly charge of \(1 \%\) of the total value of the debts transferred at the beginning of that month. The amount is debited to the factoring account in the books of \(F\) plc.
6 Any debts not collected by F plc within 90 days of transfer are regarded as bad debts by F plc and re-assigned to S Ltd. The cash previously advanced by F plc in respect of bad debts is recovered from S Ltd. The recovery is only possible out of the proceeds of other debtors which have been assigned to \(S\) Ltd. For example, if, in a particular month, S Ltd assigned trade debts having a value of \(£ 10000\) and a debt of \(£ 500\) was identified as bad, then the amounts advanced by F plc to S Ltd would be \(£ 6650[70 \%\) \(\times £ 10000-70 \% \times £ 500]\).
7 On a monthly basis, \(\mathrm{F}\) plc debits the factoring account with an interest charge which is calculated on a daily basis on the balance on the factoring account.
8 At the end of every quarter, F plc pays over to S Ltd a sum representing any credit balance on its factoring account with S Ltd at that time.
\section*{Requirement}
Write a memorandum to the Board of Directors of S Ltd which outlines

(a) how, under the principles set out in FRS 5, the substance of a transaction should be determined;

(b) how the debt factoring arrangement will be reported in the financial statements of S Ltd.
CIMA, Financial Reporting, November 1998