Diamond is looking at ways that it may improve its liquidity. One option is to sell some of its trade receivables to a debt factor. The directors are considering two possible alternative agreements as described below:

(i) Diamond could sell $40 million receivables to a factor with the factor advancing 80 per cent of the funds in full and final settlement. The factoring is non-recourse except that Diamond has guaranteed that it will pay the factor a further 9 per cent of each receivable which is not recovered within six months. Diamond believes that its customers represent a low credit risk and so the probability of default is very low. The fair value of the guarantee is estimated to be $50,000.

(ii) Alternatively, the factor would advance 20 per cent of the $40 million receivables sold. Further amounts will become payable to Diamond but are subject to an imputed interest charge so that Diamond receives progressively less of the remaining balance the longer it takes the factor to recover the funds. The factor has full recourse to Diamond for a six-month period after which Diamond has no further obligations and has no rights to receive any further payments from the factor.

Required:

If Diamond decides to go ahead with the debt factoring arrangements, explain the financial reporting principles involved and advise how each of the above arrangements would impact upon the financial statements of future years.