What is the difference between a dilution reserve and ineligible AR?
Last updated: August 27, 2026
What is ineligible AR?
Ineligible AR is accounts receivable that do not meet the credit agreement's Eligible Receivable definition. These invoices are excluded entirely from the borrowing base certificate. Common ineligible categories include cross-aged invoices, contra/affiliate AR, unbilled AR, progress billings, retention, foreign AR without LC or credit insurance, and government AR without Assignment of Claims Act compliance.
What is a dilution reserve?
A dilution reserve is a percentage deduction from the borrowing base to account for expected reductions in AR collections. Dilution occurs when the borrower issues credit memos, grants discounts, accepts returns, or makes other adjustments that reduce the amount ultimately collected on invoiced AR. The lender calculates the dilution reserve based on the borrower's historical dilution rate (total credit memos and adjustments divided by total invoiced AR over a trailing period).
Common causes of AR dilution
- Early payment discounts: Customers take discounts for paying within specified terms.
- Product returns: Customers return defective or unwanted goods, triggering credit memos.
- Pricing disputes: Customer claims invoice pricing is incorrect; seller issues partial credit.
- Quantity adjustments: Seller shipped fewer units than invoiced; credit memo issued for the difference.
- Rebates and allowances: Volume rebates or promotional allowances reduce net AR collected.
| Concept | Treatment in borrowing base | Example |
|---|---|---|
| Ineligible AR | Excluded entirely | Cross-aged invoices, unbilled AR, contra AR |
| Dilution reserve | Percentage deduction from eligible AR base | Dilution reserve based on historical credit memo activity; reduces availability |
How is the dilution reserve calculated?
The lender calculates the dilution reserve based on the borrower's historical dilution rate over a trailing period specified in the credit agreement. The OCC Comptroller's Handbook on Asset-Based Lending states that dilution "is usually expected to be 5 percent or less."
Related topics
- Before binding an ABL revolver, which AR lines are ineligible?
- Concentration reserve single-debtor cap
- Borrowing base certificate monthly compliance
Frequently asked questions
What is the difference between a dilution reserve and ineligible AR?
Ineligible AR is excluded entirely from the borrowing base (e.g., cross-aged invoices, contra AR, unbilled AR). A dilution reserve is a percentage deduction from the borrowing base to account for expected AR reductions from credits, discounts, returns, or other adjustments. Dilution does not exclude AR categories; it reduces availability to reflect historical credit memo activity.