A controller closes the books while juggling a factored receivable pool, a slow-moving inventory layer that has just dropped below cost, and a building whose carrying value exceeds undiscounted cash flows. Each item triggers a different recognition rule, and the exam rewards the candidate who can name the rule before reaching for a calculator.
Recognize AR when control of goods or services transfers and a right to consideration exists. Net AR equals gross receivables minus the allowance for credit losses. Under CECL (ASC 326), the allowance reflects lifetime expected credit losses, estimated at origination and remeasured each period. The journal entry is debit Bad Debt Expense, credit Allowance. Write-offs debit Allowance, credit AR with no income statement effect.
TRAP: The direct write-off method violates the matching principle and is unacceptable under GAAP except for immaterial amounts. The exam will offer it as a distractor.
A without-recourse sale transfers credit risk to the factor. The seller derecognizes AR, records cash received, and books a loss on sale for the discount and fees. Debt does not appear.
Common mistakes
- Treating a with-recourse factoring as automatic borrowing. With-recourse can still be a sale if the three transfer conditions are met. Read the fact pattern for "isolation" and "free to pledge."
- Applying LCM when LCNRV is required. LCM (with ceiling and floor) governs only LIFO and the retail method. LCNRV is the default for FIFO, weighted average, and specific identification.
- Classifying short-term debt as noncurrent without the agreement. Intent alone is insufficient. The entity must demonstrate ability through actual refinancing before issuance or a non-cancelable agreement extending past 12 months.
Bottom line
- Allowance for credit losses uses the CECL lifetime-expected-loss model; bad debt expense hits the income statement and AR is reported net. Direct write-off is not GAAP.
- Inventory: LCM (market within ceiling/floor) for LIFO and retail; LCNRV (cost vs selling price less completion and disposal) for other methods; IFRS bans LIFO and allows reversals.
- Factoring without recourse is always a sale; with recourse is a sale only if the three transfer conditions are met.
- Inventory errors self-correct over two periods because this year's ending inventory becomes next year's beginning inventory.
Exam shortcut
When the question gives a fact pattern around inventory write-down, identify the cost method first. LIFO or retail signals LCM with ceiling/floor; anything else signals LCNRV with selling price minus completion and disposal. When the question describes a transfer of receivables, ask whether the seller retains risk and whether the three sale conditions are met. With-recourse + conditions met = sale.
The full lesson (about 3,066 words, 20 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 1A2
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