Cash, Receivables, and Inventory
What this domain tests
This domain covers cash and cash equivalents, bank reconciliations, restricted cash, the allowance for credit losses, factoring and notes receivable, inventory costing, cost-flow methods, and lower-of-cost measurement under ASC 326, ASC 330, and IAS 2.
Cash and receivables
Cash equivalents are short-term, highly liquid investments with an original maturity of three months or less. Restricted cash is presented separately or disclosed. A bank reconciliation adjusts the book balance for bank fees, NSF checks, and errors, and adjusts the bank balance for deposits in transit and outstanding checks.
Trade discounts reduce the initial invoice. Cash discounts are recorded gross (with discounts lost in a contra-revenue or expense account) or net (with discounts lost in revenue). Under the allowance method, the adjusting entry debits bad debt expense and credits the allowance. Write-offs debit the allowance and credit accounts receivable; they do not affect net receivables or expense. Recoveries reverse the write-off and then record collection. Factoring with recourse is a sale only if control has been surrendered and the sale criteria are met; otherwise it is a secured borrowing. CECL requires expected credit losses on amortized-cost receivables.
Inventory
Cost includes purchase price, duties, freight-in, and conversion costs, but excludes abnormal waste, storage unless necessary in the production process, and selling costs. Cost formulas are specific identification, FIFO, weighted average, and LIFO. LIFO is permitted under US GAAP but prohibited under IFRS. FIFO and weighted average inventory is measured at the lower of cost and net realizable value. LIFO inventory is measured at the lower of cost or market, with market bounded by a ceiling (NRV) and a floor (NRV minus normal profit).
Worked example
An aging schedule shows current $100,000 at 1% ($1,000), 30 days $50,000 at 5% ($2,500), and 60 days $20,000 at 20% ($4,000). The required allowance is $7,500. If the existing allowance has a $2,000 credit balance, bad debt expense is $5,500. If the existing balance were a $500 debit, expense would be $8,000.
Traps
Treating a write-off as an expense; mishandling the gross versus net method; ignoring freight terms; applying LCNRV to LIFO without the ceiling and floor; reversing inventory write-downs under US GAAP, which is not permitted; and using a discounted amount as NRV.