Receivables Transfers: Sale, Borrowing, and Current Classification

Answer C. Under U.S. GAAP, assets are classified as current if they are expected to be realized in cash within one year or the entity's normal operating cycle, whichever is longer. Because Delta's operating cycle is 18 months and the receivable is due in 14 months (within that cycle), the operating cycle governs classification and the receivable should be classified as current.

Why not A: Allowance for expected credit losses affects measurement (net realizable value), not current/noncurrent classification. Classification is driven by expected timing of cash realization.

Why not B: This is attractive because many memorize a one-year rule, but classification uses the longer of one year or the operating cycle. Since Delta's operating cycle is 18 months, the 12-month test alone does not control.

Why not D: The identity or importance of the customer does not determine presentation; timing of collection determines whether a receivable is current.

Answer C. Trade accounts receivable include only open-account amounts still recognized at year-end. The $120,000 past-due account was replaced by a 90-day note on 12/20/20X5 (so it should be classified as a note receivable), and the $160,000 sold without recourse and derecognized must be removed. The $200,000 pledged as collateral remains recognized as accounts receivable (a secured borrowing), so the amount is $980,000 - $120,000 - $160,000 = $700,000.

Why not A: This reflects removing the factored receivables ($160,000) but leaving the $120,000 as accounts receivable; incorrect because the open account was replaced by a note and should be classified as a note receivable at year-end.

Why not B: Tempting if a candidate correctly reclassifies the note receivable (removing $120,000) but overlooks that the $160,000 sold and derecognized also must be removed from accounts receivable.

Why not D: Selected if a candidate erroneously treats the $200,000 assigned as collateral as derecognized. Assignment as collateral with retained collection responsibility is a secured borrowing and does not remove the receivables from Lark's books.

Answer C. ASC 860 requires the transferor to surrender effective control for sale accounting. Delta's substantive unilateral right to require Finance Co to return specific receivables is a retained power to reacquire the assets, so effective control was not surrendered and derecognition is not permitted. The first-loss recourse and servicing-for-fee are relevant continuing-involvement facts but are not the controlling reason here.

Why not A: Continued servicing for compensation that approximates adequate compensation does not, by itself, prevent derecognition, servicing can give rise to a servicing asset or liability instead. Servicing only blocks sale accounting if it reflects retained control; the decisive fact here is the return right.

Why not B: This is tempting because recourse often signals continuing exposure, but under ASC 860 limited or defined recourse does not automatically preclude sale accounting. The key question is whether effective control was transferred; here it was not because of the substantive unilateral return right.

Why not D: Legal isolation and the transferee's right to pledge or exchange are necessary sale conditions but not sufficient. ASC 860 also requires that the transferor surrender effective control; Delta's substantive right to force the return of specific receivables means that condition is not met.

Answer B. Regal's repurchase (recourse) obligation and its continued servicing indicate significant continuing involvement, so the primary question is whether Regal surrendered control of the transferred receivables. Under ASC 860 a transfer that does not surrender control is accounted for as a secured borrowing and the receivables remain on Regal's balance sheet; a transfer that surrenders control is a sale (derecognition). That initial sale-versus-borrowing determination governs whether Regal keeps the receivables and the CECL allowance, how the factoring fee is classified, and how the amounts are presented.

Why not A: This is tempting because ASC 326 requires entities to consider expected credit losses on receivables they own. However, whether Regal records CECL for these specific receivables depends on whether the transfer resulted in derecognition; if the transfer is a sale, Regal would not carry the transferred receivables or their CECL allowance, whereas if it's a secured borrowing Regal would continue to carry both.

Why not C: Factoring fees can resemble financing costs, so this distractor is plausible. Classification of the fee is secondary: if the transfer is a sale the fee is a selling expense, but if it's a borrowing the fee is treated as a financing cost. The sale-versus-borrowing determination must be resolved first.

Why not D: Presenting receivables net of an allowance is standard practice if the receivables remain Regal's assets. But presentation follows the initial determination of whether Regal retains the receivables (sale versus secured borrowing), so this is not the primary issue.

Answer C. Factor's ability to pledge or resell the receivables and the legal isolation of the assets indicate Company K surrendered control, so the transfer qualifies as a sale under ASC 860. Because Company K provided a limited recourse guarantee (reimbursement up to $25,000), it should recognize a liability for the expected payments under that guarantee. Company K should therefore derecognize the receivables, record the cash received, recognize the recourse liability, and measure any gain or loss on the sale.

Why not A: This distractor appeals to the idea that a capped recourse is immaterial. It is incorrect because U.S. GAAP requires the transferor to recognize a liability for the expected payments under any recourse guarantee when a sale occurs; a capped maximum still creates an obligation that must be reflected.

Why not B: This is tempting because students often equate recourse with retained control and financing. It is incorrect here because the transferee's right to pledge/resell and the legal isolation of the assets support derecognition as a sale under ASC 860.

Why not D: This choice conflates credit-loss allowances with guarantee exposures. If the transfer qualifies as a sale the receivables are derecognized and the seller's exposure under the recourse guarantee should be reported as a liability, not as an allowance against receivables still on the balance sheet.