Repurchase rights are an obligation or right to repurchase a good after it is sold to a customer. Repurchase rights could be included within the sales contract, or in a separate arrangement with the customer. The repurchased good could be the same asset, a substantially similar asset, or a new asset of which the originally purchased asset is a component.
There are three forms of repurchase rights:An arrangement to repurchase a good that is negotiated between the parties after transferring control of that good to a customer is not a repurchase agreement because the customer is not obligated to resell the good to the reporting entity as part of the initial contract. The subsequent decision to repurchase the item does not affect the customer's ability to direct the use of or obtain the benefits of the good.
For example, a car manufacturer that decides to repurchase inventory from one dealership to meet an inventory shortage at another dealership has not entered into a forward, call option, or put option unless the original contract requires the dealership to sell the cars back to the manufacturer upon request. However, when such repurchases are common, even if not specified in the contract, management will need to consider whether that common practice affects the assessment of transfer of control to the customer upon initial delivery.
Some arrangements do not include a repurchase right, but instead provide a guarantee in the form of a payment to the customer for the deficiency, if any, between the amount received in a resale of the product and a guaranteed resale value. The guidance on repurchase rights (described in RR 8.7.1 and RR 8.7.2) does not apply to these arrangements because the reporting entity does not reacquire control of the asset. The guarantee payment should be accounted for in accordance with the applicable guidance on guarantees. Refer to RR 4.3.3.9 for further discussion of guarantees.
A reporting entity that transfers a good and retains a substantive forward repurchase obligation or call option (that is, a repurchase right) should not recognize revenue when the good is initially transferred to the customer because the repurchase right limits the customer’s ability to control the good. While some such provisions may be deemed to lack substance based on specific facts and circumstances, in general a negotiated contract term is presumed to be substantive.
Figure RR 8-2 summarizes the considerations when determining the accounting for forwards and call options.
Figure RR 8-2The accounting for an arrangement with a forward or a call option depends on the amount the reporting entity can or must pay to repurchase the good. The likelihood of exercise is not considered in this assessment. The arrangement is accounted for as either:
A reporting entity that enters into a financing arrangement continues to recognize the transferred asset and recognizes a financial liability for the consideration received from the customer. The reporting entity recognizes any amounts that it will pay upon repurchase in excess of what it initially received as interest expense over the period between the initial agreement and the subsequent repurchase and, in some situations, as processing or holding costs. The reporting entity derecognizes the liability and recognizes revenue if it does not exercise a call option and it expires.
The comparison of the repurchase price to the original sales price of the good should include the effect of the time value of money, including contracts with terms of less than one year. This is because the effects of time value of money could change the determination of whether the forward or call option is a lease or financing arrangement. For example, if a reporting entity enters into an arrangement with a call option and the stated repurchase price, excluding the effects of the time value of money, is equal to or greater than the original sales price, the arrangement might be a financing arrangement. Including the effect of the time value of money might result in a repurchase price that is less than the original sale price, and the arrangement would be accounted for as a lease.
Example RR 8-10 illustrates the accounting for an arrangement that contains a call option. A similar scenario is illustrated in Example 62, Case A, of the revenue standard (ASC 606-10-55-402 through ASC 606-10-55-404).
EXAMPLE RR 8-10Machine Co sells machinery to Manufacturer for $200,000. The arrangement includes a call option that gives Machine Co the right to repurchase the machinery in five years for $150,000. The arrangement is not part of a sale-leaseback.
Should Machine Co account for this transaction as a lease or a financing transaction? AnalysisMachine Co should account for the arrangement as a lease. The five-year call period indicates that the customer is limited in its ability to direct the use of or obtain substantially all of the remaining benefits from the machinery. Machine Co can repurchase the machinery for an amount less than the original selling price of the asset; therefore, the transaction is a lease. Machine Co would account for the arrangement in accordance with the leasing guidance.