In: Accounting
You were recently hired to work in the controller’s office of the Balboa Lumber Company. Your boss, Alfred Eagleton, took you to lunch during your first week and asked a favor. “Things have been a little slow lately, and we need to borrow a little cash to tide us over. Our inventory has been building up and the CFO wants to pledge the inventory as collateral for a short-term loan. But I have a better idea.” Mr. Eagleton went on to describe his plan. “On July 1, 2018, the first day of the company’s third-quarter, we will sell $100,000 of inventory to the Harbaugh Corporation for $160,000. Harbaugh will pay us immediately and then we will agree to repurchase the merchandise in two months for $164,000. The $4,000 is Harbaugh’s fee for holding the inventory and for providing financing. I already checked with Harbaugh’s controller and he has agreed to the arrangement. Not only will we obtain the financing we need, but the third quarter’s before-tax profits will be increased by $56,000, the gross profit on the sale less the $4,000 fee. Go research the issue and make sure we would not be violating any specific accounting standards related to product financing arrangements.”
Required:
1) Obtain the relevant authoritative literature on product financing arrangements using the FASB Accounting Standards Codification. You might gain access at the FASB website (www.fasb.org). What is the specific citation that provides guidance for determining whether an arrangement involving the sale of inventory is “in substance” a financing arrangement?
2) What is the specific citation that addresses the recognition of a product financing arrangement?
3) Determine the appropriate treatment of product financing arrangements like the one proposed by Mr. Eagleton.
4) Prepare the journal entry for Balboa Lumber to record the “sale” of the inventory and subsequent repurchase.
Answer :
Requirement 1
The FASB's codification citation that provides guidance for determining whether an arrangement involving the sale of inventory is in substance a financing arrangement is FASB ASC 470-40-05-2: Debt-Product Financing Arrangements-Overview and Background.
Requirement 2
The FASB's codification citation that addresses the recognition of a product financing arrangement is FASB ASC 470-40-25-1: Debt-Product Financing Arrangements-Recognition
Requirement 3
The appropriate accounting treatment for this type of arrangement is for the sponsor to record a liability at the time the proceeds are received from the other entity. The sponsor does not record the transaction as a sale and does not remove the product from its inventory. The cost of the repurchase amount in excess of the originally recorded liability represents financing and holding costs. These costs are accounted for in accordance with the sponsor's accounting policies applicable to other financing and holding costs. Notice that this is an example of “substance (a loan) over form (a sale).”
Requirement 4
Journal entry to record the “sale” (cash receipt):
Cash.................................................................................. 160,000
Liability - product financing arrangement............................... 160,000
Journal entry to record the repurchase:
Liability - product financing arrangement ...................... 160,000
Holding and financing costs* .............................................. 4,000
Cash.......................................................................................... 164,000
*The treatment of these costs depends on the accounting policies of the sponsor. For example, if these costs normally are expensed as period costs, then the debit in this case would be to an expense account (or accounts).