Question

ABC Company sold equipment on October 1, 2018, to XYZ Company for £1,000,000. It agrees to repurchase this equipment in July 2019, for a price of £1,100,000. The proper accounting treatment for this transaction based on

Select one:

a. relevance

b. going concern

c. comparability

d. substance over form

Answer 1

Solution: The proper accounting treatment for this transaction is based on

Answer is: d. substance over form.

Explanation: ABC Company sold equipment to XYZ Company and agrees to repurchase this equipment later on from XYZ Company, the accounting treatment for this transaction is based on substance over form. Substance over form means that the transaction should be accounted for in accordance with actual happening and economic reality of the transactions and not by its legal form in order to present a true and fair view of the affairs of the entity. This transaction of sale and repurchase may be deemed as two different transactions which should be dealt with as such for accounting purposes i.e. recording the sale and subsequently purchase. However, the economic reality of this transaction is that no sale has in fact occured. The sale and repurchase, when considered in the context of both transactions, is actually a financing arrangement in which the seller i.e. ABC Company has obtained a loan of 1,000,000 from XYZ Company which is to be repaid with interest via inflated price of 1,100,000. Equipment acts as the security for the loan which will be returned to the seller ABC Company upon repayment. So instead of recognizing sale, the ABC Company should recognize a liability for loan obtained which shall be reversed when the loan is repaid. The excess of loan received and the amount is to be paid i.e. 100,000 is recognized as finance cost in the income statement. Thus, we can conclude that proper accounting treatment for this transaction is based on substance over form.