Question

Situation:

Birch Industries has borrowed the maximum amount available from its bank to finance the purchase of inventory under a short-term line of credit. The CFO and your boss, Susie Perkins takes you to lunch to explain a strategy called a product financing arrangement that would enable Birch Industries to obtain the necessary cash to purchase additional supplies of merchandise. Susie believes it is an ide al way to structure a transaction to meet Birch Industries financial needs. On April 1, 2015, the first day of the company’s second quarter, Susie plans to sell $200,000 of inventory to Grime Corporation for $300,000. Susie explained that Grime will pay us immediately and then we will agree to repurchase the merchandise in two months for $300,000 plus 8%APR and an $5,000 fee for storing the inventory. Susie conveyed that she had checked with Grime’s CFO and he has agreed to the arrangement, if we decide to move forward. Susie concludes that not only will we obtain the needed financing, but the second quarter pre-tax profits will increase by $95,000, the gross profit on the sale less the $5,000 storage fee.

As the assistant CFO, Susie has asked you to research the issue and make sure we will be following appropriate reporting standards.

How do I write a journal entry for the below?:

In the present case seller has made arrangement of repurchase of material after two months to finance its working capital requirement. he has failed to fulfil all the conditions sited above, so in this case, sales revenue could not be recognised & future obligation of $ 300,000 will be shown as liability. material of 200,000 will be shown as asset in form of "Material issued on Loan".

Answer 1

Answer :

In the present case, Susie is not right to report $ 300,000 as sales revenue, because this is merely arrangement of sale with buyback agreement, specifically product financing.

ASC 605, Revenue recognition

According to FASB ASC 605-15-25, If an entity sells its product but gives the buyer the right to return the product, revenue from the sales transaction shall be recognized at time of sale only if all of the following conditions are met:

1.         The seller’s price to the buyer is substantially fixed or determinable at the date of sale.

2.         The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product. If the buyer does not pay at time of sale and the buyer’s obligation to pay is contractually or implicitly excused until the buyer resells the product, then this condition is not met.

3.         The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product.

4.         The buyer acquiring the product for resale has economic substance apart from that provided by the seller. This condition relates primarily to buyers that exist on paper, that is, buyers that have little or no physical facilities or employees. It prevents entities from recognizing sales revenue on transactions with parties that the sellers have established primarily for the purpose of recognizing such sales revenue.

5.         The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer.

6.         The amount of future returns can be reasonably estimated.

In the present case seller has made arrangement of repurchase of material after two months to finance its working capital requirement. he has failed to fulfill all the conditions sited above, so in this case, sales revenue could not be recognized & future obligation of $ 300,000 will be shown as liability, material of 200,000 will be shown as asset in form of "Material issued on Loan".