According to FASB Statement [FAS] 49 [Accounting for Product Financing Arrangements], the sale and repurchase of inventory is in substance a financing arrangement. The product financing arrangement must be accounted for as a borrowing and not as a sale. In many instances, the product is stored on the company’s [sponsor’s] premises. Furthermore, the sponsor often guarantees the debt of the other entity.
Product financing arrangements are of two types:
- Sponsor sells a product to another business and contracts to reacquire it or an identical one. The price paid by the sponsor usually includes financing and storage costs.
- Sponsor controls the distribution of the product that has been bought by another company based on the aforementioned terms.
In each case, the company [sponsor] either agrees to repurchase the product at specified prices over given time periods, or guarantees resale prices to third parties.
When the sponsor sells the product to the other business and in a related transaction agrees to repurchase it, the sponsor records a liability when the proceeds are received. A sale should not be recorded, and the product should be retained as inventory on the sponsor’s balance sheet.
If another entity buys the product for the sponsor, inventory is debited and liability is credited at the time of purchase.
Costs of the product, excluding processing costs, exceeding the sponsor’s original cost represent finance and holding costs. The sponsor accounts for these costs based on its customary accounting policies. Interest expense will also be recognized.
On 1/1/20X8, a sponsor borrows $100,000 from another company and gives the inventory as collateral.
The entry is:
[Debit]. Cash = $100,000
[Credit]. Liability = $100,000
A sale is not recorded, and the inventory continues on the books of the sponsor. On 12/31/20X8, the sponsor remits payment to the other company. The collateralized inventory item is returned. If the interest rate on the loan is 8 percent and storage costs are $2,000, the journal entry is:
[Debit]. Liability = $100,000
[Debit]. Interest expense [or Deferred interest] = $8,000
[Debit]. Storage expense = $2,000
[Credit]. Cash = $110,000
In most cases, the product in the financing agreement is ultimately used or sold by the sponsor. However, in some instances, small amounts of the product may be sold by the financing entity to other parties.
The entity providing financing to the sponsor is typically an existing creditor, non-business entity, or trust. It is also possible that the finansor may have been established for the sole purpose of providing financing to the sponsor. Footnote disclosure should be made of the product financing terms.