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Revenue Recognition - Financing Arrangement

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Revenue Recognition - Financing Arrangement

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What is the definition of a financing arrangement?

Per FASB 49, the arrangement involving the sale and repurchase of inventory is, in substance, a financing arrangement. It mandates that the product financing arrangement be accounted for as a borrowing instead of a sale. In many cases, the product is stored on the company's (sponsor's) premises. Further, often the sponsor will guarantee the debt of the other entity. Typically, the sponsor eventually uses or sells most of the product in the financing arrangement. However, in some cases, the financing entity may sell small amounts of the product to other parties. The entity that gives financing to the sponsor is usually an existing creditor, nonbusiness entity, or trust. It is also possible that the finansor may have been established for the only purpose of providing financing for the sponsor.

Note that in all situations, the company (sponsor) either agrees to repurchase the product at given prices over specified time periods, or guarantees resale prices to third parties. Also, footnote disclosure should be made of the particulars of the product-financing arrangement.

What are some types of financing arrangements?

Types of product financing arrangements include:

o Sponsor sells a product to another business and agrees to reacquire the product or one basically identical to it. The established price to be paid by the sponsor typically includes financing and holding costs.
o Sponsor has another company buy the product for it and agrees to repurchase the product from the other entity
o Sponsor controls the distribution of the product that has been bought by another company in accord with the aforementioned terms.

How are financing arrangements reported?

o When the sponsor sells the product to the other firm and in a related transaction agrees to repurchase it, the sponsor should record a liability when the proceeds are received to the degree the product applies to the financing arrangement. CAUTION A sale should not be recorded, and the product should be retained as inventory on the sponsor's books.
o fn the case where another firm buys the product for the sponsor, inventory is debited and liability is credited at the time of purchase.
o Costs of the product, except for processing costs, in excess of the sponsor's original production cost or acquisition cost or the other company's purchase cost constitute finance and holding costs. The sponsor accounts for these costs according to its typical accounting policies. Interest costs will also be incurred in connection with the financing arrangement. These should be shown separately and may be deferred.

A good book to read is The Vest Pocket CPA, written by Joel G. Siegel, Nick A. Dauber, and Jae K. Shim. This book can be found on Amazon and Amazon Kindle.

Return to CPA Review.

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