Accounting for product financing arrangements

There are cases where the sale of inventory is, in substance, actually a product financing arrangement. A transaction is likely to be a financing arrangement in any of the following situations:

  • The seller agrees to repurchase the item it has just sold, or an essentially identical unit.
  • The seller commits to having a third party purchase the item, and then agrees to acquire the item from the third party.
  • The seller controls how the item sold under either of the preceding situations is disposed of.

An option for the seller to reacquire inventory is the same as a commitment to repurchase items it has sold, if there is a penalty for not exercising the option. The same treatment applies for a put option that the reseller can exercise against the seller.

A product financing arrangement is more likely to exist when there is a resale price guarantee, whereby the original seller agrees to pay any shortfall between the price at which it sold to the reseller and the price at which the reseller sold to a third party.

The accounting for a product financing arrangement is to treat it as a borrowing arrangement and not a sale transaction. Thus, the “seller” continues to report its ownership of the asset “sold,” as well as a liability for its repurchase obligation. There are two variations on the accounting for the repurchase obligation:

  • Primary repurchaser. If the seller commits to repurchase the product, it records the repurchase obligation as soon as it receives the proceeds from the initial financing transaction.
  • Secondary repurchaser. If a third party has committed to repurchase the product, the seller records the repurchase obligation as soon as the product is purchased by the third party.

In addition, the seller accrues any financing and holding costs incurred by the buyer. The following example illustrates the concept.

Example of a Product Financing Arrangement

Armadillo Industries enters into a transaction where another entity is legally created under the name ArmaLoan, accepts inventory from Armadillo as its sole asset, and then uses the inventory as collateral to obtain a loan, the funds from which it then remits to Armadillo. As part of the arrangement, Armadillo pays inventory storage costs on behalf of ArmaLoan, as well as interest on the inventory that matches the interest charges incurred by ArmaLoan on the bank financing. Armadillo agrees to repurchase the inventory in one year, when the loan arrangement expires.