Question

Anita Bithings is looking to purchase a capital asset that her company will hold, use, and eventually sell after a special project. Anita is excited to learn that a supplier in her state is willing to engage in this deal; however, the board of directors requests an explanation of the accounting methodology she will use.

Which section of the authoritative guidance best describes the three types of agreements that qualify as product financing arrangements?

Enter your response in the answer fields below. Guidance on correctly structuring your response appears above and below the answer fields. Unless specifically requested, your response should not cite implementation guidance.

     

Answer 1

Accounting method refers to the rules a company follows in reporting revenues and expenses.

There are three accounting methods:

1. Cash Basis

2. Accrual Basis

3. Hybrid Method

According to me, Anita should use Accrual Basis of accounting, as the general rule is, if a business carries inventory for resale it must use the accrual method. As in this case, Anita Bithings is looking to purchase a capital asset that her company will hold, use, and eventually sell after a special project. Therefore, Accrual basis of accounting is recommended.

The accrual basis of accounting is the concept of recording revenues when earned and expenses as incurred. Accrual basis accounting is the standard approach to recording transactions for all larger businesses.

Accrual basis accounting achieves a more accurate measurement of a business's periodic net income because it attempts to match revenues and expenses related to the same accounting period.

Accrual-basis accounting is based on two accounting principles:

• The Revenue Realization Principle: The revenue realization principle states that revenue should be recorded in the period in which it is earned, regardless of when payment is received.
• The Matching Principle: The matching principle attempts to match income with the expenses that produced the income.

While the accrual method complies with GAAP, the cash method does not. Banks and other lenders may have less confidence in your financial statements if they are prepared under the cash method, making it more difficult to secure financing. This is another reason why accrual method of accounting should be used.

Section of the authoritative guidance that best describes the three types of agreements that qualify as product financing arrangements:

This industry-specific guidance provides that a capital asset option contract is to be accounted for as a financing arrangement under ASC 470-40 if it meets all three of the following criteria:

• The product was produced by or originally purchases by the sponsor or another entity on behalf of the sponsor.
• The sponsor is required to purchase the product at specified prices; and
• The payments that the other entity will receive on the transaction are established by the financing arrangement, and the amount to be paid by the sponsor will be adjusted, as necessary to cover substantially all fluctuations in costs incurred by the other entity in purchasing and holding the product.

There is most likely to be a product finance agreement where a resale price contract occurs, whereby the initial retailer offers to pay the difference between the price at which it sells to the reseller and the price at which the reseller sells to a third party. The accounting for a lending plan for a company is to view it as a loan agreement rather than a selling transaction. Thus, the “seller” continues to report its ownership of the asset “sold,” as well as a liability for it’s repurchase obligation. There are two variations on the accounting for the repurchase obligation:

• Primary re-purchaser: 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 re-purchaser: 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.