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Chapter 18: Q24Q. (page 1031)

What are the reporting issues in a sale with a repurchase agreement?

Short Answer

Expert verified

If a business sells a product one time and promises to buy it back the next, the legal title may have changed, but the economic basisof the contract is that the seller retains ownership risks.

Step by step solution

01

Meaning of Repurchase Agreement

Arepurchase agreement (repo) is a type of short-term financing for government securities dealers. Repo occurs when a dealer sells government securities to investors overnight and then buys them back the next day at a slightly higher price.

02

Reporting issues in a sale with a repurchase agreement

The legal title may have moved if a corporation sells a product one time and promises to purchase it back the next, but the economic essence of the deal is that the seller maintains ownership risks. Companies that sign into buyback agreements are authorized to transfer an asset to a client while still having an unconditional obligation (forward) or unconditional right (call option) to repurchase the asset later. The question in these cases is whether the corporation sold the asset. These transactions are reported as finance transactions (borrowing) in most cases. If the corporation has a forward obligation or calls the option to buy the asset for a price more than or equal to the selling price, the asset is considered to be in good condition.

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Most popular questions from this chapter

Frozen Delight, Inc. charges an initial franchise fee of \(75,000 for the right to operate as a franchisee of Frozen Delight. Of this amount, \)25,000 is collected immediately. The remainder is collected in four equal annual installments of \(12,500 each. These installments have a present value of \)41,402. As part of the total franchise fee, Frozen Delight also provides training (with a fair value of $2,000) to help franchisees get the store ready to open. The franchise agreement is signed on April 1, 2017, training is completed, and the store opens on July 1, 2017. Prepare the journal entries required by Frozen Delight in 2017.

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Nate Beggs signs a 1-year contract with BlueBox Video. The terms of the contract are that Nate is required to pay a nonrefundable initiation fee of \(100. No annual membership fee is charged in the first year. After the first year, membership can be renewed by paying an annual membership fee of \)5 per month. BlueBox determines that its customers, on average, renew their annual membership three times after the first year before terminating their membership. What amount of revenue should BlueBox recognize in its first year?

Describe the critical factor in evaluating whether a performance obligation is satisfied.

Tyler Financial Services performs bookkeeping and tax-reporting services to startup companies in the Oconomowoc area. On January 1, 2017, Tyler entered into a 3-year service contract with Walleye Tech. Walleye promises to pay \(10,000 at the beginning of each year, which at contract inception is the standalone selling price for these services. At the end of the second year, the contract is modified and the fee for the third year of services is reduced to \)8,000. In addition, Walleye agrees to pay an additional $20,000 at the beginning of the third year to cover the contract for 3 additional years (i.e., 4 years remain after the modification). The extended contract services are similar to those provided in the first 2 years of the contract.

Instructions

(a) Prepare the journal entries for Tyler in 2017 and 2018 related to this service contract.

(b) Prepare the journal entries for Tyler in 2019 related to the modified service contract, assuming a prospective approach.

(c) Repeat the requirements for part (b), assuming Tyler and Walleye agree on a revised set of services (fewer bookkeeping services but more tax services) in the extended contract period and the modification results in a separate performance obligation.
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