If a reporting entity arranges for a third party to purchase inventory directly from a supplier on its behalf and agrees to purchase that same inventory, a substantially identical product, or processed goods of which the product is a component from the third party at some point in the future, the guidance in ASC 470-40 should be considered to determine if the arrangement is, in substance, a financing arrangement. In many of these arrangements, the reporting entity is required to purchase the inventory from the third party at specified prices over a certain period when the specified prices are generally not subject to change except for fluctuations in finance or holding costs incurred by the third party.  Therefore, while this arrangement may be described as a supply chain management or logistics services agreement, it is, in substance, a secured borrowing from the third party. The third party is essentially providing the reporting entity with financing to purchase the inventory from the supplier because the third party is guaranteed a fixed price from the reporting entity. The inventory in this case is being used as collateral.

If the arrangement has the characteristics described in ASC 470-40 applicable to product financing arrangements, the reporting entity must record the inventory and the related debt when the third party purchases the inventory on its behalf. In other words, the inventory and the debt are recognized prior to the reporting entity’s legal-form purchase of the inventory from the third party. Costs of the product in excess of the third party’s purchase, excluding any applicable processing costs, represent financing and holding costs and are accounted for in accordance with the reporting entity’s accounting policies for financing and holding costs.

Another situation in which the product financing guidance should be considered is when a reporting entity “sells” product to a counterparty in exchange for consideration and agrees to repurchase that product (or a substantially identical product) or processed goods of which the product is a component.  If the arrangement meets the conditions to be considered a product financing arrangement under ASC 470-40, the reporting entity will not record the transaction as a sale or remove the inventory from the balance sheet. Instead, it will record a liability at the time proceeds are received. In accordance with ASC 470-40-05-3, the reporting entity should refer to guidance on accounting for repurchase agreements in ASC 606-10-55-66 through 55-78. See RR 8.7 for guidance on repurchase agreements. Product financing arrangements subject to ASC 470-40 are different than supplier finance programs subject to the disclosure requirements of ASC 405-50. See FSP 11.3.1.5 for additional information on supplier finance programs.

EXAMPLE IV 1-2
Selling raw materials to and purchasing finished goods from a subcontractor

Company A outsources the manufacturing of certain products to Company B. Company A purchases raw materials from third-party suppliers and then sells the raw materials to Company B, which processes the raw materials into finished goods. Company A is then obligated to purchase the finished goods from Company B.

At the time of sale of the raw materials, Company A invoices Company B and executes a purchase order with Company B for the purchase of finished goods that contain that same quantity of raw materials. Company B invoices Company A for the finished goods when delivered to Company A. Company B has title to and physical risk of loss associated with the raw materials purchased from Company A once received. The price of the finished goods purchased by Company A far exceeds the price Company B pays to buy the raw materials from Company A.

How should Company A account for the sale of raw materials to Company B?

Consistent with ASC 470-40-05-2(a) and ASC 470-40-05-3, Company A should evaluate this arrangement under the repurchase agreement guidance in ASC 606-10-55-66 through ASC 606-10-55-78. Company A should retain the raw materials on its books (effectively, as consigned inventory) when they are “sold” to Company B. Since Company A’s repurchase of the finished goods far exceeds the price Company B paid to purchase the raw materials, the initial sale of raw materials to Company B should be accounted for as a financing arrangement. Any consideration received from Company B in advance of Company A’s repurchase of the finished goods should be accounted for as a financial liability. The liability would be relieved upon payment to Company B for the finished goods.

See RR 8.7 for guidance on repurchase agreements.