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8.7 Repurchase rights
Publication date: 31 May 2023
us Revenue guide
Repurchase rights are an obligation or right to repurchase a good after it is sold to a customer. Repurchase rights could be included within the sales contract, or in a separate arrangement with the customer. The repurchased good could be the same asset, a substantially similar asset, or a new asset of which the originally purchased asset is a component.
There are three forms of repurchase rights:
- A seller's obligation to repurchase the good (a forward)
- A seller's right to repurchase the good (a call option)
- A customer's right to require the seller to repurchase the good (a put option)
An arrangement to repurchase a good that is negotiated between the parties after transferring control of that good to a customer is not a repurchase agreement because the customer is not obligated to resell the good to the reporting entity as part of the initial contract. The subsequent decision to repurchase the item does not affect the customer's ability to direct the use of or obtain the benefits of the good.
For example, a car manufacturer that decides to repurchase inventory from one dealership to meet an inventory shortage at another dealership has not entered into a forward, call option, or put option unless the original contract requires the dealership to sell the cars back to the manufacturer upon request. However, when such repurchases are common, even if not specified in the contract, management will need to consider whether that common practice affects the assessment of transfer of control to the customer upon initial delivery.
Some arrangements do not include a repurchase right, but instead provide a guarantee in the form of a payment to the customer for the deficiency, if any, between the amount received in a resale of the product and a guaranteed resale value. The guidance on repurchase rights (described in RR 8.7.1 and RR 8.7.2) does not apply to these arrangements because the reporting entity does not reacquire control of the asset. The guarantee payment should be accounted for in accordance with the applicable guidance on guarantees. Refer to RR 4.3.3.9 for further discussion of guarantees.
8.7.1 Forwards and call options
A reporting entity that transfers a good and retains a substantive forward repurchase obligation or call option (that is, a repurchase right) should not recognize revenue when the good is initially transferred to the customer because the repurchase right limits the customer’s ability to control the good. While some such provisions may be deemed to lack substance based on specific facts and circumstances, in general a negotiated contract term is presumed to be substantive.
Figure RR 8-2 summarizes the considerations when determining the accounting for forwards and call options.
Figure RR 8-2
Accounting for forwards and call options
Accounting for forwards and call options
The accounting for an arrangement with a forward or a call option depends on the amount the reporting entity can or must pay to repurchase the good. The likelihood of exercise is not considered in this assessment. The arrangement is accounted for as either:
- a lease, if the repurchase price is less than the original sales price of the asset and the arrangement is not part of a sale-leaseback transaction (in which case the reporting entity is the lessor); or
- a financing arrangement, if the repurchase price is equal to or more than the original sales price of that good (in which case the customer is providing financing to the reporting entity).
A reporting entity that enters into a financing arrangement continues to recognize the transferred asset and recognizes a financial liability for the consideration received from the customer. The reporting entity recognizes any amounts that it will pay upon repurchase in excess of what it initially received as interest expense over the period between the initial agreement and the subsequent repurchase and, in some situations, as processing or holding costs. The reporting entity derecognizes the liability and recognizes revenue if it does not exercise a call option and it expires.
The comparison of the repurchase price to the original sales price of the good should include the effect of the time value of money, including contracts with terms of less than one year. This is because the effects of time value of money could change the determination of whether the forward or call option is a lease or financing arrangement. For example, if a reporting entity enters into an arrangement with a call option and the stated repurchase price, excluding the effects of the time value of money, is equal to or greater than the original sales price, the arrangement might be a financing arrangement. Including the effect of the time value of money might result in a repurchase price that is less than the original sale price, and the arrangement would be accounted for as a lease.
Example RR 8-10 illustrates the accounting for an arrangement that contains a call option. A similar scenario is illustrated in Example 62, Case A, of the revenue standard (ASC 606-10-55-402 through ASC 606-10-55-404).
EXAMPLE RR 8-10
Repurchase rights – call option accounted for as lease
Repurchase rights – call option accounted for as lease
Machine Co sells machinery to Manufacturer for $200,000. The arrangement includes a call option that gives Machine Co the right to repurchase the machinery in five years for $150,000. The arrangement is not part of a sale-leaseback.
Should Machine Co account for this transaction as a lease or a financing transaction?
Analysis
Machine Co should account for the arrangement as a lease. The five-year call period indicates that the customer is limited in its ability to direct the use of or obtain substantially all of the remaining benefits from the machinery. Machine Co can repurchase the machinery for an amount less than the original selling price of the asset; therefore, the transaction is a lease. Machine Co would account for the arrangement in accordance with the leasing guidance.
8.7.1.1 Conditional call rights
Some call rights are not unilaterally exercisable by the seller, but instead only become exercisable if certain conditions are met. The revenue standard does not provide specific guidance for assessing conditional repurchase features; therefore, judgment will be required to assess the impact of these provisions. Conditional rights should be accounted for based on their substance, with an objective of assessing whether control has transferred to the customer.
As noted in RR 8.7.1, the likelihood of the reporting entity exercising an active call right should not be considered when assessing whether control has transferred. In certain circumstances, however, a reporting entity might conclude a conditional call right does not preclude transfer of control. For example, if the call right only becomes active based on factors outside of the reporting entity’s control, this may indicate that control has transferred to the customer despite the existence of the conditional call right.
To assess whether a conditional call right precludes transfer of control to the customer, management should consider the following factors, among others:
- The nature of the conditions that result in the rights becoming active
- The likelihood that the conditions will be met that result in the rights becoming active
- Whether the conditions are based on factors within the seller’s or customer’s control
8.7.2 Put options
A put option allows a customer, at its discretion, to require the reporting entity to repurchase a good and indicates that the customer has control over that good. The customer has the choice of retaining the item, selling it to a third party, or selling it back to the reporting entity.
Figure RR 8-3 summarizes the considerations in determining the accounting for put options.
Figure RR 8-3
Accounting for put options
Accounting for put options
The accounting for an arrangement with a put option depends on the amount the reporting entity must pay when the customer exercises the put option, and whether the customer has a significant economic incentive to exercise its right. A reporting entity accounts for a put option as:
- a financing arrangement, if the repurchase price is equal to or more than the original sales price and more than the expected market value of the asset (in which case the customer is providing financing to the reporting entity);
- a lease, if the repurchase price is less than the original sales price and the customer has a significant economic incentive to exercise that right and the arrangement is not part of a sale-leaseback transaction (in which case the reporting entity is the lessor);
- a sale of a product with a right of return, if the repurchase price is less than the original sales price and the customer does not have a significant economic incentive to exercise its right; or
- a sale of a product with a right of return, if the repurchase price is equal to or more than the original sales price, but less than or equal to the expected market value of the asset, and the customer does not have a significant economic incentive to exercise its right.
A reporting entity that enters into a financing arrangement continues to recognize the transferred asset and recognize a financial liability for the consideration received from the customer. The reporting entity recognizes any amounts that it will pay upon repurchase in excess of what it initially received as interest expense (over the term of the arrangement) and, in some situations, as processing or holding costs. A reporting entity derecognizes the liability and recognizes revenue if the put option lapses unexercised.
Similar to forwards and calls, the comparison of the repurchase price to the original sales price of the good should include the effect of the time value of money, including the effect on contracts whose term is less than one year. The effect of the time value of money could change the determination of whether the put option is a lease or financing arrangement because it affects the amount of the repurchase price used in the comparison.
8.7.2.1 Significant economic incentive to exercise a put option
The accounting for certain put options requires management to assess at contract inception whether the customer has a significant economic incentive to exercise its right. A customer that has a significant economic incentive to exercise its right is effectively paying the reporting entity for the right to use the good for a period of time, similar to a lease.
Management should consider various factors in its assessment, including the following:
- How the repurchase price compares to the expected market value of the good at the date of repurchase
- The amount of time until the right expires
A customer has a significant economic incentive to exercise a put option when the repurchase price is expected to significantly exceed the market value of the good at the time of repurchase.
Example RR 8-11 and Example RR 8-12 illustrate the accounting for arrangements that contain a put option. This concept is also illustrated in Example 62, Case B, of the revenue standard (ASC 606-10-55-405 through ASC 606-10-55-407).
EXAMPLE RR 8-11
Repurchase rights – put option accounted for as a right of return
Repurchase rights – put option accounted for as a right of return
Machine Co sells machinery to Manufacturer for $200,000. Manufacturer can require Machine Co to repurchase the machinery in five years for $75,000. The market value of the machinery at the repurchase date is expected to be greater than $75,000. Machine Co offers Manufacturer the put option because an overhaul is typically required after five years. Machine Co can overhaul the equipment, sell the refurbished equipment to a customer, and receive a significant margin on the refurbished goods. Assume the time value of money would not affect the overall conclusion.
Should Machine Co account for this transaction as a sale with a return right, a lease, or a financing transaction?
Analysis
Machine Co should account for the arrangement as the sale of a product with a right of return. Manufacturer does not have a significant economic incentive to exercise its right since the repurchase price is less than the expected market value at date of repurchase. Machine Co should account for the transaction consistent with the model discussed in RR 8.2.
EXAMPLE RR 8-12
Repurchase rights – put option accounted for as lease
Repurchase rights – put option accounted for as lease
Machine Co sells machinery to Manufacturer for $200,000 and stipulates that Manufacturer can require Machine Co to repurchase the machinery in five years for $150,000. The repurchase price is expected to significantly exceed the market value at the date of the repurchase. Assume the time value of money would not affect the overall conclusion.
Should Manufacturer account for this transaction as a sale with a return right, a lease, or a financing transaction?
Analysis
Machine Co should account for the arrangement as a lease in accordance with the leasing guidance. Manufacturer has a put option to resell the machinery to Machine Co and has a significant economic incentive to exercise this right, because the guarantee price significantly exceeds the expected market value at date of repurchase. Lease accounting is required given the repurchase price is less than the original selling sales price of the machinery.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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