A seller transfers specialized equipment to a customer and separately grants the customer a put option requiring the seller to repurchase the equipment, at the customer's request, at a fixed price below the equipment's original selling price. At contract inception, the seller determines that this fixed repurchase price is close to, and not meaningfully below, the equipment's expected market value on the date the option could be exercised, so the customer has no significant economic incentive to exercise the put option. Under ASC 606-10-55-72 and 55-73, how should the seller account for this arrangement?
- As a lease of the equipment, because any put option priced below the original selling price automatically means the customer is only paying for the right to use the asset for a period of time
- As a financing arrangement, solely because the repurchase price under the put option is below the equipment's original selling price
- As a sale of a product with a right of return, because the customer has no significant economic incentive to exercise the put option and therefore is not expected to require the seller to repurchase the equipment
- As a financing arrangement if the customer is a related party of the seller, and otherwise as an outright sale with no further analysis of the put option required
Why C? And why not the others?
Correct answer: C. As a sale of a product with a right of return, because the customer has no significant economic incentive to exercise the put option and therefore is not expected to require the seller to repurchase the equipment
ASC 606-10-55-72 requires that when a seller has an obligation to repurchase an asset at the customer's request (a put option) at a price lower than the original selling price, the seller must assess at contract inception whether the customer has a significant economic incentive to exercise that right, which depends on comparing the repurchase price to the asset's expected market value at the repurchase date. Under 55-73, when the repurchase price is not significantly below the expected market value, the customer has no significant economic incentive to exercise the put, so the arrangement is instead accounted for as an ordinary sale of a product with a right of return, since the customer is not expected to actually require the seller to buy the equipment back. Treating any below-original-price put option as automatically creating a lease skips the required significant-economic-incentive assessment entirely; a lease-like outcome is reserved for cases where that incentive does exist and the repurchase price remains below the expected market value at exercise. Classifying the arrangement as a financing arrangement simply because the price is below the original selling price is also incorrect, since financing treatment under this repurchase guidance applies when the repurchase price is equal to or greater than the original selling price, not below it. There is no rule under ASC 606 that makes classification of a put-option repurchase agreement depend on whether the customer is a related party, and the standard never permits skipping the incentive analysis and defaulting to an outright sale.
Source: FASB Accounting Standards Codification: ASC 606-10-55-72 and 55-73, Revenue from Contracts with Customers — Repurchase Agreements (Put Options)