Chapter 8 — Step 5: Determine When to Recognize Revenue

8.7 Repurchase Agreements

ASC 606-10

25-26 When evaluating whether a customer obtains control of an asset, an entity shall consider any agreement to repurchase the asset (see paragraphs 606-10-55-66 through 55-78).

An entity that enters into a contract for the sale of an asset may also enter into an agreement to repurchase the asset. The repurchased asset may be the same asset originally sold, an asset that is substantially the same as the originally sold asset, or an asset of which the asset originally sold is a component. The repurchase agreement may be either a part of the original contract or a separate contract; however, the terms of the repurchase are agreed upon at inception of the initial contract. An arrangement in which the entity subsequently decides to repurchase the asset after transferring control would not constitute a repurchase agreement. Paragraph BC423 of ASU 2014-09 states that the FASB and IASB decided that a subsequent agreement would not constitute a repurchase agreement because “the entity’s subsequent decision to repurchase a good without reference to any pre-existing contractual right does not affect the customer’s ability to direct the use of, and obtain substantially all of the remaining benefits from, the good upon initial transfer.”

The boards considered repurchase agreements in developing the guidance on control since repurchase agreements may affect whether the entity is able to conclude that control of the asset has been transferred to the customer. The revenue standard sets out three ways a repurchase agreement would typically occur (forward, call option, and put option). When the entity has an obligation or right to repurchase the asset (forward or call option), it is precluded from concluding that control has been transferred to the customer given the nature of these options and should account for the contract as a lease or financing arrangement. When the arrangement includes a put option (an obligation for the entity to repurchase the asset at the customer’s request), the entity will need to exercise more judgment to determine whether the customer has a significant economic incentive to exercise that right.

ASC 606-10

55-66 A repurchase agreement is a contract in which an entity sells an asset and also promises or has the option (either in the same contract or in another contract) to repurchase the asset. The repurchased asset may be the asset that was originally sold to the customer, an asset that is substantially the same as that asset, or another asset of which the asset that was originally sold is a component.

55-67 Repurchase agreements generally come in three forms:

An entity’s obligation to repurchase the asset (a forward)
An entity’s right to repurchase the asset (a call option)
An entity’s obligation to repurchase the asset at the customer’s request (a put option).

For more information about evaluating whether an entity’s obligation or right to repurchase the asset should be accounted for as a lease, see Section 2.3.1.1 of Deloitte’s Roadmap Leases.

8.7.1 Forward or Call Option

ASC 606-10

55-68 If an entity has an obligation or a right to repurchase the asset (a forward or a call option), a customer does not obtain control of the asset because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset even though the customer may have physical possession of the asset. Consequently, the entity should account for the contract as either of the following:

A lease in accordance with Topic 842 on leases, if the entity can or must repurchase the asset for an amount that is less than the original selling price of the asset unless the contract is part of a sale and leaseback transaction. If the contract is part of a sale and leaseback transaction, the entity should account for the contract as a financing arrangement and not as a sale and leaseback transaction in accordance with Subtopic 842-40.
A financing arrangement in accordance with paragraph 606-10-55-70, if the entity can or must repurchase the asset for an amount that is equal to or more than the original selling price of the asset.

55-69 When comparing the repurchase price with the selling price, an entity should consider the time value of money.

55-70 If the repurchase agreement is a financing arrangement, the entity should continue to recognize the asset and also recognize a financial liability for any consideration received from the customer. The entity should recognize the difference between the amount of consideration received from the customer and the amount of consideration to be paid to the customer as interest and, if applicable, as processing or holding costs (for example, insurance).

55-71 If the option lapses unexercised, an entity should derecognize the liability and recognize revenue.

The graphic below illustrates the application of this guidance to transactions involving forward or call options that are not sale-and-leaseback transactions.

The following example in ASC 606 illustrates how a repurchase agreement that includes a call option would be accounted for as a financing arrangement:

ASC 606-10

Example 62 — Repurchase Agreements

55-401 An entity enters into a contract with a customer for the sale of a tangible asset on January 1, 20X7, for $1 million.

Case A — Call Option: Financing

55-402 The contract includes a call option that gives the entity the right to repurchase the asset for $1.1 million on or before December 31, 20X7.

55-403 Control of the asset does not transfer to the customer on January 1, 20X7, because the entity has a right to repurchase the asset and therefore the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Consequently, in accordance with paragraph 606-10- 55-68(b), the entity accounts for the transaction as a financing arrangement because the exercise price is more than the original selling price. In accordance with paragraph 606-10-55-70, the entity does not derecognize the asset and instead recognizes the cash received as a financial liability. The entity also recognizes interest expense for the difference between the exercise price ($1.1 million) and the cash received ($1 million), which increases the liability.

55-404 On January 1, 20X7, the option lapses unexercised; therefore, the entity derecognizes the liability and recognizes revenue of $1.1 million.

8.7.1.1 Contingent Repurchase Agreements

ASC 606-10-55-68 states, in part, that “[i]f an entity has an obligation or a right to repurchase the asset (a forward or a call option), a customer does not obtain control of the asset because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset even though the customer may have physical possession of the asset.” In some situations, an entity may exercise its call option (i.e., repurchase the asset) only upon the occurrence of a future event (e.g., termination of the contract).

The presence of a right to repurchase an asset typically precludes an entity’s customer from obtaining control of that asset and therefore typically precludes the entity from recognizing revenue from the sale of that asset. This conclusion is based on the notion that the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Therefore, it is important for the entity to consider whether the contingency related to the call option limits the customer’s ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Specifically, when determining whether the contingent call option affects the customer’s ability to control the asset, the entity should consider whether the triggering of the contingency is within the entity’s or the customer’s control.

Repurchase options that are contingent on factors within the entity’s control would generally imply that the customer has not obtained control of the asset. In such cases, the entity should account for the contract as a lease or financing arrangement in a manner consistent with the guidance in ASC 606-10-55-68. Alternatively, repurchase options that are contingent on factors within the customer’s control may imply that the customer has the ability to determine whether the call option may be exercised. For example, if an entity can repurchase an asset sold to a customer only in the event that the customer terminates the contract for convenience (i.e., the entity does not have a right to terminate the contract), the triggering of the call option is within the customer’s control. In that situation, the entity may reasonably conclude that the customer obtains control of the asset even though there is a contingent call option.

8.7.1.2 Accounting for Contracts With a Right to Recall a Product After Its “Sell-By” Date

Certain contracts, such as those between a perishable goods supplier (the “entity”) and its customer, include provisions permitting or obligating the entity to remove (and sometimes replace) out-of-date products (e.g., to ensure that the end consumers receive a certain level of product quality or freshness, or both). Under these circumstances, the entity does not have the unconditional right or obligation to repurchase the products at any time from the customer. Rather, the products must be past their “sell-by date” before the entity would repurchase the goods.

A call option or forward that is dependent on the passing of an expiration date (such as the one discussed above) does not require a transaction to be accounted for as a lease or financing, in accordance with ASC 606-10-55-68. In the type of scenario described above, it would be appropriate for the entity to account for such an arrangement in a manner similar to the accounting for a sale with a right of return (i.e., as variable consideration) rather than as a lease or a financing transaction.

In lease or financing arrangements, the customer does not have the ability to control the asset for the asset’s economic life. This is because in these arrangements, the customer is constrained in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. For example, in a lease arrangement, the customer may not sell the asset even though it has physical possession of the asset. However, in the type of scenario described above, a customer is free to sell, consume, or otherwise direct the use of the product unless the product becomes out of date. That is, the entity’s call option in such a scenario is a protective right to recall the goods upon their expiration, which does not prevent the customer from controlling the asset (i.e., selling it) before the asset’s sell-by date.

8.7.1.3 Sale of a Commodity That Is Subject to an Agreement to Repurchase the Commodity at Its Prevailing Market Price on the Date of Repurchase

ASC 606-10-55-68 provides that when an entity sells an asset to a customer but has an obligation or a right to repurchase the asset (a forward or a call option), the customer “does not obtain control of the asset because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset even though the customer may have physical possession of the asset.” Consequently, the entity should account for the contract as either (1) a lease in accordance with ASC 842 (if the repurchase price of the forward or call option is less than the original selling price) or (2) a financing arrangement in accordance with ASC 606-10-55-70 (if the exercise price of the forward or call option is equal to or greater than the original selling price). The accounting treatment of a repurchase at market price (which could be greater than, less than, or equal to the original selling price) is not specifically addressed.

If an entity sells a quantity of a commodity to a customer but has an obligation or a right to repurchase an equivalent amount of that commodity (i.e., an asset that is substantially the same as that originally sold) at the prevailing market price for that commodity, the entity is not always precluded from recognizing a sale for the original commodity.

Although ASC 606-10-55-68 precludes an entity from recognizing revenue when a contract includes a forward or call option, this guidance is based on the notion that control of the asset has not passed to the entity’s customer “because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.” Similarly, paragraph BC424 of ASU 2014-09 notes that the FASB’s and IASB’s rationale for concluding that no revenue should be recognized when an entity holds a forward or call option to repurchase an asset is that the entity’s customer does not obtain control of the asset.

As acknowledged in paragraph BC425 of ASU 2014-09, in circumstances in which a substantially similar asset is readily available in the marketplace (which may be the case for a commodity), an entity’s agreement with a customer to repurchase an asset at the asset’s prevailing market price on the date of repurchase may not constrain the customer’s ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset originally sold. Accordingly, it is important to consider whether an entity’s obligation or right to repurchase a substantially similar commodity does, in fact, limit the ability of the entity’s customer to control the commodity originally sold. This will depend on a careful analysis of the specific facts and circumstances.

If the entity’s customer is in any way limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset originally sold, the entity should not account for the contract as a sale but instead should account for the contract in accordance with the contract’s nature (e.g., as a lease or financing arrangement). In addition, the entity should consider whether the contract includes any other element, such as payment for transport of the commodity, which should be accounted for separately.

However, if there is sufficient evidence to demonstrate that the entity’s customer is not limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset (and, therefore, that control of the asset has clearly been transferred to the customer), the entity should account for the contract as a sale in accordance with ASC 606. For this to be possible, it would be necessary that (1) the customer could readily source the equivalent commodities and the requisite quantities at the appropriate time and in the appropriate location to satisfy the requirements of the forward or call option and (2) the repurchase price to be paid is equivalent to the prevailing market price on the date of repurchase.

8.7.2 Put Option

ASC 606-10

55-72 If an entity has an obligation to repurchase the asset at the customer’s request (a put option) at a price that is lower than the original selling price of the asset, the entity should consider at contract inception whether the customer has a significant economic incentive to exercise that right. The customer’s exercising of that right results in the customer effectively paying the entity consideration for the right to use a specified asset for a period of time. Therefore, if the customer has a significant economic incentive to exercise that right, the entity should account for the agreement as a lease in accordance with Topic 842 on leases unless the contract is part of a sale and leaseback transaction. If the contract is part of a sale and leaseback transaction, the entity should account for the contract as a financing arrangement and not as a sale and leaseback transaction in accordance with Subtopic 842-40.

55-73 To determine whether a customer has a significant economic incentive to exercise its right, an entity should consider various factors, including the relationship of the repurchase price to the expected market value of the asset at the date of the repurchase and the amount of time until the right expires. For example, if the repurchase price is expected to significantly exceed the market value of the asset, this may indicate that the customer has a significant economic incentive to exercise the put option.

55-74 If the customer does not have a significant economic incentive to exercise its right at a price that is lower than the original selling price of the asset, the entity should account for the agreement as if it were the sale of a product with a right of return as described in paragraphs 606-10-55-22 through 55-29.

55-75 If the repurchase price of the asset is equal to or greater than the original selling price and is more than the expected market value of the asset, the contract is in effect a financing arrangement and, therefore, should be accounted for as described in paragraph 606-10-55-70.

55-76 If the repurchase price of the asset is equal to or greater than the original selling price and is 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, then the entity should account for the agreement as if it were the sale of a product with a right of return as described in paragraphs 606-10-55-22 through 55-29.

55-77 When comparing the repurchase price with the selling price, an entity should consider the time value of money.

55-78 If the option lapses unexercised, an entity should derecognize the liability and recognize revenue.

The flowchart below illustrates the application of this guidance to transactions involving a put option held by the customer.

The following example in ASC 606 illustrates how a repurchase agreement that includes a put option would be accounted for as a lease:

ASC 606-10

Example 62 — Repurchase Agreements

55-401 An entity enters into a contract with a customer for the sale of a tangible asset on January 1, 20X7, for $1 million.

[Case A omitted8]

Case B — Put Option: Lease

55-405 Instead of having a call option [as in Case A], the contract includes a put option that obliges the entity to repurchase the asset at the customer’s request for $900,000 on or before December 31, 20X7. The market value is expected to be $750,000 on December 31, 20X7.

55-406 At the inception of the contract, the entity assesses whether the customer has a significant economic incentive to exercise the put option, to determine the accounting for the transfer of the asset (see paragraphs 606-10-55-72 through 55-78). The entity concludes that the customer has a significant economic incentive to exercise the put option because the repurchase price significantly exceeds the expected market value of the asset at the date of repurchase. The entity determines there are no other relevant factors to consider when assessing whether the customer has a significant economic incentive to exercise the put option. Consequently, the entity concludes that control of the asset does not transfer to the customer because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

55-407 In accordance with paragraphs 606-10-55-72 through 55-73, the entity accounts for the transaction as a lease in accordance with Topic 842 on leases.

8.7.2.1 Accounting for Trade-In Rights

In certain contracts with customers, an entity may agree to provide its customer with the right to trade in the original specified good for a fixed price if the customer purchases the next version of the specified good once it becomes available (the “trade-in right”).

To account for a trade-in right in its contract with a customer, an entity will need to evaluate the specific terms of the arrangement and determine whether the trade-in right is within the scope of ASC 460. If the entity concludes that the trade-in right is outside the scope of ASC 460, it should apply the guidance in ASC 606 to the entire arrangement.

If the entity concludes that the trade-in right is within the scope of ASC 460, the fixed-price trade-in right should be measured at fair value and excluded from the transaction price. The remaining transaction price should then be allocated to the remaining elements within the scope of ASC 606 (i.e., the product) and recognized when control of the product is transferred to the customer (e.g., upon delivery).

If the trade-in right is outside the scope of ASC 460, the fixed-price trade-in right should be assessed under the repurchase guidance in ASC 606. The trade-in right is a put option since the entity is obligated to repurchase the product at the customer’s option. If the repurchase price is less than the original selling price, the entity must evaluate whether the customer has significant economic incentive to exercise the right. If the entity determines that the customer has significant economic incentive to exercise the right, it would account for the arrangement as a lease. If the entity determines that the customer does not have a significant economic incentive to exercise the right, it may be appropriate to account for the element as a sale with a right of return. However, the facts and circumstances of the trade-in right should be evaluated, and other accounting models may be appropriate.

8.7.3 Residual Value Guarantees

Throughout their discussions on repurchase agreements, the FASB and IASB also considered whether other arrangements should be accounted for as leases, such as those in which an entity provides its customer with a guaranteed amount to be paid on resale (i.e., a residual value guarantee). Respondents provided feedback indicating that such arrangements appeared to be economically similar to repurchase agreements. However, as noted in paragraph BC431 of ASU 2014-09, the boards made the following observation:

[W]hile the cash flows [in repurchase agreements and residual value guarantees] may be similar, the customer’s ability to control the asset in each case is different. If the customer has a put option that it has significant economic incentive to exercise, the customer is restricted in its ability to consume, modify, or sell the asset. However, when the entity guarantees that the customer will receive a minimum amount of sales proceeds, the customer is not constrained in its ability to direct the use of, and obtain substantially all of the benefits from, the asset.

Accordingly, the boards decided that sales with a residual value guarantee should not be accounted for under the repurchase agreement implementation guidance in the revenue standard. Rather, such arrangements should be accounted for in accordance with the general five-step model outlined in the standard. However, in arrangements involving residual value guarantees, an entity should bifurcate and account for the residual value guarantee at fair value under ASC 460 while accounting for the remaining contract consideration under ASC 606.

ASU 2014-09 clarifies that arrangements involving residual value guarantees do not represent repurchase agreements and should be accounted for under ASC 460 and ASC 606. This guidance is similarly reflected in ASU 2016-02. Specifically, ASC 842-10-55-32 states, in part, that “except as provided in paragraph 460-10-15-7, the provisions of Subtopic 460-10 on guarantees apply to indemnification agreements (contracts) that contingently require an indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party.” A residual value guarantee is generally a provision that contingently requires a seller (guarantor) to make a payment to a purchaser (guaranteed party) based on the change in the fair value (i.e., resale value, which is the underlying) of the asset transferred. Accordingly, a residual value guarantee would generally be accounted for under ASC 460.

8.7.4 Right of First Refusal and Right of First Offer in Connection With a Sale

An entity should carefully consider a revenue contract’s terms related to the sale of an asset that provide the entity with future rights to the asset sold. Two common types of such rights are a right of first refusal (ROFR) and a right of first offer (ROFO), which are often found in real estate transactions.

A ROFR gives the entity an option to repurchase the asset being sold to the customer if the customer subsequently plans to accept a bona fide offer from a third party to purchase the asset from the customer. If the entity exercises its option, the repurchase transaction would be subject to terms and conditions that are similar to those in the bona fide offer the customer received from the third party.

ASC 606-10-55-68 states, in part, that “[i]f an entity has an obligation or a right to repurchase the asset (a forward or a call option), a customer does not obtain control of the asset because the customer is limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset even though the customer may have physical possession of the asset.” However, an entity’s ROFR would not, on its own, prevent the customer from obtaining control of the asset (as defined in ASC 606-10-25-25).

A ROFR as described above allows the seller to influence the determination of the party to whom the customer subsequently sells the asset but not whether, when, or for how much the subsequent sale is made. Consequently, the entity’s right does not limit the customer’s ability to direct the use of the asset or to obtain substantially all of the remaining benefits from the asset.

A ROFO may be found in sale-and-leaseback arrangements and gives the seller-lessee an option to make a first offer to the buyer-lessor to repurchase the underlying asset that has been leased at the end of the lease term. Sale accounting is generally not precluded if the buyer-lessor is not required or compelled to accept the offer and the price of the asset is not fixed. If the buyer-lessor is required or compelled to accept the offer, the seller-lessee essentially has a repurchase option that may prevent the buyer-lessor from obtaining control of the asset. On the other hand, if the seller-lessee is required or compelled to make the offer, the buyer-lessor essentially has a put option, as described in Section 8.7.2.

Example 8-17

Entity B enters into a contract to sell a building to Entity C. The contract’s terms provide that if, after the sale, C receives a bona fide offer from an unaffiliated third party to purchase the building and C plans to accept the offer, B has the option to repurchase the building subject to terms and conditions that are similar to those contained in the offer C received from the third party.

In the assessment of whether B has transferred control of the building to C, the ROFR, on its own, would not prevent C from obtaining control of the building.

Footnotes

Case A of Example 62, on which Case B is based, is reproduced in Section 8.7.1.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.