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Digital signature repurchase agreement

hello and welcome to this session and if you will continue to look at major revenue issues and the next thing we're gonna look at is a when there's the repurchase agreement between the buyer and the seller and the prior session we looked at the sales returns and we learn how to account for the sales rigour so how what is a repurchase agreement so what is basically a purchase agreement you sell something and you tell the by-the-by your look I'm gonna be buying it back from you in the future okay so the question becomes that you really make a sale that you really make a sale if you're selling something and you're gonna buy it back think about it I sell something that I buy it back from you and I say I'm gonna buy it for sure you don't have to worry about anything well guess what you should not be treating those as a sale because if you're gonna buy it especially if you're gonna pay more okay so let's take a look at an example let's take a look at the general rule so what is a REIT repurchase agreement allows the company to transfer an answer to a customer but have an unconditional which is called forward obligation or unconditional right and we'll talk about you know obligation or right to repurchase the answer at a later date if the obligation or the right to repurchase the asset is for an amount greater than or equal to the selling price then the transaction is a financing transaction so what are we saying here we go I have a I don't know a computer I'm gonna sell it to you I'm gonna put sale for 1500 then I'm gonna in a month buy back for 1700 well did I really sell it not really basically what I did I gave you the computer you gave me 1500 I'm gonna give you back 1700 so basically why did we do this well I needed the money so basically I'm trying to finance myself so basically it's alone why because I said give me the 1500 I'll give you my computer then I'm gonna buy back the computer back from you so the difference the 200 is technically interests and the computer is basically a collateral between us it's a collateral between us that's where you make sure you make sure if you don't get paid your money maybe you will keep it okay so this is basically as simple as a simple explanation as I can as I can work but let's work an example anyway Morgan an equipment dealer sells equipment on January 1st Alain company for 100,000 it agrees to repurchase this equipment on December 31st 2018 for 1:21 so they solve it early January and they agreed to buy it on December 31st for 1:21 notice they're gonna be buying it for more than the cost well basically this is not a sale this is basically a finance transaction you're given the equipment to get the money in the form of a log so what do you debit okay well let's we want to know since it's alone we want to use some interest rate assume that an interest rate of 10% is imputed from the agreement so basically it's costing us 10% to to get this loan okay so this is a this is a financing transaction therefore we debit cash 100,000 we credit liability to lie in a hundred thousand so we have to pay back we have an obligation to pay back a hundred thousand of course plus interest and the interest component will be how much twenty one thousand but this is the initial entry because we don't count the interest until when at those time time goes by and when time is gonna go by well we started in January 1st 2017 so most probably at the end of the year well at the end of the year December 31st we're gonna have to compute the interest expense on this and quote loan so we're gonna what's the balance the balance is a hundred thousand and we said 10% is the interest therefore we're gonna have ten thousand an interest expense therefore we debit interest expense ten thousand then we credit we credit the loan now we're gonna increase the liability we credit the loan ten thousand dollars so remember when we started this the liability tulane was a hundred thousand now we increased it by another hundred thousand by by ten thousand now we are up to 110 then another year goes by December 28 at December 31st 2018 now we're gonna have to compute interest on one hundred and ten thousand so one hundred and ten thousand is the New Balance steins 10% that's 11,000 so by December twenty thirty first 2018 we're gonna debit interest expense eleven thousand and again what do we do we add the expense to the loan now the loan we add in another eleven thousand now the loan is 121 which is this is how much we have to pay back now we pay back the loan debit the liability and credit the cash 121 and this is basically an example of any purchase agreement now what else would we need to know about repurchase agreement just kind of basically now let me just take a look at this so let's read this and just explain it a little bit just to kind of expand on this topic a little okay rather than more can have an afford word or the con option to repurchase the asset assume that lane okay assume that Lane Company has the option so now Lane has the option to do what Lane has the option to require Morgan to repurchase the asset at December 31st so they only have the option so Lane has the option so Lane can say buy it back or link and say don't worry about it we're done this option is a put option that is Lane has the option to put the asset back to Morgan or to get to sell it back to Morgan so would Lane do this the question is it all depends on the value of the asset when December 31st 2018 comes into place because we don't know if lanes gonna do it or not they may ask them to buy back the asset or they may say no this is a good asset we're gonna keep it what does it depend on depend on the value of the equipment so Lane will decide now the lane have the upper hand basically in this state they would say okay well we should give it back to them and get the money or no we should not give it back and keep the asset okay so Lane has control of the asset so it can keep the equipment or sells it to Morgan or to some other party once you have a control lease can set up to some other party now what's going to happen to value of the spot option the value of the put option will increase when the underlying asset and the situation the equipment decrease so if DF the answer goes down and value okay then Lane has protection they can set it back for 121 okay in determining how to account for this transaction Morgan has to determine whether Lane will have the economic incentive to exercise the option so how would Morgan then under those circumstances when they give Lane the option to give it back to them well it all depends how are they gonna how they have to predict basically what's gonna happen to the value of the equipment if the value of the equipment going down guess what the equipment coming back to them if the value of the equipment going up most probably they're not gonna see that equipment again because they are Morgan will keep it because they have every incentive to keep the equipment because it went up in value okay so specifically Lane has a significant economic incentive to exercise its put option if the value of the equipment declined this is what we just said in this case the transaction if that's the case the transaction is a financing transaction so we'd say well this is a financing transaction that is lane would return the equipment back to Morgan if the repurchase agreement price exceeds the fair value of the equipment for example of the repurchase price of the equipment is 150 but it's fair value is 125 Lane is better off returning the equipment of course if they can return the equipment and get 125 and the equipment is worth 1 and if they can get 150 and the equipment is worth 125 for sure they're gonna return it so on December 31st if the fair value equal to 125 and the option is to make them buy it at 150 you're gonna make them buy it back at 150 because you have something for 125 and you have the option to force them to buy it at 150 now conversely if Lane does not have a significant economic incentive to exercise the option let's assume the value the fair value is 200,000 and you can sell it at 150 if you want to you don't sell it at 150 you keep it for yourself then the transaction should be reported as a sale of sale of a product with the right of return it all depends what do you think is can happen on December 31st with the option have value and the option has a value when the asset declined when the S of the client the option will have a value for more units is when they will give you back the asset they want back their money if the asset went up in value then say more than the exercise price then they would say now we're gonna keep the asset we're not gonna exercise therefore you technically sold the asset so this so you have to know you really kind of you have to guess what's gonna happen okay and let's work another multiple choice question that deals with this topic just kind of look at look at another questions so let's take a look at this question we have just take a look at the question read it and see if you can find the answer I suggest you pause first so we have Bradley a car dealer sells a car on January 1st - Steven company for half a million Bradley agrees to repurchase the car an unconditional obligation on December 31st which is a year later at a price of five hundred and ten well this is a repurchase agreement which of the following is true recording the transaction so notice it's said we're gonna buy it back okay then conditionally we're gonna buy it back an imputed interest rate will have to be used to record interest revenue fibrate by Bradley no Bradley it's gonna have an interest if anything they're gonna have an interest expense not interest revenue so that's out the transaction should be accounted for as a lease no an imputed interest rate will have to be used to record interest expense yes let's look at they make sure we didn't cover anything on January 1st Bradley will have to credit inventory know if it was a sale they would credit the inventory but this is a financing deal so they will debit cash and our credit liability - Stevens okay for half a million basically they're using the car as a collateral for the loan okay and the additional $10,000 they're gonna they're gonna count it as interest expense so this is an example of a repurchase agreement if you have any questions any comments email me or see me in class