Repurchase agreements in IFRS 15
INTRO Repurchase agreements in IFRS 15 – An entity has executed a repurchase agreement if it sells an asset to a customer and promises, or has the option, to repurchase it. If the repurchase agreement meets the definition of a financial instrument, then it is outside the scope of IFRS 15. If not, then the repurchase agreement is in the scope of IFRS 15 and the accounting for it depends on its type – e.g. a forward, call option, or put option – and on the repurchase price.
A forward or a call option
If an entity has an obligation (a forward) or a right (a call option) to repurchase an asset, then a customer does not have control of the asset. This is because the customer is limited in its ability to direct the use of, and obtain the benefits from, the asset despite its physical possession. If the entity expects to repurchase the asset for less than its original sales price, then it accounts for the entire agreement as a lease. [IFRS 15.B66–B67]
Conversely, if the entity expects to repurchase the asset for an amount that is greater than or equal to the original sales price, then it accounts for the transaction as a financing arrangement. When comparing the repurchase price with the selling price, the entity considers the time value of money.
In a financing arrangement, the entity continues to recognize the asset and recognizes a financial liability for any consideration received. The difference between the consideration received from the customer and the amount of consideration to be paid to the customer is recognized as interest, and processing or holding costs if applicable. If the option expires unexercised, then the entity derecognises the liability and the related asset, and recognizes revenue. [IFRS 15.B68–B69, IFRS 15.B75]
A put option
If a customer has a right to require the entity to repurchase the asset (a put option) at a price that is lower than the original selling price, then at contract inception the entity assesses whether the customer has a significant economic incentive to exercise the right. To make this assessment, an entity considers factors including the: [IFRS 15.B70–B71]
- relationship of the repurchase price to the expected market value of the asset at the date of repurchase; and
- amount of time until the right expires.
If the customer has a significant economic incentive to exercise the put option, then the entity accounts for the agreement as a lease. Conversely, if the customer does not have a significant economic incentive, then the entity accounts for the agreement as the sale of a product with a right of return (see sale with the right of return in the link). [IFRS 15.B70, IFRS 15.B72]
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, then the contract is accounted for as a financing arrangement. In this case, if the option expires unexercised, the entity derecognizes the liability and the related asset and recognizes revenue at the date on which the option expires. [IFRS 15.B73, IFRS 15.B76]
When comparing the repurchase price with the selling price, the entity considers the time value of money. [IFRS 15.B75]
|Worked example – Handset trade-in|
Telco T enters into a 24-month wireless service contract with Customer C. At contract inception, T transfers to C a handset for 600, together with a right to trade in that handset for 100 at the end of the service contract. The stand-alone selling price of the handset at contract inception is 600. T expects the handset market value to be 150 in 24 months.
T’s obligation to repurchase the handset at the customer’s option is a put option. T assesses, at contract inception, whether C has a significant economic incentive to exercise the put option, to determine the accounting for the transfer of the handset.
T concludes that C does not have a significant economic incentive to exercise the put option because the repurchase price of 100 is lower than the expected market value of 150. Additionally, customers usually have easy access to the second-hand market to resell similar phones. T determines that there are no other relevant factors to consider when assessing whether C has a significant economic incentive to exercise the put option. Consequently, T concludes that control of the handset transfers to C because C is not limited in its ability to direct the use of, and obtain substantially all of the remaining benefits from, the handset.
T therefore accounts for the transaction as a sale with a right of return (see sale with a right of return in the link).
An approach that focuses on the repurchase price
IFRS 15 includes guidance on the nature of the repurchase right or obligation and the repurchase price relative to the original selling price. In contrast, the current accounting focuses on whether the risks and rewards of ownership have been transferred. As a result, determining the accounting treatment for repurchase agreements may, in some cases, be more straightforward under IFRS 15, but differ from current practice.
However, judgment will be required to determine whether a customer with a put option has a significant economic incentive to exercise its right. This determination is made at contract inception and is not updated for subsequent changes in asset prices. Historical customer behavior in similar arrangements will be relevant to this determination.
Requirements for repurchase agreements not applicable to arrangements with a guaranteed resale amount
The Boards observed that although the cash flows of an agreement with a guaranteed minimum resale value may be similar to those of an agreement with a put option, the customer’s ability to control the asset is different, and therefore the recognition of revenue may differ. This is because if a customer has a significant economic incentive to exercise a put option, then it is restricted in its ability to consume, modify, or sell the asset. This would not be the case if the entity instead had guaranteed a minimum amount of resale proceeds. This could result in different accounting for arrangements with similar expected cash flows.
Conditional forwards or call options
In some cases, a forward contract or a call option may be conditional on a future event. Although all of the facts and circumstances need to be evaluated for each arrangement, treating certain conditional forwards or call options as rights of return (see 10.1) may be more consistent with the economics of these transactions. In these cases, it is appropriate to apply the principles for recognizing and measuring variable consideration from a right-of-return provision, rather than accounting for the arrangement as a lease or a financing transaction.
For example, some perishable goods manufacturers include provisions in their agreements with customers where they have the right to remove and replace out-of-date products to ensure the end consumers receive the product quality and freshness they expect. Under these circumstances, the manufacturer does not have the unconditional right to repurchase the products at any time. The product must be past its sell-by date for the manufacturer to apply this right.
In this example, the existence of a conditional call option does not restrict the customer’s ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset unless and until the conditional event occurs, because the customer has no right to return the product if the sell-by date has not passed. Consequently, the customer has control over the asset until the contingent event occurs. Therefore, in this example the manufacturer accounts for the arrangement as a sale with a right of return.
Right of first refusal
A seller may retain the right of a first refusal for a future sale of the purchased asset by the customer. This allows the seller to repurchase the asset at the same price as a third-party agrees to pay to the customer for the sale of the asset.
This right is not a call or a put option because it does not prevent the customer from controlling the asset. Accordingly, it does not generally constitute a repurchase agreement and therefore does not affect revenue recognition by the seller. Additionally, the customer has no right to return the asset to the seller so the returns are not estimated.
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