 Hello and welcome to the session in which we would look at sales with repurchase agreement and sales with high return. This topic is part of costing inventory and overall this topic is covered in intermediate accounting as well as the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest to visit my website farhatlectures.com. I don't replace your CPA review course. I'm a useful addition to your CPA review course. I explain the material differently. I give you the theory behind the concept which in turn it's going to help you with your CPA review course which in turn will help you pass the exam. Your risk is one month of subscription. You give it a try. You like it. You keep it. You don't like it. You cancel. That's your risk. Your potential return is increasing your grade by 10 to 15 points. If not for anything, take a look at my website to find out how well or not well your university is doing on the CPA exam. This is a list of all my accounting courses such as auditing, advance accounting, governmental accounting, intermediate accounting, so on and so forth. My CPA supplemental resources are aligned with your CPA review course such as Becker, Wiley, Roger, Gleam. So you can go back and forth between your CPA review course and my material. I also have all the AI CPA previously released questions, almost 1500 CPA exam questions with detailed solution. If you haven't connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit. In the previous session, we looked at what's included in the cost of the inventory. Then we looked at FOB shipping and FOB destination and we looked at consigned goods. So in this session, we're going to focus on two other topics that we have to understand when it comes to dealing with inventory. The first topic is sales with repurchase agreement known as repo. Sales with repurchase agreement is really a form of financing. What do I mean by this? What does financing means? Financing is how you raise money. How do you raise money? You either sell stocks or you borrow money. Well, guess what you can do sometime? You can sell and quote your inventory, sell your inventory. And at the same time, agree with the purchaser that you will buy this inventory later at a later date at a higher price. So simply put, you sell them something for 100,000, you buy it from them at 105,000. What happened is you sold them, they gave you 100,000, you buy at 105,000, you give them 105 back. So you'll give them an additional 5,000. This difference, additional 5,000 is technically interest. This is called repo. Now one company that was notorious for doing so and they utilize this strategy for illegal objective, which is called Lehman Brothers. It's an investment firm on Wall Street and what Lehman used to do, Lehman, rather than having actual physical inventory, you could use repo for anything. You could, even if you have any asset, like if you have your computer, you could go somewhere, sell, tell someone, look, here's my computer. Buy it from me and I will buy it back from you at a later date. What you're doing is they're going to give you money now. They allow you to keep the computer most likely. This is the agreement and later on you will buy it back from them. But if you don't buy it back from them, they have the right to take your computer. So what Lehman used to have on their books, Lehman have assets and as an investment bank, their assets consist of investments. So rather than inventory, they have investments, which is technically it's their inventory. That's what they have. They buy and sell investments. So what they used to do at the end of every year, right before the year end, what they would do, they will go into the repo investments. Let's assume they have a million-dollar worth of investment and I'm talking here maybe not millions, hundreds of millions. Let's assume a million-dollar worth of investments. Now, those investments, they went down in value. It means they are bad investments. So what Lehman used to do to avoid writing down those investments, they will go into repo agreement with another party. They will tell another party, look, we're going to sell you, I'm going to put in quotes, sell you those investments, then we're going to buy it back from you. So what they do by the end of the year, before the end of the year, they will sell those investments. And let's assume they sold them by December 31st, January, February, they will get them back and they will pay a little bit more. So why would they do this? For one thing is if they need the cash, they got the cash. But the other thing what they were trying to do, they were trying to remove those investments to somewhere else, to the repo company. And by doing so, when the auditor look at their investments, if those investments don't exist, they don't have to write them down. So they did it for a different purpose. I just want to let you know that repo could be done for any type of asset, any asset you have, you could basically repo is putting up something as a collateral. You're telling someone, look, buy it from me, buy it from me now and I will buy it back later at a higher price. This is what we are looking at basically. So, so it's basically what you are doing. You are parking your inventory on someone else's balance sheet because we are dealing with inventory here. We are dealing with inventory here. Okay, rather than investments, it's inventory. It's a form of a substance. So the company did not give up control over the inventory because they did not give up control. It's not really a sale because if you give up control, the other party can enjoy can do whatever they want to the inventory. That's not the case. You're selling them the inventory and you're telling them, look, I'm going to buy it back so they can do anything with it really. Okay, so that's why it's not really a sale. Therefore, it cannot be considered a sale. It's a financing agreement. The best way to illustrate this is to look at an example. January 1st, Adam Company sold in quote 100,000 of its inventory to Ryan while agreeing with Ryan to purchase the inventory at the end of the year for 110. So here's the entry that we make. We debit cash 100,000. This is what Ryan gave us and we credit a liability to Ryan for 100,000. We don't credit sales. Okay, we don't credit sales because we're going to buy it back on December 31st. A year later, we're going to pay off the liability. We're going to debit the liability. Debit interest expense for 10,000 and give Ryan 110,000. Simply put, we borrowed the money from Ryan and we pay back with interest. The reason we are discussing this in the context of inventory, the point is the inventory stayed on Adam's balance sheet. The inventory stays on the balance sheet as Adam has control of the inventory unless they fail to pay back Ryan, then it will become a different story. But they cannot remove the inventory because if they remove the inventory, it's technically a sale. It becomes a sale because they gave up the inventory. Now Ryan has control over the inventory. That's not the case here. Another issue that we have to deal with when it comes to inventory, sales with high rate of return. Certain industries, the toys, books, and sporting goods grant the purchaser a generous return policy. Simply put, if you don't sell whatever you bought from us, you can return it for full credit. The best way to illustrate this is to work an example. January 1st, premium publishing company PPC shipped and sold 100 intermediate accounting textbook to your college bookstore for $90. The cost of each book for PPC is $60. PPC gave the bookstore the right to return any unsold textbook for full credit. And PPC, based on past experience, expect a 10% of the books to be returned unsold. That's what they think. So if they sold 100 books, they think the bookstore will give them back 10 books. Now why would the bookstore will have an extra 10 books? Well, you never know. Maybe more students are taking intermediate accounting. We don't know. But the point is they want to have a buffer zone. In this way, in case they have more demand for books, they will have it. During the year, the college bookstore returned three tax books. So the college bookstore returned three tax books. Let's look at the journal entries. First, we're going to book the sale debit account receivable credit sale. They sold 100 books at $90. Then we debit cost of goods sold credit inventory 100 books, the cost of each book for PPC is $60. Now the bookstore returned three books. So we will debit sales returns and allowances three books times 90. And we credit account receivable for 270. So debit sales return and allowances, which is a contra sales. This is going to reduce the sales for PPC. Then we'll debit inventory or return inventory three books. They're still in good shape. The cost is 60. We put them back on the on the books for their original cost 60. So we debit 180 inventory or inventory return credit cost of goods sold 180. This is what actually happened. Now at the end of the year, what's going to happen is this PPC will have to book an adjustment. What is the adjustment for? They expect 10 books to be returned. Three books already were returned. There are seven books we need to make an adjustment for. Therefore they will debit sales returns and allowances seven books times $90, 630. And they will debit an account called allowance for sales returns and allowances. This is a contra receivable because they think seven more books will be returned. We have to reduce our account receivable. Therefore we create an allowance for now. Also what we have to do, we debit estimated inventory return. Estimated inventory return is an inventory account. So it's an asset, but it's listed separately. It's not with the with the other inventory. Nevertheless, it's an asset. So we have to estimate what inventory we're going to be getting. We're going to be getting seven more books back from that bookstore, from that local bookstore. And we credit cost of goods sold for 420. So the point is, although we made the sale because we have this generous policy and we expect those books to be returned. We have to update our inventory because this is what we're talking about here. This chapter is about inventory. Now the same concept applies when we are dealing with sales returns. When we are dealing with sales returns and allowances, the same example would apply. But I'll be focusing more on the sales return as a reduction of sales, sales returns and allowances as a contra sales or a contra revenue. In the next recording, I will illustrate the difference between product and period costs and how do we treat purchase discount. At the end of this recording, I'm going to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course. I'm a useful addition to your CPA review course. I can help you understand the material better. I can show you the theory behind the concept, which will help you with your CPA review course. My offer, my risk is one month of subscription. You give it a try. You like it, you keep it. You don't like it, you cancel. Your potential return is actually understanding the material better, adding 10 to 15 points to your CPA exam score, scoring that 75, putting the exam behind you, focusing on your career. The CPA exam is worth it. Study hard, good luck and of course, stay safe.