June 2010 Wardle – in substance loan

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    stubarny
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    Hello Mike,

    This question asks for an in substance loan to be reflected in income statements accross 3 years.

    The finance costs (compound interest rates) are shown in each year and the revenue is shown in the last year which I agree with. But please could you explain why the cost of sales is reflected in year 3 (when the product is sold) but not in year 1 (when the product was made, but before it matures over the next couple of years)?

    (The legal form has the cost of sales reflected in year 1)

    Thank you.

    Stu


    Avatar of MikeLittle
    MikeLittle
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    I presume that this is a sale and repurchase situation where, for example, you sell whisky to the bank. If so, it’s not a sale as such because the risks and rewards of ownership haven’t really passed. At the end of three years you will have to buy the whisky back from the bank ( if they haven’t drunk it all – but, hey, what a party! )

    So for the three year period, if in fact you haven’t sold it, then the whisky would still be in the inventory of the company and the money received from the “sale” is, in substance, a loan.

    As for cost of sales not being in year 1, well I’ve just explained that the sale doesn’t take place until we “buy” the whisky back and then sell it on the market. If you accept that the sale doesn’t take place until year 3 then, under the matching concept, in which year should you be showing the cost of that year 3 sale?


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    stubarny
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    ahhh, so it was ‘in substance’ still in inventory in year q1 so the “purchases” and “inventory adjustment” cancel out to zero in year 1. Thank you!


    Avatar of MikeLittle
    MikeLittle
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    You’re welcome

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