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Revenue includes a $3 million sale made on 1 jan 2015 of maturing goods which are not biolovical assets. The carrying amount of these goods at the date of sale was $2 million.Moston is still in possession of the goods (but they have not been included in the inventory count) and has an unexercised option to repurchase them at any time in the next three years. In three years time the goods are expected to be worth $5million.The repuchase price will be the original selling price plus interest at 10% per annum from the date of sale to the date of repurchase.
This is treated as a loan in substance in the solution. Can you please explain me how this transaction will affect the cash flow staement.Is it financing or investing?
It’s financing – it’s a loan that is secured by the maturing asset
The entry that will have been recorded is:
Dr Cash $3 million
Cr Revenue $3 millionand the asset has been excluded from the inventory valuation
The correct treatment should have been:
Dr Cash $3 million
Cr Loan Account $3 millionso we now need to reduce the reported revenue by $3 million and increase the long-term liabilities by that amount
In addition, as we decrease revenue, we also decrease cost of sales because we are bringing back into inventory that $3 million so reported profits will not change
But liabilities have been increased, so where’s the double entry to balance that increase?
It’s in long-term assets – those maturing goods are still our inventory
In the cash flow statement, changes in working capital are affected because the inventory is now $3 million greater than originally reported so that’s an additional ‘outflow’ in the calculation of net cash flow from operating activities
In addition there is now a $3 million inflow in financing activities – the money received from the “sale”
OK?
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