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(extract from P2 bbp examkit) Question 3 part b:
On 1 July 20X6, Venue entered into a contract with Reven for the sale of plant for $500,000. The contract
included a call option that gave Venue the right to repurchase the plant for $550,000 on or before 30 June
20X7.Required
Discuss how the above transaction would be treated in subsequent financial statements of Venue for the
year ended 31 July 20X7
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Answer:
‘Reven DOES NOT ” obtain control” of the plant, because the repurchase option means that it is limited in its
ability to use and obtain benefit from the plant.As control has not been transferred, Venue must account for the transaction as a financing arrangement,
because the exercise price is above the original selling price. Venue must continue to recognise the plant
and recognise the cash received as a financial liability. The difference of $50,000 is recognised as interest
expense.
If, on 31 July 20X7, the option lapses unexercised, Reven will then obtain control of the plant. In this case,
Venue must will derecognise the plant and recognise revenue of $550,000 (the $500,000 already received
plus the $50,000 charged to interest).
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My Question is:I don’t understand WHY the answer above said ”Reven DOES NOT ” obtain control” of the plant” which i think Reven does have CONTROL over the plant as it is the buyer of the plant.
The ”Call-Option” as i checked the term means ”buyer has the CONTROL”, so Reven as the Buyer should have the Control over the plant it has purchased.
Hope anyone can explain me.
Thank you,
SambathHi,
The call option gives Venue the option to buy back the plant in one year’s time. As it has the option to do so at a price that could be reasonably expected to be paid then there is a likelihood the repurchase will occur. If there is any likelihood of repurchase then the buyer doesn’t have full control.
Please note that just because one party has bought the plant doesn’t mean to say that they have control, you need to look in the detail of the transaction.
Hope this helps.
Thanks
Hi,
in the same question part it is said that :
“If, on 31 July 20X7, the option lapses unexercised, Reven will then obtain control of the plant. In this case,
Venue must will derecognise the plant and recognise revenue of $550,000 (the $500,000 already received
plus the $50,000 charged to interest). ”I don’t understand why Venue must also recognise the interest paid as revenue?
Effectively, Venue sold the plant for 500 000 and the financial liability is 500 000. Why do we include the interest as revenue, as we did not receive the cash?
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