Original Equipment Manufacturers (OEMs) may have a right or obligation to repurchase vehicles as part of a contract with a customer or may provide residual value guarantees to certain customers. Examples include repurchase options on sales of fleet vehicles or residual value guarantees to fleet customers or third-party purchasers of vehicles (e.g., finance companies). While the economics of a repurchase agreement and a residual value guarantee may be similar, the accounting outcome could be quite different under IFRS 15.
Repurchase agreements Repurchase options and residual value guarantees
Some agreements include repurchase provisions, either as part of the original sales contract or as a separate contract that relates to the original sales contract. These provisions affect how an entity applies the guidance on control to affected transactions.
Forward or call option held by the entity Repurchase options and residual value guarantees
The standard indicates that if the entity has the right or obligation to repurchase the asset at a price less than the original sales price (taking into consideration the effects of the time value of money), the entity would account for the transaction as a lease in accordance with ASC 842, Leases, or ASC 840, Leases, if an entity hasn’t yet adopted ASC 842, unless the contract is part of a sale-leaseback transaction. When an OEM has the obligation or right to repurchase a vehicle, the transaction will most often be accounted for as a lease because the repurchase price is typically less than the original sales price.
Put option held by the customer Repurchase options and residual value guarantees
If the customer has the ability to require the OEM to repurchase a vehicle (i.e., a put option) at a price lower than the vehicle’s original selling price, the standard requires the OEM to consider at contract inception whether the customer has a significant economic incentive to exercise that right. This determination influences whether the customer has control over the asset received and, therefore, whether the contract is treated as a lease or a sale with the right of return. Repurchase options and residual value guarantees
To determine whether a customer has a significant economic incentive to exercise the repurchase option, OEMs need to consider various factors, including the relationship of the repurchase price to the expected market value (e.g., auction price) of the vehicle at the date of repurchase and the amount of time until the right expires. For example, if the repurchase price is expected to significantly exceed the market value at the time of repurchase, this may indicate that the customer has a significant economic incentive to exercise the repurchase option.
Under IFRS 15, arrangements with repurchase features must be evaluated to determine whether they represent a sale, lease or financing, based on specified criteria. This evaluation includes considering factors such as the likelihood of a customer exercising a put option or the relationship between the repurchase price and the market value of the asset at the date of repurchase. Contracts that include residual value guarantees and make whole provisions may qualify for sale accounting under the revenue standard and also may include a component of variable consideration. These assessments will require considerable judgement.