Special Sales Agreements
The term special sales agreements refers to situations where legal transfer of ownership does not align with the economic risk of ownership. The three most common forms of these special sales agreements include installment sales, merchandise with high rates of return, and buyback agreements.
Generally, when the legal title to merchandise passes from the seller to buyer, the value of that item is removed from the seller’s inventory. There are occasions whereby the economic value of ownership and legal title are not aligned. For example, the title passes to the buyer, but the seller remains economically responsible for ownership. Alternatively, the title remains with the seller, but the buyer is economically responsible for ownership. Three common examples of these special sales agreements include:
- Installment Sales: in this example, the merchandise is purchased over an extended period of time. The legal title to this merchandise remains with the seller, but the buyer is economically responsible. In this example, the seller would remove the merchandise from inventory, even though it retains legal title.
- High Return Rates: in this next example, the legal title to the merchandise passes from the seller to the buyer, but because the merchandise has a high rate of return and the refund rate on a return is high, the seller remains economically responsible for the merchandise. Even though legal title to the merchandise has passed to the buyer, the seller may elect to reserve a portion of those sales in inventory to account for returns.
- Buyback Agreements: finally, there can be complex financial transactions that allow one company to sell its merchandise to another, with the promise to repurchase that same merchandise over time. With a buyback agreement, legal title passes to the buyer, but the seller remains economically responsible for the merchandise.
Special sales agreements are of particular concern to accountants, since they can have an impact on the value of a company’s inventory. Typically, when legal title to merchandise is passed from seller to buyer, the seller would remove its value from inventory. It does this because economic value of the transaction has passed to the buyer.