USA Accounting for inventory trade-ins that have become obsolete

[blushinbelle]

One part of a particular S-corp's business is to act as a sales agent for a larger manufacturer. In doing so, the S-corp accepts the deposits on the large machines the manufacturer sells. The S-corp has an agreement that once the manufacturer delivers the product, they then keep the deposit as their commission. The catch is, the deposits are not always cash, sometimes they are a trade-in of an old machine or a mixture of cash and an old machine. Either way they assign a value with the customer at the time of deposit for these trade-ins and credit them that amount as part of their "deposit".

The S-corp owner states that the old machines (some of which are inoperable) are sitting collecting dust and will continue to do so providing no value to the company. My initial thoughts for this process were to debit cash and debit a trade-in inventory account crediting customer deposits (liability). Once the machine is delivered, debiting customer deposits for the full amount (cash and trade-in value) and crediting a commission income account. Then my thought is to treat the trade-ins as obsolete inventory creating a contra-inventory account for obsolete inventory and debiting an allowance for obsolete expense account crediting the contra-inventory account. However I think I may be overcomplicating the situation. Is there an easier way to handle this? Am I thinking about this completely wrong?

 

[Dave In Capital]

Per FASB Original Pronouncement 153, the obsolete machinery is "a nonmonetary asset with no commercial substance."

FASB Pronouncement 153

Therefore, it must be recorded at its fair market value. If on the other hand it met the definition of having commercial substance by providing a future cash flow to the S Corp, then it would be recorded at the value of the assets the S Corp gave up in consideration. In this case, the S Corp is not giving up any items of consideration in exchange for the obsolete assets. So, that in addition to the fact that the obsolete machinery has no market value supports the conclusion that the machinery must in fact be regarded as "a nonmonetary asset with no commercial substance."

Based on the circumstances you described, both the manufacturer and the S Corp are assigning the obsolete machinery an arbitrary value that results in a book loss on the S Corp's P&L. If such a loss were to reduce taxable income by offsetting any future gains, the reduction of those taxable gains would be considered arbitrary not only under GAAP but also under the US Code which govern the Department of the Treasury.

This would be an example of the SEC filing charges against a tech company which recorded revenue for nonmonetary assets which had no market value.

SEC v. ComScore

In any case, the "customer deposits" account sounds like it more appropriately meets the definition of deferred revenue, which is a liability account. But, since the non-cash ie nonmonetary revenue does not meet the GAAP definition of having commercial substance, the recognition of any revenue --deferred or not-- in relation to obsolete machinery would be inapplicable.