Question: Using inventory to achieve off-balance-sheet financing. P. J. Lorimar Company grows and ages tobacco. On January 2, 2008, the firm has aging tobacco with a

Using inventory to achieve off-balance-sheet financing. P. J. Lorimar Company grows and ages tobacco. On January 2, 2008, the firm has aging tobacco with a cost of $200,000 and a current market value of $300,000. P. J. Lorimar Company wants to use this tobacco to obtain financing. The firm uses a December 31 year-end.

a. Prepare journal entries during 2008 and 2009 for the transactions in parts (i) and (ii) below:

(i) The firm borrows $300,000 from its bank, using the tobacco inventory as collateral. The loan is repayable on December 31, 2009, with interest at 10% per year compounded annually Assume zero storage costs. The firm expects to sell the tobacco on December 31, 2009, for $363,000.

(ii) The firm sells the tobacco inventory to the bank for $300,000. It promises to sell the inventory on behalf of the bank at the end of t years and remit the proceeds to the bank.

b. Compare and contrast the income statement and balance sheet effects of these two transactions.

c. How should P. J. Lorimar Company structure this transaction to ensure that it qualifies as a sale instead of a collateralized loan?

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