My company is buying a piece of equipment for our subcontractor to use to manufacture our inventory. They will be repaying us back in the form of a reduction of the inventory cost as we order inventory from them. Once they have fully reimbursed us, we will transfer title of the equipment over to them. How do we account for the piece of equipment while its being re-paid? Is it an asset held for sale or do we capitalize it and depreciate it. We have a firm commitment in place.

You certainly would never depreciate it because it's not a plant asset to your company.

They have the equipment. They owe you for it. They're responsible for it I assume. Of course, you're holding the title. It's a bit like an installment sale, except that you aren't in business to sell equipment. Really, it's more like a capital lease.

I'm curious why you are allowing them this kind of time to pay you back. Is it a short time? If you're a small company that doesn't have to worry about getting too terribly picky, and if this isn't going to take very long, you could just record it as a receivable (I would make a separate account) and then remove it from that as you take possession of inventory.

If you feel you need to do something a little more "official" or it's going to be longer term, that'll be a different story and more info might be useful.

The time it takes for them to pay us back will be determined by how much inventory we purchase from them. I believe for each purchase we make, there will be 20% reduction in the unit cost, which will be for the repayment of the asset. It can take them 1 yr or up to 5 (the contract stipulates that if by the 5th year, they haven't paid us back in full, they need to submit payment within 90 days).

The fact that this could be up to 5 years is making a difference to me. If it were a shorter period, I would just do this the easy way.

Because of the fact that you will still be holding title, I think I'd treat it like a lease. There's two problems though. One is that it's a topic I haven't done for years and don't remember much about. (Someone else could help you figure out how to do that.)

The other problem is that you have not mentioned anything about interest. Are you charging them any? Is the value of the thing the same as what they are to be paying you? Are you reducing what they owe by the exact, normal cost of that inventory? In other words, technically there should be interest in some fashion, even if not "direct." (Seems like there has to be some advantage to your company going without the cash flow for up to 5 years.)

Think of it like this. I sell you my used car for $5000. I let you take the car but I say you don't have to pay me for 6 months. If I can sell it now to someone else for that $5000, why do I want to let you have it and not get any cash for 6 months? If I make you pay $5000 but it's really only worth $4800, then we have "interest."

Is this a small company? Does anyone -- banks, suppliers, owners, etc. -- care if it's totally correct? Is this a huge amount of money?

There is no interest. We got into the arrangement because we need them to manufacture the product for us but they don't have the cash to buy the equipment themselves at the moment. They are paying us back exactly what we are purchasing the equipment for. And yes, we are reducing what they owe us by the exact, normal cost of the inventory. We are a small company so this is a lot of money to us but we didn't have much of a choice (that or the individuals who agreed to this - before I got here, just weren't thinking clearly!) We are not public but are subject to audit by our bank so the accounting needs to be correct. I haven't gone down the path of accounting for this as a lease because they are so many "what ifs". Does it really seem like that's the way to go?