by Transfers of financial assets take many forms, including sales, assignments, factoring arrangements and securitizations. Often transfers involve the seller (transferor) having some continuing involvement either with the transferred assets or with the buyer (transferee). Continuing involvement can exist in different forms such as seller recourse provisions, servicing arrangements and call options.
Accounting for transfers in which the transferor has no continuing involvement with the transferred financial assets or with the transferee is not a controversial topic. However, transfers of financial assets with continuing involvement often raise questions about the circumstances under which the transfers should be accounted for as sales (i.e., assets are removed from the balance sheet and a resulting gain or loss is recognized) or secured borrowings (i.e., assets remain on the balance sheet with no change in measurement).
Transfers and Servicing, establishes principles and a control-based accounting framework for evaluating transfers of financial assets, which can be summarized as follows:
- The economic benefits provided by a financial asset (generally, the right to future cash flows) are derived from the contractual provisions of that asset, and the entity that controls those benefits should recognize them as its asset.
- An entire financial asset cannot be divided into components prior to a transfer unless all of the components meet the definition of a participating interest.
- A transferred financial asset should be considered sold and therefore should be derecognized if “control” is surrendered.
- A transferred financial asset should be considered pledged as collateral to secure an obligation of the transferor (and therefore should not be derecognized) if the transferor has not surrendered control.
- The recognition or derecognition of financial assets and liabilities should not be affected by the sequence of transactions that led to their existence unless the effect of those transactions is to maintain effective control over a transferred financial asset.
- To the extent that a transfer of financial assets does not qualify for sale accounting, the transferor’s contractual rights or obligations related to the transferred assets are not accounted for separately if doing so would result in recognizing the same rights or obligations twice. For example, a call option retained by the transferor may prevent a transfer from being accounted for as a sale. In that case, the call option is not separately recognized as a derivative asset.
- Transferors and transferees generally should account symmetrically for transfers of financial assets.
- When determining whether control has been surrendered over transferred financial assets, the transferor (and its consolidated affiliates included in the financial statements being presented) should consider its continuing involvement in the transferred financial assets and all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. Certain exceptions apply (e.g., accounting for repurchase financings, as defined).
A transfer of a financial assets can take many forms; from the sale of a widely-held equity security for cash to sales of trade receivables to a securitization entity in exchange for cash, a subordinated economic interest in the receivables, and servicing rights. A transfer may involve the conveyance of all rights and title in a financial asset to its purchaser or, alternatively, a transferor may sell an ownership interest in only certain of an underlying financial asset’s cash flows. In other instances, the transferor may grant only a security interest in a financial asset pledged with the transferee.
ASC 860, Transfers and Servicing, provides comprehensive guidance to assist a transferor of financial assets to account for transactions that involve a transfer of a recognized financial asset or an interest therein. Perhaps most importantly, ASC 860 prescribes the conditions that a transfer must satisfy to allow the transferor to derecognize the financial asset from its balance sheet. The guidance in ASC 860 addresses not only the transferor’s accounting, but also informs the corresponding accounting by the transferee.
ASC 860’s derecognition model incorporates the so-called financial components approach. The fundamental tenets of that approach include:
- The economic benefits provided by a financial asset (generally, the right to future cash flows) stem from the asset’s underlying contractual provisions, and the entity that controls those benefits should recognize them as its asset.
- A financial asset should be considered sold–and therefore derecognized–if it is transferred and control is surrendered.
- If a transferor has not surrendered control of a financial asset, derecognition is inappropriate; the asset should be considered pledged as collateral to secure an obligation of the transferor.
- The recognition of financial assets (and liabilities) should not be affected by the sequence of transactions that led to their existence; the controlling principle instead is whether a transferor maintains effective control over a transferred asset.
- Transferors and transferees should account for transfers of financial assets similarly (symmetrical reporting).
ASC 860’s derecognition model does not incorporate consideration of an asset’s “risks and rewards” and how a transfer impacts the transacting parties’ assumption or retention of those risks. Instead, it is a control-based framework.
To apply ASC 860’s derecognition template, companies must first identify which party to a transfer controls the financial assets after the exchange. This assessment should consider the transferor’s continuing involvement in the transferred financial asset, including all arrangements or agreements made contemporaneous with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. Under the financial components approach, an entity that has surrendered control over a transferred financial asset should derecognize the asset. Conversely, an entity must recognize all financial assets acquired (controlled), and any liabilities incurred, stemming from a transfer.
Financial Asset: Cash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right to do either of the following:
- Receive cash or another financial instrument from a second entity
- Exchange other financial instruments on potentially favorable terms with the second entity.
There are some similarities between securities lending transactions and repurchase agreements, both of which represent securities financing transactions. For example, in both types of transactions:
- One party generally transfers legal title to a security or basket of securities to another party for a limited time in exchange for the receipt of a legal interest in the collateral pledged as part of the transaction. Therefore, in both types of transactions, there is a lender and a borrower of the security.
- Fees are involved.
- An entity generally accounts for the transaction as a secured borrowing, though this may not always be the case.
