Guarantees involving leases for land and buildings, measuring loss accruals by transferors of receivables with recourse and table funding arrangements.

Statement on Auditing Standards no. 69, The Meaning of "Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report, identifies Financial Accounting Standards Board emerging issues task force (EITF) consensuses as sources of established generally accepted accounting principles.

This month's column lists 1992 EITF consensuses adopted from July 23 through November 19 (see the sidebar on page 80). In addition, three of the consensuses are summarized: allocation of a residual value guarantee to minimum lease payments in leases involving land and buildings, measuring loss accruals by transferors of receivables with recourse and table funding arrangements. The summaries are presented in order of importance from broad to narrow applicability.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: [phone].

ISSUE NO. 92-2

Issue no. 92-2, Measuring Loss Accruals by Transferors for Transfers of Receivables with Recourse, discusses the measurement of the transferor's obligation to the transferee under the recourse provisions (when debtors fail to pay when due). The issue assumes the transfer meets all the conditions of paragraph 5 of FASB Statement no. 77, Reporting by Transferors for Transfers of Receivables with Recourse, to be recognized as a sale. One condition is the amount of the transferor's obligation under the recourse provisions must be reasonably estimable at the sale date. Paragraph 6 of FASB Statement no. 77 requires recourse obligations to be accrued in accordance with FASB Statement no. 5, Accounting for Contingencies. The issues are determining which credit losses should be included in the accrual; whether the accrual should be discounted and, if so, at which discount rate; and the subsequent accounting for the recourse obligation.

The EITF reached a consensus that the recourse obligation recorded at the sale date should include all probable credit losses over the life of the transferred receivables - including, but not limited to, the probable credit losses recognized before the sale date.

The EITF also reached a consensus that discounting the recourse obligation is acceptable if the timing of the estimated cash flows can be reasonably estimated. If the obligation is discounted, subsequent accruals to the discounted amount should be made at the rate used in determining the initial obligation. In addition, if the discounting effect is material, both the undiscounted amount of the recourse obligation and the interest rate used should be disclosed in the financial statements.

The EITF abstract for this issue also includes Securities and Exchange Commission staff guidance on determining the appropriate discount rate and the right of setoff between the recourse obligation and other related assets.

ISSUE NO. 92-1

Issue no. 92-1, Allocation of Residual Value or First-Loss Guarantee to Minimum Lease Payments in Leases Involving Land and Building(s), helps lessees and lessors classify land and building leases with the following characteristics:

1. The lessee has given the lessor either a residual value or first-loss guarantee on the leased property at the inception of the lease.

2. Title to the leased property does not automatically transfer to the lessee at the end of the lease term.

3. There is no bargain purchase option.

4. The land's fair market value is 25% or more of the leased property's total fair value at the inception of the lease.

Real estate and equipment lease agreements frequently include a lessee residual value or first-loss guarantee of the leased property. Lessors use the guarantees to ensure returns both on and of their investment and to transfer some of the property risks to the lessee.

This issue interprets FASB Statement no. 13 (as amended), Accounting for Leases, paragraph 26(b)ii, which says if the land's fair value exceeds the 25% threshold, lessees and lessors consider the land and building(s) separately when applying the economic life test and the 90% test, respectively, to determine the classification of the leased property's building component. The issue is whether the guarantee amount should be allocated between the land and the building component or should be allocated to the building component alone.

The EITF reached a consensus that paragraph 26(b)ii of FASB Statement no. 13 should be applied literally. The lessee's and lessor's annual minimum lease payments applicable to the land are calculated by multiplying the lessee's incremental borrowing rate by the fair value of the land. Any remaining lease payments, including the full guarantee amount, are attributed to the building component.

ISSUE NO. 92-10

Issue 92-10, Loan Acquisitions Involving Table Funding Arrangements, is a specialized issue relating to the mortgage banking industry. Table funding arrangements involve three parties: a purchaser (mortgage banker), a mortgage broker or correspondent firm (correspondent) and a borrower. The purchaser provides original funding for the mortgage loan "at the table" (that is, at the loan closing between the broker and the borrower). Concurrently with the loan closing the mortgage banker acquires the loan and the related loan servicing right from the correspondent.

The issues are whether the mortgage banking enterprise should account for table funding arrangements as loan purchases or loan originations and what criteria should be used to make this distinction.

Under existing GAAP, a mortgage banking enterprise that originates a loan must capitalize all direct loan origination costs as part of the loan's cost basis, which includes the cost that could be assigned to the acquired servicing rights.

In contrast, a mortgage banking enterprise that purchases (rather than originates) a loan must capitalize the cost of the acquired servicing rights as a separate asset (apart from the cost basis of the loan) if a definitive plan for the loan's sale exists when it is acquired. If the servicing rights are retained when the loans are sold, any resulting gains on the sale are higher and any resulting losses are lower than would have been the case had the enterprise originated the loan.

The EITF reached a consensus that a mortgage loan acquired in a table funding arrangement should be accounted for as a loan purchase if it is legally structured as an origination by the correspondent and if the correspondent is independent of the mortgage banking enterprise. The correspondent must satisfy five conditions (listed in EITF Abstracts) to meet these requirements.

If any of the required criteria are not met, the loan must be accounted for as an originated loan by the mortgage banking enterprise.

The FASB currently is soliciting input from constituents and advisory groups about whether it should add to its agenda a project to consider whether FASB Statement no. 65, Accounting for Certain Mortgage Banking Activities, should be amended to eliminate inconsistencies in accounting for costs incurred to acquire loan servicing rights through loan purchase and loan origination transactions.

EXECUTIVE SUMMARY

* EITF Issue no. 92-2

Accounting problem: (1) At the sale date of receivables with recourse, should the transferor accrue all probable credit losses over the life of the transferred receivables? (2) May the recourse obligation be discounted if the timing of the cash flows can be reasonably estimated? Consensus: (1) Yes. (2) Yes.

* EITF Issue no. 92-1

Accounting problem: If a lessee grants the lessor a first-loss or residual value guarantee on land and building leases and the land is 25% or more of the leased property's fair value, should the entire guarantee amount be allocated to the building for purposes of the economic life or 90% tests for lease capitalization? Consensus: Yes.

* EITF Issue no. 92-10

Accounting problem: Should a mortgage loan that is acquired in a table funding arrangement be accounted for as a loan purchase if the loan is legally structured as an origination by an independent correspondent (that is, the mortgage broker)? Consensus: Yes, if specified conditions are met.

1992 EITF CONSENSUSES ADOPTED
JULY 23 THROUGH NOVEMBER 19, 1992
Issue no.                  Title
92-1        Allocation of Residual Value or First-loss
            Guarantee to Minimum Lease Payments in
            Leases Involving Land and Building(s)
92-2        Measuring Loss Accruals by Transferors
            for Transfers of Receivables with Recourse
92-5        Amortization Period for Net Deferred
            Credit Card Origination Costs
92-7        Accounting by Rate-Regulated Utilities
            for the Effects of Certain Alternative
            Revenue Programs (amended 7/23/92)
92-9        Accounting for the Present Value of
            Future Profits Resulting from the
            Acquisition of a Life Insurance Company
92-10        Loan Acquisitions Involving Table
             Funding Arrangements
92-13        Accounting for Estimated Payments in
             Connection with "Coal Industry Retiree
             Health Benefit Act of 1992"
  All consensuses were adopted after March 15, 1992, the
effective date of the new GAAP hierarchy. See the JofA, May92,
pages 103-110, for a complete discussion of the new GAAP
hierarchy and EITF consensuses.