Implementing SFAS No. 125: accounting for transfers and servicing of financial assets and extinguishment of liabilities.
(1) The economic benefits provided by a financial asset are derived from the contractual provisions that underlie that asset, and the entity which controls those benefits should recognize them as its asset.
(2) A financial asset should be considered sold, and therefore should be de-recognized, if it is transferred and control is surrendered.
(3) A transferred financial asset should be considered pledged as collateral to secure an obligation of the transferor (i.e., not de-recognized) if the transferor has not surrendered control of the financial asset.
(4) Each liability should be recognized by the entity which is primarily liable and, accordingly, an entity which guarantees another entity's obligation should recognize only its obligation to perform on the guarantee.
(5) The recognition of financial assets and liabilities should not be affected by the sequence of transactions that led to their existence, unless as a result of those transactions, the transferor maintains effective control over a transferred asset.
(6) Transferors and transferees should account symmetrically for transfers of financial assets.
What Has Changed
SFAS No. 125 supersedes the following documents:
(1) SFAS No. 76, entitled Extinguishment of Debt.
(2) SFAS No. 77, entitled Reporting by Transferors for Transfers of Receivables with Recourse.
(3) SFAS No. 122, entitled Accounting for Mortgage Servicing Rights.
(4) FASB Technical Bulletin No. 84-4, entitled In-Substance Defeasance of Debt.
(5) FASB Technical Bulletin No. 85-2, entitled Accounting for Collateralized Mortgage Obligations (CMOs).
SFAS No. 125 also amends SFAS No. 115, entitled Accounting for Certain Investments in Debt and Equity Securities, stipulating a security may not be classified as held-to-maturity if the security contractually can be prepaid or otherwise settled in such a way that the holder of the security would not recover substantially all of its recorded investment.
The term "substantially all" is not defined in SFAS No. 125; the FASB decided not to require a specific percentage test that would be inherently arbitrary. Practitioners may decide to refer to APB Opinion No. 16, entitled "Business Combinations," where a 90% test is used to indicate substantially all. Because the guidance in SFAS No. 125 in this area is not specific, callable securities are not necessarily disallowed from being classified as held-to-maturity but practitioners should be careful in implementing this new guidance. Importantly, reclassifications of securities from the held-to-maturity category to comply with the provisions of SFAS No. 125 will not "taint" the remaining securities in that category.
The Technical Requirements
A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration, other than beneficial interests in the transferred assets, is received in exchange. The transferor has surrendered control over transferred assets if and only if all of the following conditions are met:
(1) The transferred assets have been isolated from the transferor.
(2) Either (a) each transferee obtains the right to pledge or exchange the transferred assets or (b) the transferee is a qualifying special-purpose entity and the holders of beneficial interests in that entity have the right to pledge or exchange those interests. (Note: Qualifying special-purpose entities include trusts, corporations, or other legal vehicles that hold title to transferred assets, issue beneficial interests, service assets held, distribute proceeds to holders of beneficial interests, and have a standing at law which is distinct from the transferor.)
(3) The transferor does not maintain effective control over the transferred assets through (a) an agreement which both entitles and obligates the transferor to repurchase or redeem them before their maturity or (b) an agreement which entitles the transferor to repurchase or redeem transferred assets that are not readily obtainable.
Agreements both entitling and obligating the transferor to repurchase or redeem transferred assets from the transferee maintain the transferor's effective control over those assets, and these transfers should be accounted for as secured borrowings. To qualify for secured borrowing accounting treatment, all of the following conditions should be met:
(1) The assets to be repurchased or redeemed are the same or substantially the same as those transferred. (Note: The term "substantially the same" as used in SFAS No. 125 is consistent with the use of that term in SOP 90-3, entitled "Definition of the Term Substantially the Same for Holders of Debt Instruments, as Used in Certain Audit Guides and a Statement of Position.")
(2) The transferor is able to repurchase or redeem them on substantially agreed terms, even in the event of default by the transferee.
(3) The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price.
(4) The agreement is entered into concurrently with the transfer.
Upon completion of any transfer of financial assets, the transferor should:
(1) Continue to carry in its statement of financial position any retained interest in the transferred assets.
(2) Allocate the previous carrying amount between the assets sold, if any, and the retained interests, if any, based on their relative fair values at the date of transfer.
Upon completion of a transfer of assets which satisfies the conditions to be accounted for as a sale, the transferor (seller) should:
(1) De-recognize all assets sold.
(2) Recognize all assets obtained and liabilities incurred in consideration as proceeds of the sale.
(3) Initially measure at fair value assets obtained and liabilities incurred in a sale or, if it is not practicable to estimate the fair value of an asset or a liability, apply alternative measures. (Note: If it is not practicable to estimate the fair values of assets, the transferor should record those assets at zero. If it is not practicable to estimate the fair values of liabilities, the transferor should recognize no gain on the transaction and should record those liabilities at the greater of: (a) the excess, if any, of (1) the fair values of assets obtained less the fair values of other liabilities incurred, over (2) the sum of the carrying values of the assets transferred, or (b) the amount that would be recognized in accordance with SFAS No. 5, entitled Accounting for Contingencies, as interpreted by FASB Interpretation No. 14, entitled Reasonable Estimation of the Amount of a Loss.)
(4) Recognize in earnings any gain or loss on the sale.
When transfers of financial assets do not meet the criteria to be accounted for as a sale, both the transferor and the transferee should account for the transfer as a secured borrowing with pledge of collateral. Transferees should recognize all assets obtained and any liabilities incurred and initially measure them at fair value.
In superseding SFAS No. 76, the FASB has eliminated the "in-substance defeasance" rules. As such, transactions which previously were accounted for under these rules now are subject to the recognition/de-recognition rules under SFAS No. 125. A debtor should de-recognize a liability if and only if it has been extinguished. A liability is considered to be extinguished if either of the following conditions is met:
(1) The debtor pays the creditor and is relieved of obligation for the liability.
(2) The debtor legally is released from being the primary obligor under the liability, either judicially or by the creditor.
Example 1: Real Company sells loans with a carrying amount of $10,000 to another entity for cash plus a call option to repurchase the loans sold or similar loans and incurs a recourse obligation to repurchase any delinquent loans. Real Company undertakes to service the transferred assets for the other entity. In Case 1, Real Company finds it impracticable to estimate the fair value of the servicing contract, although it is confident that servicing revenues will be more than adequate compensation for performing the servicing. In Case 2, Real Company finds it impracticable to estimate the fair value of the recourse obligation. (Charts at right)
Example 2: At the beginning of the second year in a 10-year sales-type lease, Real Company sells for $5,050 a nine-tenths interest in the minimum lease payments and retains a one-tenth interest in the minimum lease payments and a 100% interest in the unguaranteed residual value of leased equipment. Real Company receives no explicit compensation for servicing, but estimates other benefits of servicing are just adequate to compensate it for its servicing responsibilities, and hence records no servicing asset or liability. The carrying amounts and related gain computation are shown to the right.
Example 3 Real Company factors $1,000,000 of accounts receivable with Factor Inc. on a recourse basis. Receivable records are transferred to Factor Inc. which will receive all collections. Factor Inc. assesses a finance charge of 3% of the amount of accounts receivable and retains an amount equal to 5% of the accounts receivable. If this transaction meets the SFAS No. 125 criteria to be accounted for as a sale, Real Company would make the following journal entry:
(Note: There are two substantive differences between these accounting treatments. First, when the transaction is classified as a borrowing, Real Company recognizes a liability instead of writing off the related receivables. Second, rather than recording a loss of $30,000 on the transfer, Real Company records a discount under the borrowing which should be amortized to interest expense over the borrowing period.)
Effective Date and Transition
SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and should be applied prospectively. Earlier or retroactive application of SFAS No. 125 is not permitted. The amendment to SFAS No. 115 is effective for financial assets held on or acquired after January 1, 1997.
[TABULAR DATA FOR EXAMPLE 1 OMITTED]
Example 2 Carrying Amounts Minimum lease payments $ 5,400 Unearned income related to minimum lease payments 3,700 Gross investment in minimum lease payments 9,100 Unguaranteed residual value $ 300 Unearned income related to residual value 600 Gross investment in residual value 900 Total gross investment in lease receivable $10,000 Gain on Sale Cash received $ 5,050 Nine-tenths of carrying amount of gross investment in minimum lease payments $8,190 Nine-tenths of carrying amount of unearned income related to minimum lease payments 3,330 Net carrying amount of minimum lease payments sold 4,860 Gain on sale $190 Journal Entry Cash 5,050 Unearned income 3,330 Lease receivable 8,190 Gain on sale 190 To record sale of nine-tenths of the minimum lease payments at the beginning of year 2 Example 3 Cash 920,000 Due from Factor 50,000(*) Loss on Sale of Receivables 30,000(**) Accounts (Notes) Receivable 1,000,000 (*)5% X $1,000,000 (**)3% X $1,000,000 If this transaction does not meet the SFAS No. 125 criteria to be accounted for as a sale, Real Company would make the following journal entry: Cash 920,000 Due from Factor 50,000 Discount on Transferred Receivables 30,000 Liability on Transferred Receivables 1,000,000
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|Author:||Ratcliffe, Thomas A.|
|Publication:||The National Public Accountant|
|Date:||Aug 1, 1997|
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