2.2 The Asset

2.2.1 Financial Assets

With one exception (discussed in Section 2.2.3.2), only transfers of recognized financial assets are subject to ASC 860-10.

2.2.2 Unrecognized Financial Assets

2.2.2.1 General

ASC 860-10-15-4(b) indicates that ASC 860-10 does not apply to transfers of unrecognized financial assets. Therefore, such transfers must be accounted for in accordance with other U.S. GAAP.

2.2.2.2 Options and Forward Contracts to Purchase or Sell a Financial Asset

ASC 860-10

Forward Contract on a Financial Instrument

55-12 A forward contract to purchase or sell a financial instrument that must be (or may be) net settled or physically settled by exchanging that financial instrument for cash (or some other financial asset) is a financial asset or financial liability. Therefore, because a forward contract on a financial instrument that must be (or may be) physically settled by the delivery of that financial instrument in exchange for cash is a financial asset or financial liability, the transfer of such a financial asset is within the scope of this Subtopic (see paragraph 405-20-40-1 for guidance on extinguishments of liabilities).

The financial asset underlying an option or forward contract to purchase a financial asset is not a recognized financial asset. However, an option to purchase a financial asset (i.e., a purchased call option) is a recognized financial asset.2 Similarly, a forward contract to purchase a financial asset is a recognized financial asset if the contract is in-the-money to the holder.3 Therefore, recognized financial assets related to options or forward contracts to purchase financial assets are within the scope of ASC 860-10.4 Options to sell financial assets (i.e., purchased put options) and forward contracts to sell financial assets that are recognized financial assets are also within the scope of ASC 860-10. However, options and forward contracts to purchase or sell nonfinancial assets are not within the scope of ASC 860-10 unless they are accounted for as derivative instruments under ASC 815-10 (see Section 2.2.3.2).

2.2.2.3 Operating Leases

Future lease payments to be received under an operating lease do not represent recognized financial assets. Such payments, which are executory in nature, are not within the scope of ASC 860-10. However, once lease payments become due, they become recognized receivables and are within the scope of ASC 860-10’s guidance on transfers of financial assets.

If an entity transfers the rights to future lease payments under an operating lease, it must account for the proceeds received as a secured borrowing. A lessor’s sale or assignment of future lease payments due under an operating lease is accounted for as a borrowing because the lessor’s economic interest in an operating lease is not a receivable but a right to future revenues under an executory contract. The presumption is that lessors have an obligation to provide services to earn the lease revenues even if this obligation involves a minimal effort. A lessor that has transferred its rights to future lease payments under an operating lease continues to record rental income on the operating lease in addition to recognizing interest expense on the borrowing. As the lessee makes payments under the lease agreement, the lessor-transferor will reduce the outstanding amount of the borrowing on the basis of the portion of such payments that represents principal reductions as opposed to interest expense (e.g., the lessor-transferor would debit interest expense as well as the borrowing and credit rental income). Since the financing is considered a transaction separate from the operating lease, a lessor may not offset rental income with the interest expense on the borrowing. As discussed in Section 5.5.1.2.1, gross presentation in the income statement is required.

If an entity transfers the operating lease payments receivable along with the underlying leased asset, it should consider ASC 610-20 (or ASC 360-20 if the entity has not adopted ASC 610-20) and ASC 842 (or ASC 840 if the entity has not adopted ASC 842). Depending on the facts and circumstances, derecognition of the underlying leased property may be appropriate.

2.2.2.4 Revenue Transactions

2.2.2.4.1 Unearned Revenues

Transfers of rights to future revenues that will result in the recognition of receivables in the future are not within the scope of ASC 860-10. These transactions are often referred to as sales of future revenues. They may involve the transfer of a specified amount or percentage of future revenues or of a measure of future performance of a product line, business segment, trademark, patent, royalty, or other income-generating activity. The accounting for sales of future revenues is discussed in ASC 470-10-25-1 and 25-2 and ASC 470-10-35-3.

In a speech at the 2006 AICPA Conference on Current SEC and PCAOB Developments, Joseph McGrath, then a professional accounting fellow in the SEC’s Office of the Chief Accountant, made the following comments regarding revenue recognition and transfers of financial assets:

Moving on to revenue recognition and transfers of financial assets — we are aware of instances in which a vendor (transferor), which is unable to satisfy the revenue recognition criteria that apply to particular transactions, transfers the rights to future cash flows related to such transactions and, by virtue of the transfer, asserts that revenue recognition is now appropriate. This is based, in part, on the assumption that, if evaluated independent of revenue recognition, the transfer would satisfy the sales criteria under Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (Statement No. 140) [ASC 860-10-40-5]. Certainly, it is important to highlight the relevance of the individual facts and circumstances in evaluating any of these transactions. However, in many instances, these transactions have been inappropriately characterized as sales of trade receivables.

When evaluating the accounting for these arrangements, generally the first step should be to determine whether revenue and a corresponding receivable should be recognized. If revenue recognition is dependent upon the transfer being accounted for as a sale, revenue recognition is likely inappropriate. If revenue recognition is inappropriate, then the right to the underlying cash flows is not a receivable. Since Statement No. 140 [ASC 860-10] only applies to transfers of financial assets, this type of arrangement seems more appropriately characterized as a financing transaction — similar to a sale of future revenues pursuant to EITF 88-18, Sales of Future Revenues [ASC 470-10-25-1 and 25-2 and ASC 470-10-35-3]. Registrant’s may also want to keep in mind the guidance in the AICPA Technical Practice Aids on software revenue recognition where extended payment terms are transferred or converted to cash without recourse to the vendor. Upon satisfaction of the revenue recognition model, the underlying cash flows would constitute a receivable and would then be eligible for sales treatment under Statement No. 140 [ASC 860-10].

Although this speech was given before the issuance of ASU 2014-09, which changed the revenue recognition guidance, the principles discussed therein are still relevant. If an entity transfers rights to cash flows related to an income-generating transaction, ASC 860-10 does not apply unless the receivable related to those cash flows has been appropriately recognized before the transfer. That is, a receivable cannot be recognized as a result of a transfer. If a receivable has not been recognized in accordance with ASC 606 or other relevant U.S. GAAP, the entity should consider the guidance in ASC 470-10 that applies to sales of future revenues.

Connecting the Dots

Although an entity’s sale of future revenues is not a transfer within the scope of ASC 860-10, the transferee’s (buyer’s) right to receive the seller’s future revenue is a recognized financial asset (i.e., a receivable from the transferor that does not depend on the transferee’s delivery of goods or services to a customer). If the buyer of the contractual right to receive future revenues subsequently transfers that right to a third party, such a transfer would generally be within the scope of ASC 860-10. This is consistent with the discussion in Section 2.2.3.3.

2.2.2.4.1.1 Rights to Receive Future Fees Under Rule 12b-1 of the Investment Company Act of 1940

Until earned, rights to receive Rule 12b-1 fees do not represent recognized financial assets. Thus, any transfer of rights to receive such future fees is outside the scope of ASC 860-10. However, once the fees are earned, the receivable recognized by its recipient is a recognized financial asset.

2.2.2.4.2 Unearned Receivables

An entity may recognize a receivable from a customer before it meets the conditions to recognize the related revenue. If an entity transfers a recognized receivable related to a transaction for which the revenue has not yet been recognized, the transfer is generally within the scope of ASC 860-10. Entities should consider the guidance in ASC 606 in determining whether it is appropriate to recognize a receivable before the recognition of the related revenue. ASC 860-10 never applies to contract assets.

Example 2-1

Transfer of Advance Billings

Entity A provides telecommunication services. On the first day of each month, A bills its customers for the following amounts:

Overage charges for the prior monthly period.
Base charges for the current monthly period that begins on the first day of the month. Note that although the revenue related to these billings may not be recognized on the billing date, these amounts are nonrefundable (i.e., if the customer has not terminated the contract as of the beginning of the month, these amounts are due in full even if the customer cancels the contract during the month).

Amounts billed for overage charges represent recognized financial assets for which revenue is recognizable. Amounts billed for current monthly charges also represent recognized financial assets even though A cannot recognize the related revenue as of the billing date. Considering that the amounts billed for current monthly charges are due within a relatively short period after the billing date, it is appropriate to apply ASC 860-10 to transfers of these amounts.

2.2.2.5 Charged-Off Loans and Other Receivables

ASC 860-10

Transfer of Bad-Debt Recovery Rights

55-73 A financial institution (transferor) transfers to a third-party transferee the right to an amount of future recoveries from loans previously written off by the transferor as uncollectible. The transferee is entitled to recoveries equal to the purchase price plus a market rate of interest on the unrecovered purchase price. There is no recourse to the transferor. The transferee can initiate its own collection efforts if dissatisfied with the transferor’s recovery efforts. The transaction is a secured borrowing (that is, a borrowing secured by the transferred rights).

ASC 326-20-35-8 (ASC 310-10-35-41 for entities that have not adopted ASU 2016-13) requires entities to write off financial assets when they are deemed uncollectible. As a result, regulated financial institutions often charge off loan receivables when they reach a certain number of days past due, the borrower declares bankruptcy, or other factors suggest that the loans are not collectible. For entities that have adopted ASU 2016-13, estimated recoveries on charged-off loan receivables are recognized as a reduction of the allowance for credit losses.

Although they have a zero amortized cost basis (i.e., any estimated recovery is part of the allowance for credit losses), we believe that it is appropriate to apply ASC 860-10 to transfers of fully charged-off loan receivables. That is, we believe that it is appropriate to consider fully charged-off loan receivables as recognized financial assets that have no carrying amount because of an accounting convention. However, sale accounting cannot be achieved if the loans receivable are not transferred. Under ASC 860-10-55-73, if a lender only transfers the rights to future recoveries on charged-off loans receivable (i.e., the loans themselves are not transferred), both the transferor and transferee must account for the transfer as a secured borrowing.

2.2.2.6 Loans and Other Receivables From Consolidated Subsidiaries

A parent entity may transfer, to a third party, a loan or other receivable due from a consolidated subsidiary. From the perspective of the parent’s consolidated financial statements, the financial asset is not recognized because it is eliminated in consolidation. Therefore, the transaction should be considered an origination of a loan or other receivable rather than a transfer of a recognized financial asset that is within the scope of ASC 860-10.

2.2.2.7 Insurance Contracts

2.2.2.7.1 General

Under insurance contracts, an insured party pays premiums to an insurance entity in return for protection against specified losses. An insurance contract that requires a cash payment if the insured event occurs represents a financial instrument even though the right of the insured party and the obligation of the insurance entity are both conditional. An insurance contract that permits the insurance entity to settle a claim by either making a cash payment or providing goods or services does not represent a financial instrument.

2.2.2.7.2 Insured Party

For insurance contracts that meet the definition of a financial instrument, the potential benefits receivable by the insured party are generally not recognized. As noted in ASC 860-10-15-4(b), transfers of unrecognized financial assets are outside the scope of ASC 860-10. Such transfers would be considered akin to a sale of future revenue (see Section 2.2.2.4). However, the following amounts that are recognized by an insured party under an insurance contract would generally meet the definition of a recognized financial asset that is within the scope of ASC 860-10:

Cash surrender value of a BOLI or COLI policy.
Claims receivable that have been agreed to by the insurance entity.

2.2.2.7.3 Insurance Entity

Generally, only earned and unpaid premiums receivable would represent recognized financial assets that are within the scope of ASC 860-10.

2.2.2.8 Short Sales

A short sale represents a sale of a security that is not owned. Since the security is not a recognized financial asset, short sales are not within the scope of ASC 860-10.

2.2.3 Nonfinancial Assets

With one exception (discussed in Section 2.2.3.2), ASC 860-10 does not apply to transfers of nonfinancial assets (see ASC 860-10-15-4(a)). Therefore, transfers of nonfinancial assets, such as property and real estate, computer software and hardware, intangible assets, servicing rights, operating leases, certain residual values related to sales-type and direct financing leases, contract assets, regulatory assets, certain insurance contracts, capitalized advertising costs, prepaid expenses and other deferred costs, and certain contingent assets (e.g., judgments from litigation) are outside the scope of ASC 860-10. For example, a conveyance of nonfinancial assets to the holder of a loan or other receivable in partial or full settlement of an obligation is not subject to ASC 860-10.

Paragraph 148 of the Basis for Conclusions of FASB Statement 140 provides the FASB’s rationale for excluding transfers of nonfinancial assets from the standard’s scope:

The concepts underlying the financial-components approach could be applied by analogy to accounting for transfers of nonfinancial assets and thus could result in accounting that differs significantly from that required by existing standards and practices. However, the Board believes that financial and nonfinancial assets have significantly different characteristics, and it is not clear to what extent the financial-components approach is applicable to nonfinancial assets. Nonfinancial assets have a variety of operational uses, and management skill plays a considerable role in obtaining the greatest value from those assets. In contrast, financial assets have no operational use. They may facilitate operations, and financial assets may be the principal “product” offered by some entities. However, the promise embodied in a financial asset is governed by contract. Once the contract is established, management skill plays a limited role in the entity’s ability to realize the value of the instrument. Furthermore, the Board believes that attempting to extend Statement 125 and this Statement to transfers of nonfinancial assets would unduly delay resolving the issues for transfers of financial assets, because of the significant differences between financial assets and nonfinancial assets and because of the significant unresolved recognition and measurement issues posed by those differences. For those reasons, the Board concluded that existing accounting practices for transfers of nonfinancial assets should not be changed at this time. The Board further concluded that transfers of servicing assets and transfers of property subject to operating leases are not within the scope of Statement 125 and this Statement because they are nonfinancial assets.

2.2.3.1 Servicing Assets

Separately recognized servicing assets represent nonfinancial assets. Although FASB Statements 125 and 140 did not address transfers of servicing assets, the original pronouncements addressing the transfer of servicing assets were codified in ASC 860-50. See Chapter 6 for more information.

2.2.3.2 Nonfinancial Derivative Assets

ASC 815-10-40-2 and 40-3 and ASC 860-10-15-5 indicate that transfers of nonfinancial derivative assets that are recognized in accordance with ASC 815 are accounted for in accordance with ASC 860-10. For example, a transfer of a physically settleable option to purchase or sell a commodity that is accounted for as a derivative instrument under ASC 815 is subject to the sale accounting guidance in ASC 860-10- 40-5.5 This guidance applies to the accounting by both the transferor and the transferee.

Connecting the Dots

Many physically settleable purchase and sale contracts involving commodities are not accounted for as derivatives because the normal purchases and normal sales exception in ASC 815-10- 15-13(b) is applied. Since these contracts are considered executory in nature, transfers of them are not within the scope of ASC 860-10.

2.2.3.3 Regulatory Assets

ASC 860-10

Securitized Stranded Costs

55-7 The deregulation of utility rates charged for electric power generation has caused electricity-producing entities (utilities) to identify some of their electric power generation operations as stranded costs. Before deregulation, utilities typically expected to be reimbursed for costs through regulation of rates charged to customers. After deregulation, some of these costs may no longer be recoverable through unregulated rates. Hence, such potentially unrecoverable costs often are referred to as stranded costs. However, some of those stranded costs may be recovered through a surcharge or tariff imposed on rate-regulated goods or services provided by another portion of the entity whose pricing remains regulated. Some entities have securitized their enforceable rights to impose that tariff (often referred to as securitized stranded costs), thereby obtaining cash from investors in exchange for the future cash flows to be realized from collecting surcharges imposed on customers of the rate-regulated goods or services.

55-8 Securitized stranded costs are not financial assets, and therefore transfers of securitized stranded costs are not within the scope of this Subtopic. Securitized stranded costs are not financial assets because they are imposed on ratepayers by a state government or its regulatory commission and, thus, while an enforceable right for the utility, they are not a contractual right to receive payments from another party. To elaborate, while a right to collect cash flows exists, it is not the result of a contract and, thus, not a financial asset.

55-9 However, beneficial interests in a securitization trust that holds nonfinancial assets such as securitized stranded costs or other similar imposed rights would be considered financial assets by the third-party investors, unless that third party must consolidate the trust. The Variable Interest Entities Subsections of Subtopic 810-10 should be applied, together with other guidance on consolidation policy, as appropriate, to determine whether such a special-purpose entity should be consolidated by a third-party investor.

Regulatory assets that are recognized by regulated utilities in accordance with ASC 980 do not represent financial assets because they do not arise from a contractual agreement between two parties. Although regulatory assets may result in enforceable rights, those rights do not represent contractual rights. Rather, regulatory assets arise when a regulated utility receives a right that results from the imposition of an obligation by one party (e.g., a regulatory authority acting in accordance with legislation) on another party (e.g., a customer that will bear the surcharge or tariff). Since financial assets are limited to rights to cash or other financial assets that arise from a contract between two parties, regulatory assets do not meet the definition of a financial asset. Therefore, transfers of regulatory assets are not within the scope of ASC 860-10.

ASC 860-10-55-7 and 55-8 address transfers of stranded costs. Legislation gives a utility’s regulator the authority to impose a tariff or surcharge on electricity sold by a regulated utility in the future. This legislation creates an enforceable right but not a contractual right. The fact that a utility can securitize stranded costs does not mean that those assets are financial assets, because the conditions for recognizing revenue are generally not met by the utility before amounts are billable to a customer. As a result, a transfer of stranded costs to a securitization entity, like any other transfer of regulatory assets, is not within the scope of ASC 860-10. If a utility transfers stranded costs to a third party or securitization entity, any cash received does not represent the proceeds for assets sold. Rather, transfers of stranded costs or other regulatory assets that are not within the scope of ASC 860-10 must be accounted for as sales of future revenues (generally as debt) in accordance with ASC 470-10.

Although a utility’s transfer of stranded costs to a securitization entity does not itself represent a transfer within the scope of ASC 860-10, ASC 860-10-55-9 indicates that the beneficial interests issued by the securitization entity that holds the stranded costs are considered recognized financial assets by the third-party investors, unless that third party must consolidate the securitization entity. Therefore, transfers of beneficial interests in securitized stranded costs by third-party investors are within the scope of ASC 860-10.

2.2.3.4 Litigation Judgments

ASC 860-10

Judgment From Litigation

55-10 A judgment from litigation is generally not a financial asset. However, the determination depends on the facts and circumstances. A contingent receivable that ultimately may require the payment of cash but does not as yet arise from a contract (such as a contingent receivable for a tort judgment) is not a financial asset. However, when that judgment becomes enforceable by a government or a court of law and is thereby contractually reduced to a fixed payment schedule, the judgment would be a financial asset.

55-11 A judgment from litigation is a financial asset if it is transferred to an unrelated third party and would be within the scope of this Subtopic only if that judgment is enforceable by a government or a court of law and has been contractually reduced to a fixed payment schedule.

ASC 860-10-55-10 and 55-11 indicate that a litigation judgment generally does not represent a financial asset that is within the scope of ASC 860-10. That is, a contingent receivable that ultimately may result in the receipt of a cash payment, but that does not yet arise from a contract (e.g., a contingent receivable for a tort judgment), is not a financial asset. When a judgment becomes enforceable by a government or a court of law and is, therefore, contractually reduced to a fixed payment schedule, the judgment would be a financial asset.

2.2.3.5 Investments in Sales-Type and Direct Financing Lease Receivables

A lessor in a sales-type or direct financing lease recognizes a lease receivable for the lease payments receivable as well as the residual value of the leased asset. In determining the applicability of ASC 860-10, lessors must consider which recognized amounts related to sales-type and direct financing lease receivables represent financial asset components for which transfers are within the scope of ASC 860-10. For additional discussion of applying the definition of participating interest to sales-type and direct financing lease receivables, see Section 3.2.2.2.

ASC 860-10

Lease Receivables From Sales-Type and Direct Financing Leases

55-6 Lease receivables from sales-type and direct financing leases are made up of two components: the right to receive lease payments and guaranteed residual values. Lease payments for sales-type and direct financing leases involve requirements for lessees to pay cash to lessors and meet the definition of a financial asset. Residual values represent the lessor’s estimate of the salvage value of the underlying asset at the end of the lease term and may be either guaranteed or unguaranteed. Residual values meet the definition of financial assets to the extent that they are guaranteed at the commencement of the lease. Thus, transfers of lease receivables from sales-type and direct financing leases are subject to the requirements of this Subtopic. Unguaranteed residual assets do not meet the definition of financial assets, nor do residual values guaranteed after commencement, and transfers of them are not subject to the requirements of this Subtopic.

A lessor’s right to receive lease payments on a sales-type or direct financing lease represents a recognized financial asset that is within the scope of ASC 860-10. In addition, residual values that are guaranteed at the commencement of the lease, whether guaranteed by the lessee or a third party, also represent financial assets. However, unguaranteed residual values and residual values guaranteed after lease commencement are not financial assets and therefore are not subject to ASC 860-10 (i.e., any portion of a residual value that is not guaranteed at lease commencement is outside the scope of ASC 860-10). Unguaranteed residual values and residual values guaranteed after lease commencement should be accounted for in accordance with ASC 842.

2.2.3.6 Taxes Receivable

Receivables arising from taxes, such as sales and property taxes or value-added tax, are not considered financial assets since they arise from an imposition of an obligation by law or regulation. Such receivables would only be considered recognized financial assets if the parties agree to the payment terms in accordance with a contract.

2.2.3.7 ADC Arrangements

ADC arrangements6 are accounted for as either loans receivable or investments in real estate in accordance with ASC 310-10-25. ADC arrangements that are accounted for as loan receivables represent recognized financial assets; therefore, transfers of such loans are within the scope of ASC 860-10. ADC arrangements that are accounted for as investments in real estate are outside the scope of ASC 860-10. Transfers of ADC arrangements that are not accounted for as loan receivables are subject to ASC 610-20 (or ASC 360-20 for entities that have not adopted ASC 606-10 and ASC 610-20). See Section 2.2.4 for further discussion.

2.2.4 In-Substance Nonfinancial Assets

ASC 610-20

Entities

15-1 The guidance in this Subtopic applies to all entities.

Transactions

15-2 Except as described in paragraph 610-20-15-4, the guidance in this Subtopic applies to gains or losses recognized upon the derecognition of nonfinancial assets and in substance nonfinancial assets. Nonfinancial assets within the scope of this Subtopic include intangible assets, land, buildings, or materials and supplies and may have a zero carrying value. In substance nonfinancial assets are described in paragraphs 610-20-15-5 through 15-8.

15-3 The guidance in this Subtopic applies to a transfer of an ownership interest (or a variable interest) in a consolidated subsidiary (that is not a business or nonprofit activity) only if all of the assets in the subsidiary are nonfinancial assets and/or in substance nonfinancial assets.

15-4 The guidance in this Subtopic does not apply to the following:

A transfer of a nonfinancial asset or an in substance nonfinancial asset in a contract with a customer, see Topic 606 on revenue from contracts with customers
A transfer of a subsidiary or group of assets that constitutes a business or nonprofit activity, see Section 810-10-40 on consolidation
Sale and leaseback transactions within the scope of Subtopic 842-40 on leases
A conveyance of oil and gas mineral rights within the scope of Subtopic 932-360 on extractive activities — oil and gas
A transaction that is entirely accounted for in accordance with Topic 860 on transfers and servicing (for example, a transfer of investments accounted for under Topic 320 on investments — debt securities, Topic 321 on investments — equity securities, Topic 323 on investments — equity method and joint ventures, Topic 325 on investments — other, Topic 815 on derivatives and hedging, and Topic 825 on financial instruments)
A transfer of nonfinancial assets that is part of the consideration in a business combination within the scope of Topic 805 on business combinations, see paragraph 805-30-30-8
A nonmonetary transaction within the scope of Topic 845 on nonmonetary transactions
A lease contract within the scope of Topic 842 on leases
An exchange of takeoff and landing slots within the scope of Subtopic 908-350 on airlines — intangibles
A contribution of cash and other assets, including a promise to give, within the scope of Subtopic 720-25 on other expenses — contributions made or within the scope of Subtopic 958-605 on not-for-profit entities — revenue recognition
A transfer of an investment in a venture that is accounted for by proportionately consolidating the assets, liabilities, revenues, and expenses of the venture as described in paragraph 810-10-45-14
A transfer of nonfinancial assets or in substance nonfinancial assets solely between entities or persons under common control, such as between a parent and its subsidiaries or between two subsidiaries of the same parent.

ASC 606-10 addresses all transfers of nonfinancial assets or in-substance nonfinancial assets that occur in connection with a contract with a customer. ASC 610-20 addresses transfers of nonfinancial assets and in-substance nonfinancial assets that are not within the scope of ASC 606-10.7 Because ASC 606-10 and ASC 610-20 address the accounting for transfers of nonfinancial assets and in-substance nonfinancial assets, those transfers are not within the scope of ASC 860-10 (see ASC 860-10-15-4(a) and (e)).

ASC 610-20-15-5 states that an in-substance nonfinancial asset is “a financial asset (for example, a receivable) promised to a counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) that are promised to the counterparty in the contract is concentrated in nonfinancial assets.” That paragraph further states that “[i]f substantially all of the fair value of the assets that are promised to a counterparty in a contract is concentrated in nonfinancial assets, then all of the financial assets promised to the counterparty in the contract are in substance nonfinancial assets.” Thus, if financial assets are transferred as part of a contract that includes nonfinancial assets, the transferor must consider whether those financial assets represent in-substance nonfinancial assets. In accordance with ASC 610-20, this evaluation takes into account the fair value of all the promised assets, including unrecognized assets such as intangible assets not recognized by the transferor (e.g., in-process research and development or internally generated intangible assets), and off-market contracts. ASC 610-20 may also apply to transfers of subsidiaries that are not businesses (see ASC 810-10-40-3A(c)(5)).

2.2.5 Ownership Interests in Unconsolidated Entities

2.2.5.1 General

Transfers of ownership interests in unconsolidated entities, including equity method investments, are within the scope of ASC 860-10 unless those transfers represent in-substance nonfinancial assets. See Section 2.2.5.2 for discussion of exchanges of equity method investments.

ASC 860-10 applies to all transfers of ownership interests in unconsolidated entities, including equity method investments, that are not part of a contract that also includes nonfinancial assets, unless another scope exception in ASC 860-10-15-4 applies. That is, stand-alone transfers of ownership interests in unconsolidated entities, including equity method investments, represent transfers of financial assets to which ASC 860-10 applies. There is no need for an entity to evaluate whether these transfers represent sales of real estate or nonfinancial assets in substance. This is because (1) ASU 2014-09 eliminated the scope exception in ASC 860-10-15-4(e) on transfers of investments, including equity method investments, in real estate or in-substance real estate entities and (2) ASU 2017-05 eliminated the scope exception in ASC 610-20-15-2(b) (as originally issued in ASU 2014-09) that applied to transfers of stand-alone financial assets that are in-substance nonfinancial assets. After these amendments, all stand-alone transfers of debt securities within the scope of ASC 320, equity securities within the scope of ASC 321, equity method investments within the scope of ASC 323, and other investments within the scope of ASC 325 are within the scope of ASC 860-10. See also ASC 860-10-55-3(b) and ASC 970-323-40-1.

Some transactions include the transfer of both financial assets and nonfinancial assets. As discussed in Section 2.2.4, a financial asset that is promised to a counterparty in a contract that includes nonfinancial assets is considered an in-substance nonfinancial asset if substantially all of the fair value of the assets that are promised to the counterparty to the contract are concentrated in nonfinancial assets. Thus, if an ownership interest in an unconsolidated entity, including an equity method investment, is transferred as part of a contract that includes nonfinancial assets, the transferor must consider whether those financial assets represent in-substance nonfinancial assets in accordance with ASC 610-20. Note that in performing this assessment, entities do not look through to the underlying assets and liabilities of the investee. Rather, a transfer of an ownership interest in an unconsolidated entity, including an equity method investment, will only be considered a transfer of an in-substance nonfinancial asset if the transfer is included in a contract in which substantially all of the fair value of the assets promised in the contract is concentrated in nonfinancial assets. As discussed in Section 2.2.4, this evaluation must take into account the fair value of all the promised assets, including unrecognized assets. ASC 610-20 may also apply to transfers of subsidiaries that are not businesses (see ASC 810-10-40-3A(c)(5)).

In summary, ASC 860-10 applies to transfers of ownership interests in unconsolidated entities, including equity method investments, unless one of the following five conditions is met:

The transfer of the investment is included in a contract that involves nonfinancial assets and ASC 610-20 applies because substantially all of the fair value of the assets promised in the contract is concentrated in nonfinancial assets.
The investment is included in a transfer of a subsidiary that is a business (i.e., ASC 810 applies).
The investment is included in a transfer of a subsidiary that is not a business and the substance of the transaction is addressed by ASC 610-20.
The transaction does not represent a transfer under ASC 860-10.
The transfer is subject to another scope exception in ASC 860-10-15-4 (e.g., an investment by or distribution to an owner).

Connecting the Dots

The derecognition guidance in ASC 610-20 substantially differs from the derecognition guidance in ASC 860-10. In some situations, entities will need to use judgment to determine whether ASC 610-20 or ASC 860-10 applies. An entity often needs to pay particular attention in determining the appropriate unit of account for contracts. For example, an entity may enter into an agreement to sell both a consolidated subsidiary that is not a business that holds only nonfinancial assets and a consolidated subsidiary that is not a business that holds only loans receivable. (As noted in Section 2.4.3.1, ASC 860-10 applies to a transfer of a consolidated subsidiary that holds only financial assets.) In this example, if the entity views the transfer of the two subsidiaries in the aggregate, it may conclude that the transfer is entirely within the scope of ASC 610-20 and meets the derecognition conditions in that guidance. However, if the transfer of the consolidated subsidiary that holds only loan receivables was evaluated under ASC 860-10, sale accounting may not be achieved (e.g., the transferor maintains effective control over the transferred loans). Depending on the circumstances, the application of ASC 610-20 to the entire transfer may be considered a circumvention of the requirements of ASC 860-10. This could be the case if the transferred loan receivables are entirely unrelated to the consolidated subsidiary that holds only nonfinancial assets.

Example 2-2

Transfer of a Partnership Interest in a Real Estate Entity

Entity B owns a 2 percent limited partnership interest in Entity C, which owns and leases a mixed-use commercial and retail office building. Entity B has adopted ASC 606-10 and ASC 606-20 and accounts for its investment in C under ASC 321.

If B transfers its partnership interest in C to a third party, that transfer is within the scope of ASC 860-10. There is no need for B to apply other U.S. GAAP even though its partnership interest represents a real estate investment.

2.2.5.2 Exchange of One Equity Method Investment for Another

An exchange of one equity method investment for another is within the scope of ASC 860-10 unless (1) the investment is considered an in-substance nonfinancial asset or (2) another exception in ASC 860-10-15-4 applies.8 However, in an exchange of equity method investments that meets the conditions for sale accounting, the transferor must consider whether recognition of a full gain is appropriate. It is appropriate to recognize a full gain on the sale only if the substance of the transaction is an exchange of an existing investment for a new investment in an unrelated investee. If the substance of the transaction is analogous to a partial dilution of the existing equity method investment, the transfer is subject to the guidance in ASC 323-10-40-1 on recognition of a partial gain rather than the guidance in ASC 860-20 on recognition of a full gain. A loss on an exchange of equity method investments would always be recognized. See Section 4.3.3 of Deloitte’s Roadmap Equity Method Investments and Joint Ventures for more information about exchanges of equity method investments.

2.2.5.3 Beneficial Interests in a Securitization Entity That Holds Nonfinancial Assets

Investments in beneficial interests issued by a securitization entity that holds nonfinancial assets are considered financial assets unless the investor must consolidate the securitization entity. Therefore, transfers of such beneficial interests are within the scope of ASC 860-10; there is no need to consider the beneficial interests to be nonfinancial assets in substance. See Section 2.2.3.3 for further details.

Footnotes

Purchased call options on financial assets are accounted for as equity securities under ASC 321, as derivative instruments under ASC 815-10, or in accordance with the guidance in ASC 815-10 on certain contracts related to debt and equity securities.

Forward contracts to purchase financial assets are accounted for as equity securities under ASC 321, as derivative instruments under ASC 815-10, or in accordance with the guidance in ASC 815-10 on certain contracts on debt and equity securities.

See Section 3.6.6 for discussion of the derecognition conditions that must be met for financial instruments that may be assets or liabilities.

Section 3.6.6 discusses the derecognition conditions that must be met for a derivative instrument that may be an asset or a liability.

In an ADC arrangement, a lender, usually a financial institution, participates in the expected residual profit from a sale or refinancing of property.

As discussed in ASC 610-20-15-4, an entity is exempt from applying the guidance in ASC 610-20 in certain instances.

This is consistent with the table in ASC 845-10-55-2, which states that the exchange of one equity method investment for another is within the scope of ASC 860-10.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.