4.3 Regaining Control of Financial Assets Sold

4.3.1 Transferor’s Accounting

4.3.1.1 General

ASC 860-20

Regaining Control of Financial Assets Sold

25-8 Paragraph 860-10-40-41 explains that a change in law or other circumstance may result in a transferred portion of an entire financial asset no longer meeting the conditions of a participating interest (see paragraph 860-10-40-6A) or the transferor’s regaining control of transferred financial assets after a transfer that was previously accounted for as a sale, because one or more of the conditions in paragraph 860-10-40-5 are no longer met.

25-9 Such changes shall be accounted for in the same manner as a purchase of the transferred financial assets from the former transferee(s) in exchange for liabilities assumed unless they arise solely from either:

Consolidation of an entity involved in the transfer at a subsequent date (see paragraph 860-20-25-10)
A change in market prices (for example, an increase in price that moves into the money a freestanding call option on a non-readily-obtainable, transferred financial asset that was originally sufficiently out of the money that it was judged not to constrain the transferee).

See the related guidance beginning in paragraph 860-20-25-1.

25-10 After that change, the transferor shall do all of the following:

Recognize in its financial statements those transferred financial assets together with liabilities to the former transferee(s) or beneficial interest holders of the former transferee(s).
Not change the accounting for the servicing asset related to the previously sold financial assets. That is, even though the transferor has regained control over the previously sold assets, the cash flows from those assets will contractually be paid to the special-purpose entity, which will then distribute the proceeds to satisfy its contractual obligations (including obligations to the beneficial interest holders). Because the transferor, as servicer, is still contractually required to collect the asset’s cash flows for the benefit of the special-purpose entity and otherwise service the assets, it shall continue to recognize the servicing asset and assess the asset for impairment if subsequently measured using the amortization method, as required by paragraph 860-50-35-9. Once a servicing asset is recognized it shall not be added back to the underlying asset. Even when the transferor has regained control over the underlying assets through an event that triggers a transferor to rerecognize previously transferred assets that were accounted for as having been sold, the related servicing asset shall continue to be separately recognized.
Continue to account for the transferor’s interests in those underlying financial assets apart from any rerecognized financial assets. That is, the transferor’s interests shall not be combined with and accounted for with the rerecognized financial assets. Example 10 (see paragraph 860-20-55-83) illustrates this guidance. However, a subsequent event that results in the transferor reclaiming those financial assets from the transferee, for example, the exercise of a removal-of-accounts provision or the consolidation by the transferor of the securitization entity in accordance with applicable GAAP, including the Variable Interest Entities Subsections of Subtopic 810-10, would result in a recombination of the transferor’s interests with the underlying financial assets.

For guidance on consolidation, which is relevant to determining whether a transferor must consolidate an entity involved in a transfer that was accounted for as a sale, see Topic 810.

25-12 Upon application of paragraph 860-20-25-10, no gain or loss shall be recognized in earnings with respect to any of the transferor’s beneficial interests. A gain or loss may be recognized upon the exercise of a removal-of- accounts provision or similar contingent right with respect to the repurchased transferred financial assets that were sold if the removal-of-accounts provision or similar contingent right held by the transferor is not accounted for as a derivative instrument under Subtopic 815-10 and is not at the money, resulting in the fair value of those repurchased financial assets being greater or less than the related obligation to the transferee.

25-13 For financial assets rerecognized in accordance with paragraph 860-20-25-10, an entity shall initially recognize a financial asset at fair value. An entity shall then apply relevant guidance, including this Topic, Topic 310 on receivables, Topic 320 on investments — debt securities, Topic 321 on investments — equity securities, Topic 323 on investments — equity method and joint ventures, and Topic 325 on investments — other. In addition, an entity shall measure an allowance for credit losses in accordance with Topic 326, if applicable.

For those financial assets that are not purchased financial assets with credit deterioration within the scope of Topic 326, an entity shall recognize an allowance for credit losses with a corresponding charge to credit loss expense as of the reporting date.
For those financial assets that are purchased financial assets with credit deterioration (which includes beneficial interest that meets the criteria in paragraph 325-40-30-1A) within the scope of Topic 326, an entity shall recognize an allowance for credit losses in accordance with Topic 326 with a corresponding increase to the amortized cost basis of the financial asset(s) as of the recognition date.

Regaining Control of Financial Assets Sold

30-3 The transferor shall initially measure transferred financial assets and liabilities that are rerecognized under paragraph 860-20-25-10(a) as a result of regaining control of the financial assets sold at fair value on the date of the change as if the transferor purchased the transferred financial assets and assumed the liabilities on that date.

ASC 860-10

Circumstances That Result in a Transferor Regaining Control of Financial Assets Previously Sold

40-41 A change in law or other circumstance may result in a transferred portion of an entire financial asset no longer meeting the conditions of a participating interest (see paragraph 860-10-40-6A) or the transferor’s regaining control of transferred financial assets after a transfer that was previously accounted for as a sale, because one or more of the conditions in paragraph 860-10-40-5 are no longer met. See the related guidance beginning in paragraph 860-20-25-8.

ASC 860-20 provides guidance on situations in which a transferor regains control of financial assets previously considered sold. A transferor may regain control of previously sold financial assets in the following circumstances:

A contingency underlying a repurchase option is resolved, resulting in the transferor’s unilateral ability to repurchase specific financial assets. (Note that ASC 860-20-55-41 indicates that the transferor must rerecognize the related financial assets even if it does not intend to exercise its purchase option, unless the repurchase option does not provide the transferor with a more than trivial benefit.)
A contingency underlying a forward repurchase contract is resolved, resulting in the requirement for the transferor to repurchase specific financial assets.
An interest in a previously sold financial asset no longer meets the definition of a participating interest. (Note that this could occur if an entity transfers a new interest in the entire financial asset that does not meet the definition of a participating interest, as discussed in Example 3-5.)
Changes in laws or regulations or amendments to the underlying sales agreement cause the transferor to no longer meet all of the conditions in ASC 860-10-40-5 for sale accounting (e.g., amendments to the sales agreement cause the transfer to no longer meet the legal isolation condition or impose constraints on the transferee’s ability to pledge or exchange the transferred financial assets).2

Connecting the Dots

The evaluation of whether a transferor’s right to purchase a specific transferred financial asset provides a more than trivial benefit applies only to options held by the transferor. That is, if the contingent repurchase feature is a forward rather than an option, then once the contingency is resolved, the transferor must repurchase the previously sold financial assets and an evaluation of whether this repurchase provides the transferor with a more than trivial benefit is not relevant.

In evaluating whether a transferor would receive a more than trivial benefit from a contingently exercisable repurchase option, an entity would apply the guidance in ASC 860-10-40-28(a), which indicates that a call option or other right conveys a more than trivial benefit “if the price to be paid is fixed, determinable, or otherwise potentially advantageous, unless because that price is so far out of the money or for other reasons it is probable when the option is written that the transferor will not exercise it.” In other words, the assessment focuses on whether, on the basis of the pricing of the option, there is a potentially reasonable scenario in which the call price is advantageous compared with the cost of exercising the call option. The holder’s liquidity position (i.e., ability to exercise the option) should not be taken into account in this assessment.

The transferor evaluates whether a repurchase option conveys a more than trivial benefit to the transferor as of the date sale accounting for the transferred financial assets is achieved (which could be later than the initial transfer date) and should not reconsider this evaluation. This view is consistent with the guidance in ASC 860-10-40-28(a), which indicates that the assessment of probability for a deep-out-of-the-money option is performed when the option is written, as well as with that in ASC 860-20-25-9(b), which indicates that a change in market prices should not affect a transferor’s assessment of whether it has regained control over specific transferred financial assets. Because the threshold for determining that the transferor receives a more than trivial benefit from a repurchase option is very low, we believe that it would be rare for a transferor not to rerecognize specific financial assets previously considered sold when it has subsequently regained control over those financial assets.

Sections 4.3.1.2 and 4.3.1.3 discuss the accounting in situations in which a transferor regains control over previously sold financial assets. For discussion of when a transferor controls a transferred financial asset, see Sections 3.4 and 3.5.

4.3.1.2 Removal-of-Accounts Provisions

4.3.1.2.1 General

ASC 860-20

Regaining Control of Financial Assets Sold

25-11 Whether the removal-of-accounts provision is exercised or not, the transferor shall recognize any financial assets subject to the removal-of-accounts provision if all of the following conditions are met:

A third party’s action (such as default or cancellation) or decision not to act (expiration) occurs.
The occurrence allows removal of assets to be initiated solely by the transferor.
The provision provides a more-than-trivial benefit to the transferor.

For example, once a contingency is met (such as when a given loan goes into default), the call option on that asset (loan) is no longer contingent.

Regaining Control Through a Removal-of-Accounts Provision

55-40 This guidance addresses implementation of paragraph 860-20-25-11. Under that paragraph’s guidance, if the removal-of-accounts provision is not exercised, the financial assets are recognized because the transferor now can unilaterally cause the transferee to return those specific financial assets and, therefore, the transferor once again has effective control over those transferred financial assets (see paragraphs 860-20-25-8 through 25-10).

55-41 Similarly, when a contingency related to a transferor’s contingent right has been met, the transferor generally must account for the repurchase of a specific subset of the financial assets transferred to and held by the entity. When the contingency has been met, the transferor has a unilateral right to purchase a specific transferred financial asset. At that point, the transferor must determine whether the unilateral right to purchase a specific transferred financial asset provides the transferor with a more-than-trivial benefit. If the unilateral right to purchase a specific transferred financial asset provides the transferor with a more-than-trivial benefit, the transfer fails the criterion in paragraph 860-10-40-5(c)(2). The transferor must perform this analysis regardless of whether it intends to exercise its call option.

55-42 Although this guidance uses removal-of-accounts provisions as an example, the guidance is not limited to removal-of-accounts provisions. Contingent rights can arise in many other situations. See paragraphs 860-10-55-39 through 55-42 for more information.

ASC 860-20-25-11 and ASC 860-20-55-40 through 55-42 provide guidance on the transferor’s accounting for a ROAP. While this guidance specifically discusses ROAPs, it is relevant to any type of contingent repurchase right. For example, when a default ROAP becomes exercisable by the transferor because previously sold financial assets default, the transferor must rerecognize the specific financial assets for which it has regained control.

4.3.1.2.2 Accounting When the Transferor Regains Control Over Previously Sold Financial Assets

4.3.1.2.2.1 General

ASC 860-20-25-9 requires a transferor to account for regaining control over previously sold financial assets in the same manner as if it purchased the financial assets in exchange for liabilities. If, however, the control is associated with the consolidation of the transferee, ASC 810 applies rather than ASC 860-20-25-9. In the discussion below, it is assumed that the transferor is not required to consolidate the transferee in accordance with ASC 810.

As of the date a transferor regains control over specific transferred financial assets (e.g., a contingently exercisable call option becomes exercisable or a contingently settleable forward repurchase contract becomes settleable), ASC 860-20-25-10 requires the transferor to do all of the following:

Recognize the previously sold financial assets and a liability for the purchase price payable to the transferee or beneficial interest holders in the transferred financial assets. ASC 860-20-30-3 requires that these amounts be recognized at the fair value of the financial assets as of the date control is obtained.

The fair value amount recognized for the financial assets is not reduced by the value of any beneficial interest in those financial assets that is owned by the transferor. Before FASB Statement 166 was issued, the examples in EITF Issue 02-9 indicated that the transferor should rerecognize the fair value of “the portion of the originally transferred financial assets that were previously accounted for as sold.” As a result, the transferor rerecognized the fair value of the specific financial assets for which control was regained less the transferor’s beneficial interests in those assets. The liability for the purchase price was determined on the basis of the amounts payable to third parties (i.e., it excluded the amount that would ultimately be paid to the transferor as a result of its beneficial interest in the transferred financial assets). However, FASB Statement 166 amended EITF Issue 02-9 to require the transferor to rerecognize the entire fair value of the financial assets for which control is regained. See Example 4-3 for an illustration.
Continue to separately account for any servicing asset or servicing liability related to the previously sold financial assets. Previously recognized servicing rights continue to be separately accounted for because the transferor is still required to service the financial assets previously sold (e.g., the transferor still services the financial assets held by an unconsolidated trust and passes through the cash flows on those financial assets to the trust’s beneficial interest holders) and the transferor has not yet repurchased the financial assets previously sold. As discussed in ASC 860-20-25-10(b), “[o]nce a servicing asset is recognized it shall not be added back to the underlying asset.” Because the price payable to repurchase the financial assets for which control has been regained would not include any amounts related to the rights to service those financial assets, the continued recognition of a servicing asset or servicing liability will not cause the same asset to be counted twice. See Section 6.2.2.5 for more information about accounting for servicing rights when control is regained over the related financial assets.
Continue to separately account for any beneficial interests in the previously sold financial assets. The transferor should not combine any beneficial interests in the previously sold financial assets with the rerecognized financial assets. However, ASC 860-20-35-9 requires the transferor to evaluate its beneficial interests for impairment as of the date control is regained over financial assets previously sold. (Any impairment loss would be recognized in accordance with other U.S. GAAP applicable to the beneficial interests.) Beneficial interests in the previously sold financial assets would only be derecognized when the transferor repurchases the financial assets for which it has regained control (see Section 4.3.1.2.5).
Recognize no gain or loss in earnings as a result of rerecognizing the previously sold financial assets and the liability for the purchase price. While a gain or loss may be recognized when the previously sold financial assets are repurchased (i.e., a repurchase option is exercised), no gain or loss is recognized as of the date of initial recognition of the financial assets for which the transferor has regained control.

Connecting the Dots

ASC 860-20-25-12 indicates that “no gain or loss shall be recognized in earnings with respect to any of the transferor’s beneficial interests.” Further, ASC 860-20-35-9 requires the transferor to evaluate any beneficial interests for impairment when financial assets are rerecognized under ASC 860-20-25-10. In most cases, any impairment of the transferor’s beneficial interests would have existed and would have been recognized before the date on which the event occurs that requires the transferor to rerecognize transferred financial assets.

With the exception of any impairment of a transferor’s beneficial interests that could be recognized in conjunction with the rerecognition of previously sold financial assets, no gain or loss should be recognized as of the date the transferor regains control over previously sold financial assets. This is evident from the examples in EITF Issue 02-9.3 A gain or loss may, however, be recognized when the transferor repurchases the financial assets (see Section 4.3.1.2.5).

Example 4-3 illustrates the accounting as of the date a transferor regains control over previously sold financial assets.

4.3.1.2.2.2 Accounting for a Previously Recognized Asset or Liability That Causes the Transferor to Regain Control Over Previously Sold Financial Assets

ASC 860-20-25-1 requires a transferor to recognize all assets obtained and liabilities incurred in a sale of financial assets. Therefore, the transferor may have previously recognized an asset or liability for an option or forward that subsequently causes the transferor to regain control over previously sold financial assets. In some situations, the transferor may have recognized that asset or liability as a derivative instrument.

Connecting the Dots

A ROAP (e.g., a default ROAP), cleanup call option, or other contingently exercisable repurchase right that a transferor recognizes upon a sale of financial assets is often not accounted for as a derivative instrument under ASC 815. For example, a default ROAP generally does not meet the definition of a derivative instrument in ASC 815-10-15-83 because it must be physically settled and the underlying financial assets are not considered readily convertible to cash when settlement occurs. Although conforming mortgage loans may be considered readily convertible to cash through the TBA market, defaulted mortgage loans (which would be acquired upon exercise of a default ROAP) would not be considered readily convertible to cash.

ASC 860-20 does not specifically address how a transferor should account for any previously recognized asset or liability (e.g., a contingently exercisable call option or contingently settleable forward repurchase contract) when the financial asset that is the underlying of such an instrument must be rerecognized under ASC 860-20-25-10. While we believe that any such call option or forward contract represents a beneficial interest in the underlying financial assets previously sold, we do not believe that ASC 860-20-25-10(c) specifically addresses such instruments. This conclusion is based, in part, on the fact that the examples in EITF Issue 02-9 (the original pronouncement that was codified in ASC 860-20’s guidance on regaining control over previously sold financial assets) do not include any consideration of previously recognized options or forwards that become exercisable or settleable and result in the need for the transferor to rerecognize the related financial assets previously sold.

We believe that it is appropriate for the transferor to derecognize (wholly or partially, depending on the circumstances) any previously recognized asset or liability for a contingently exercisable call option or contingently settleable forward repurchase contract that gave rise to the requirement to rerecognize financial assets previously considered sold. This accounting is appropriate regardless of whether such an asset or liability was previously recognized as a derivative instrument. The entire asset or liability would be derecognized only if the transferor rerecognizes all the related financial assets under ASC 860-20-25-10. The offsetting entry for any such derecognition should not be made to earnings because no gain or loss should be recognized before rerecognized financial assets are repurchased (see Section 4.3.1.2.2.1). Rather, the offsetting entry should be reflected as an adjustment to the liability recognized under ASC 860-20-25-10(a) for the purchase price payable to repurchase the financial assets for which control has been regained.4

Connecting the Dots

A contingently exercisable call option or contingently settleable forward repurchase contract that was previously accounted for as a derivative instrument would no longer meet the definition of a derivative once the underlying financial asset has been recognized because of the scope exception in ASC 815-10-15-63. Since entities are required to continually evaluate whether an instrument meets the definition of a derivative in ASC 815, it is appropriate to apply the scope exception in ASC 815-10-15-63 and derecognize any derivative asset or liability amount that pertains to the financial assets rerecognized under ASC 860-20-25-10.

4.3.1.2.2.3 Offsetting

When applying the rerecognition guidance in ASC 860-20-25-10, a transferor may recognize a liability for the purchase price of financial assets for which control has been regained that, when paid, will be partially distributed to the transferor as a result of its ownership of a beneficial interest in the previously sold financial assets. It would not be appropriate for the transferor to offset any portion of the liability for the purchase price with the transferor’s beneficial interest unless all the conditions for offsetting in ASC 210-20 are met. It is unlikely that the conditions in ASC 210-20-45-1(b) and (c) would be met because the liability for the purchase price must generally be paid in full to the transferee, who then disburses the proceeds to its beneficial interest holders.

4.3.1.2.3 Subsequent Accounting for the Rerecognized Financial Assets

Once rerecognized, the financial assets should be accounted for in the same manner as if they had been purchased from a third party. A rerecognized loan receivable would be accounted for as a purchased financial asset with credit deterioration if, as of the date of initial recognition, the loan receivable has experienced a more-than-insignificant deterioration in credit quality since origination. In accordance with ASC 326-20-30-13, an allowance for credit losses would be recognized in accordance with ASC 326, with a corresponding increase to the amortized cost basis of the asset as of the recognition date. If the rerecognized financial asset is a security, it would be accounted for under ASC 320, ASC 321, ASC 323, or ASC 325-40.

4.3.1.2.4 Subsequent Accounting for the Liability for the Purchase Price

Once recognized, the liability for the amount payable to acquire the rerecognized financial assets should be accounted for in a manner similar to other liabilities incurred to purchase assets. If the FVO is not elected, the accounting for this liability will depend on whether it pertains to an option or a forward repurchase contract:

Option — The transferor is not required to adjust the initial carrying amount of the liability recognized under ASC 860-20-25-10(a) because it is not required to repurchase the related financial assets. That is, the transferor is not required to apply the interest method in ASC 835-30 and therefore would not amortize any discount or premium between the initially recognized amount of the liability and the purchase price. Any difference would be recognized only if the transferor repurchases the financial assets.
Forward — Since the transferor is obligated to repurchase the financial assets over which it has regained control, it must amortize any discount or premium between the initially recognized amount of the liability and the purchase price so that the carrying amount of the liability will equal the purchase price of the financial assets as of the repurchase date.

4.3.1.2.5 Accounting When the Transferor Repurchases the Financial Assets

A transferor’s repurchase of the financial assets over which it had regained control (i.e., the transferor exercises a contingent option, or settles a contingent forward, to repurchase the financial assets) is accounted for as follows:5

Derecognize the carrying amount of the liability for the purchase price.
Derecognize any beneficial interests in the repurchased financial assets (and any related amounts in AOCI). (Note that only the portion of beneficial interests related to the repurchased financial assets should be derecognized; in conjunction with such derecognition, the transferor should recognize a receivable for the proceeds paid to repurchase the financial assets that are due from the transferee as a result of its ownership of the beneficial interests in those transferred financial assets.)
Recognize a gain or loss for any difference between the carrying amounts of assets and liabilities recognized and derecognized and the cash amount paid to repurchase the financial assets. (Note that no gain or loss should exist when the repurchase occurs under a forward repurchase contract because (1) the purchase price payable should equal the carrying amount of the liability as of the purchase date [see Section 4.3.1.2.4] and (2) the derecognition of any beneficial interests held by the transferor should be offset by the recognition of a receivable from the transferee that will be distributed to the transferor.)

Connecting the Dots

As discussed in Section 4.3.1.2.2.1, the transferor should not recognize any gain or loss upon regaining control over previously sold financial assets. However, ASC 860-20-25-12 states that a “gain or loss may be recognized upon the exercise of a removal-of-accounts provision or similar contingent right with respect to the repurchased transferred financial assets that were sold if the removal-of-accounts provision or similar contingent right held by the transferor is not accounted for as a derivative instrument under Subtopic 815-10 and is not at the money, resulting in the fair value of those repurchased financial assets being greater or less than the related obligation to the transferee.” Effectively, in the case of a right to repurchase previously sold financial assets, even though the transferor must rerecognize the financial assets when it regains control of them, it does not recognize any gain or loss on such rerecognition because it is not obligated to repurchase those financial assets (i.e., any such gain or loss is recognized only when the transferor decides to repurchase the financial assets). If the previously sold financial assets are rerecognized as a result of a contingently settleable forward repurchase contract, any income statement effect of such a repurchase will generally be recognized before the related financial assets are repurchased because the transferor is required to adjust the initially recognized carrying amount of the liability for the purchase price so that it equals the purchase price as of the date payment is made to repurchase the financial assets (see Section 4.3.1.2.4).

The transferor should not derecognize any previously recognized servicing asset or servicing liability even though some (or potentially all) of the value of such a recognized servicing right is derived from the financial assets that have been repurchased. ASC 860-20-25-10(b) states that “[o]nce a servicing asset is recognized it shall not be added back to the underlying asset.” Therefore, unless the servicing contract expires as a result of the repurchase of the underlying financial assets (e.g., a contractual separate servicing fee no longer exists), any previously recognized servicing asset should not be derecognized. Note that the continued recognition of the servicing asset or servicing liability related to the financial assets that the transferor has repurchased should not result in “double-counting” the value that pertains to the servicing right because the purchase price of the financial assets reacquired would be expected to be determined on the basis of the purchase price payable to acquire financial assets without the related servicing rights.

Example 4-3 illustrates the accounting when a transferor repurchases financial assets for which control was previously regained.

4.3.1.2.6 Accounting When an Option to Repurchase Financial Assets Expires

If a transferor rerecognizes financial assets under ASC 860-20-25-10(a) because a right to purchase specific financial assets becomes unilaterally exercisable by the transferor, it should not derecognize those financial assets and the related liability for the purchase price unless its right to repurchase those financial assets expires. It is appropriate to derecognize the financial assets once the option expires since the transferor would no longer have effective control over those financial assets. Derecognition of the related liability for the purchase price as of the date the option expires is consistent with ASC 405-20-40-1.

As of the date of expiration of a transferor’s right to repurchase the financial assets, the transferor should:

Derecognize the financial assets.
Derecognize the carrying amount of the liability for the purchase price.
Recognize a gain or loss for any difference between the carrying amount of the financial assets derecognized and the carrying amount of the liability derecognized.

Example 4-3 illustrates the accounting as of the date a repurchase option expires.

4.3.1.3 Cleanup Call Options

4.3.1.3.1 Accounting Before the Option Becomes Exercisable

In accordance with ASC 860-20-25-4, a transferor must recognize a cleanup call option as an asset as part of the proceeds received in the sale. ASC 860-20-30-1 requires initial recognition of an asset for a cleanup call option at fair value even if the cleanup call option is not subsequently accounted for as a derivative instrument.

Connecting the Dots

A cleanup call option generally does not meet the definition of a derivative instrument in ASC 815-10-15-83 because it must be physically settled and the underlying financial assets are not considered readily convertible to cash when settlement occurs. For example, although conforming mortgage loans may be considered readily convertible to cash through the TBA market, seasoned mortgage loans (i.e., what the underlying of a clean-up call option represents) are not considered readily convertible to cash.

4.3.1.3.2 Accounting When the Option Becomes Exercisable

The exercisability of a cleanup call option does not affect the conclusion about prior sale accounting. That is, even when the clean-up call option becomes unilaterally exercisable, the transferor would not be considered to have regained control over financial assets previously sold. ASC 860-10-40-5(c)(2) provides an exception from the effective-control guidance and indicates that control exists when the transferor has “[t]he unilateral ability to cause the holder to return specific financial assets . . . other than through a cleanup call” (emphasis added). Thus, in the case of a cleanup call option, the transferor is not required to rerecognize previously sold financial assets before the option is exercised.

In addition, the transferor would not be required to consolidate a securitization entity that holds the underlying financial assets once a cleanup call option becomes exercisable. That is, if the cleanup call option is exercisable, the transferor would not be required to reevaluate whether any servicing right becomes a variable interest under ASC 810-10-55-37. Requiring consolidation when a cleanup call becomes exercisable would defeat the purpose of the exception in ASC 860-10-40-5(c)(2).

4.3.1.3.3 Accounting When the Option Is Exercised

Once irrevocable notification is given that a cleanup call option has been exercised, the option becomes a forward contract to repurchase financial assets. At this point, there is no exception from rerecognizing the remaining financial assets held by the transferee (i.e., the exception in ASC 860-10-40-5(c)(2) does not apply because the guidance in ASC 860-10-40-5(c)(1) applies).6 We believe that there are two acceptable views on the accounting by the transferor once it exercises a cleanup call option. These two views result in similar accounting and are premised on an assumption that the transferee (i.e., a securitization entity) will be dissolved after the cleanup call option is exercised. The two views are as follows:

View A: Consolidate the transferee (e.g., the securitization entity) under ASC 810 — Under ASC 810, the transferor would:
- Recognize the financial assets (including any cash held by the securitization entity) at fair value.
- Recognize any nonfinancial assets (e.g., other real estate owned) at fair value.
- Derecognize the cleanup call option, any servicing asset or servicing liability previously recognized, and any beneficial interests in the financial assets (including any amounts in AOCI related to such beneficial interests).
- Recognize a liability equal to the purchase price payable to exercise the cleanup call option.
- Recognize a gain or loss for the difference between the purchase price and the assets and liabilities recognized or derecognized.
This accounting is consistent with ASC 810-10-30-3 and 30-4, which state:
30-3 When a reporting entity becomes the primary beneficiary of a VIE that is not a business, no goodwill shall be recognized. The primary beneficiary initially shall measure and recognize the assets (except for goodwill) and liabilities of the VIE in accordance with Sections 805-20-25 and 805-20-30. However, the primary beneficiary initially shall measure assets and liabilities that it has transferred to that VIE at, after, or shortly before the date that the reporting entity became the primary beneficiary at the same amounts at which the assets and liabilities would have been measured if they had not been transferred. No gain or loss shall be recognized because of such transfers.
30-4 The primary beneficiary of a VIE that is not a business shall recognize a gain or loss for the difference between (a) and (b):
1. The sum of:
  1. The fair value of any consideration paid
  2. The fair value of any noncontrolling interests
  3. The reported amount of any previously held interests
2. The net amount of the VIE’s identifiable assets and liabilities recognized and measured in accordance with Topic 805.
Connecting the Dots

When control is regained over previously sold financial assets, the transferor does not change its accounting for any servicing asset or servicing liability related to the transferred financial assets (see ASC 860-20-25-10(b)). The servicing asset or liability is also not derecognized when the transferor repurchases the related financial assets because a contractual obligation to service the financial assets still exists. However, it is appropriate to derecognize any servicing asset or servicing liability when a transferor consolidates the transferee under ASC 810 because the rerecognition guidance in ASC 860-20 is not applied.
View B: Recognize the financial assets under ASC 860-20 — The transferor applies ASC 860-20- 25-10 and ASC 860-20-25-12. The transferor should recognize the financial assets (and any nonfinancial assets, such as other real estate owned) and the related amount payable to purchase those financial assets as of the date an irrevocable notice of exercise of the cleanup call option is given. These amounts are recognized at the fair value of the rerecognized assets. Any remaining beneficial interests in the previously sold financial assets should be derecognized (including any amounts in AOCI related to such beneficial interests). The transferor should also derecognize any servicing asset or servicing liability if, as a result of exercising the cleanup call, a separate servicing fee no longer exists (i.e., the servicing contract terminates or expires). A gain or loss may be recognized. Although the transferor reduces any gain or increases any loss as a result of derecognizing a servicing asset, the fair value of the previously sold loans includes amounts that would have otherwise been attributable to servicing fees. See Section 4.3.1.2.5 for more information.

Connecting the Dots

When control is regained over previously sold financial assets, the transferor does not change its accounting for any servicing asset or servicing liability related to the transferred financial assets (see ASC 860-20-25-10(b)). The servicing asset or liability is also not derecognized when the transferor repurchases the related financial assets when a contractual obligation to service the financial assets still exists. However, it is appropriate to derecognize any servicing asset or servicing liability when a transferor exercises a cleanup call option if a separate servicing fee no longer exists (i.e., the servicing contract terminates or expires).

The table below summarizes the two views and illustrates that the accounting will be similar under each of them.

Table 4-2

Accounting for:	View A (ASC 810)	View B (ASC 860-20)
Rerecognized assets (i.e., financial assets and any nonfinancial assets, such as other real estate owned)	Fair value as of the date an irrevocable notice of exercise of the cleanup call option is given.	Fair value as of the date an irrevocable notice of exercise of the cleanup call option is given.
Liability to purchase rerecognized financial assets	Exercise price of the cleanup call option.	Fair value of the financial assets rerecognized.
Beneficial interests owned by the transferor	Derecognized as of the date an irrevocable notice of exercise of the cleanup call option is given.	Derecognized as of the date an irrevocable notice of exercise of the cleanup call option is given.
Servicing asset or servicing liability	Derecognized as of the date an irrevocable notice of exercise of the cleanup call option is given.	Derecognized as of the date an irrevocable notice of exercise of the cleanup call option is given provided that the transferor is no longer entitled to any separate servicing fees.
Gain or loss recognition	Recognized as of the date an irrevocable notice of exercise of the cleanup call option is given. Recognition is based on (1) the sum of (a) the liability recognized for the purchase price of the cleanup call option, (b) the net carrying amount of any beneficial interests derecognized, and (c) the carrying amount of any servicing assets or servicing liabilities derecognized, compared with (2) the fair value of the rerecognized assets.	Recognized as of the date an irrevocable notice of exercise of the cleanup call option is given. Recognition is based on (1) the sum of (a) the liability recognized for the purchase price of the cleanup call option, (b) the net carrying amount of any beneficial interests derecognized, and (c) the carrying amount of any servicing assets or servicing liabilities derecognized, compared with (2) the fair value of the rerecognized assets. If the carrying amount of the liability recognized for the purchase price of the cleanup call option differs from the purchase price payable, an additional gain or loss will be recognized for this difference no later than when the purchase price is paid.

4.3.2 Transferee’s Accounting

ASC 860-20

Transferor and Transferee Accounting Circumstances Upon Regaining Control

40-3 The guidance beginning in paragraph 860-20-25-8 discusses the transferor’s accounting upon regaining control of financial assets sold. In such circumstances, the former transferee would derecognize the transferred financial assets on that date, as if it had sold the transferred financial assets in exchange for a receivable from the transferor.

ASC 860-20-40-3 requires a transferee to derecognize financial assets on the date the transferor regains control of them. The transferee should account for such derecognition “as if it had sold the transferred financial assets in exchange for a receivable from the transferor.” The amount of the receivable represents the purchase price payable by the transferor, which may differ from the amount the transferor recognizes as a liability as of the date it rerecognizes those previously sold financial assets. The transferee would recognize a gain or loss on the basis of the difference between the receivable recognized and the carrying amount of the financial assets derecognized.

4.3.3 Examples

ASC 860-20

Example 10: Rerecognition of Transferred Assets and Subsequent Accounting for Transferor’s Interest and a Servicing Asset

55-83 This Example illustrates the accounting for a sale of loans in their entirety by a transferor to an unconsolidated entity and the subsequent accounting for the transferor’s interest and a servicing asset. In this Example, the transferor’s interest is an interest-only strip that is accounted for at fair value in the same manner as an available-for-sale security under paragraph 860-20-35-2.

55-84 This Example has the following assumptions.

55-85 On January 2, 20X1, Entity I (the transferor) originates $1,000 of loans, yielding 10.5 percent interest income for their estimated life of 9 years. Entity I later transfers the loans in their entirety to an unconsolidated entity and accounts for the transfer as a sale. Entity I receives as proceeds $1,000 cash plus a beneficial interest that entitles it to receive 1 percent of the contractual interest (an interest-only strip receivable). Entity I will continue to service the loans for a fee of 100 basis points. The guarantor, a third party, receives 50 basis points as a guarantee fee.

55-86 At the date of transfer, the following facts are assumed.

The fair value of the servicing asset is $40.
The total fair value of the loans including servicing is $1,040.
The fair value of the interest-income strip receivable is $60.

55-87 On December 1, 20X1, an event occurs that results in the transfer not meeting the conditions for sale accounting. The fair value of the originally transferred financial assets that remain outstanding in the entity on that date is $929. The fair value of Entity I’s interest (in the form of an interest-only strip) on that date is $58. The fair value of the servicing asset on that date is $38. The guarantee that was entered into by the entity does not trade with the underlying financial assets. The fees on this guarantee will be paid as part of the cash waterfall.

55-88 All cash flows from the financial assets transferred to the trust are initially sent directly to the trust and then distributed in order of priority. The priority of payments in the cash waterfall is as follows: servicing fees, guarantees, amounts due to outside beneficial interest holders, and amounts due to Transferor’s beneficial interest.

55-90 The following journal entries would be made.

55-91 The following illustrates the accounting entry to be made after the event occurs that results in the transfer not meeting the conditions for sale accounting.

55-92 Entity I would account for the rerecognized financial assets and transferor’s interests as follows:

Entity I would continue to account for transferor’s interests (in accordance with paragraph 320-10-35-1) at fair value with changes in fair value recognized in other comprehensive income.
Entity I would account for the loans at cost plus accrued interest in accordance with Subtopic 310-20.

Example 4-3

Accounting for Default ROAP

July 1, 20X1

On July 1, 20X1, Entity B sells 10 high-credit-quality loan receivables to an unconsolidated securitization entity. The transfer meets the conditions in ASC 860-10-40-5 for sale accounting. Assume the following:

The carrying amount of the loans as of the transfer date is $100 million.
In return for selling the loans, B receives the following:
- $90 million in cash.
- A beneficial interest that entitles B to 10 percent of the cash flows related to the transferred loans. This beneficial interest represents a residual interest in the cash flows of the unconsolidated securitization entity; thus, B absorbs the first $10 million of credit losses on the financial assets sold. The fair value of the beneficial interest as of the transfer date is $8 million. There is a $2 million difference between the fair value of the beneficial interest and its stated amount because there are $2 million of estimated losses on the loan receivables acquired by the securitization entity. Entity B classifies this beneficial interest as an available-for-sale debt security. Entity B will recognize an allowance for credit losses on this investment.
- The right to service the transferred loans, which have a fair value of $3 million as of the date of sale. Entity B elects to account for the servicing asset at fair value.
- A default ROAP (call option) that gives B 15 days to repurchase the first loan receivable that becomes more than 90 days past due. The purchase price is equal to the principal amount of the loan. The fair value of the repurchase option is $500,000 as of the date of sale. This option does not meet the definition of a derivative instrument in ASC 815.

Entity B recognizes the following entry as of the date of sale:

Note that when a transfer of financial assets achieves sale accounting, the transferor must recognize any default ROAP (which is a conditionally exercisable call option) as part of the recognition of the sale. Such recognition is required even if the default ROAP does not meet the definition of a derivative instrument in ASC 815. However, before the default ROAP option becomes exercisable, the transferor is not required to recognize the related financial assets since it does not control them.

Entity B determines that the beneficial interest is a purchased financial asset with credit deterioration. The expected credit loss is $2 million (i.e., there is no noncredit discount). In accordance with ASC 326-30-30-2, B recognizes the following entry:

Assume that between the date of sale and December 1, 20X1, there are no changes in the carrying amounts of the transferor’s beneficial interest, the servicing asset, or the default ROAP option.

December 1, 20X1

On December 1, 20X1, a loan with a $20 million principal amount unexpectedly defaults. The fair value of the loan on the date of default is $16 million. Entity B recognizes the following entry to reflect that it has regained control over this loan:

Note that B does not recognize any loss as of the date it obtains control over the loan receivable because it is not obligated to repurchase the defaulted loan receivable.

Entity B analyzes the loan receivable and concludes that it represents a purchased financial asset with credit deterioration. The expected credit loss is $3 million. In accordance with ASC 326-20-30-13, B recognizes the following entry:

Entity B evaluates its beneficial interest for impairment. The fair value of the beneficial interest has declined to $5 million. Fair value is determined under ASC 820 on the basis of market-participant assumptions. A market participant would not purchase the transferor’s beneficial interest for more than $5 million because this interest absorbs the credit loss on the defaulted loan and any remaining credit losses on the nine loan receivables that have not defaulted up to the total $10 million stated value of the beneficial interest. A market participant would not assume that B would exercise its option to repurchase the defaulted loan receivable. (Note that in this example, it is assumed that the fair value of the beneficial interest has declined from $8 million to $5 million.) The default on the loan receivable was unexpected. Before such default, it was expected that the securitization entity would incur $2 million in credit losses that would be absorbed by this beneficial interest. As a result of this unexpected default, it is now expected that the beneficial interest will absorb the $4 million loss on this defaulted loan receivable and $1 million in additional losses on the remaining nine loans in the securitization entity. This example uses a simplifying assumption that the decline in fair value of the beneficial interest equals the expected credit losses. In practice, this assumption would generally not be true because the fair value of the beneficial interest would be expected to change for other reasons (e.g., changes in market rates of interest) and expected credit losses do not necessarily equal the decline in fair value of the interest that results from such expected credit losses.

Entity B recognizes the following impairment loss on its beneficial interest:

No adjustments are made to the carrying amount of B’s servicing asset because its fair value remains at $3 million.

December 15, 20X1 (Default ROAP Option Is Exercised)

On December 15, 20X1, B repurchases the defaulted loan, recognizing the following entry on repurchase:

Note that, in this example, no portion of the servicing asset is recombined with the loan receivable purchased. Furthermore, no amortization on the noncredit discount on the loan receivable is shown for simplicity (i.e., assume that B recognizes this amortization only at the end of each financial reporting period).

After this purchase, B reevaluates the need for the allowance for credit losses on its beneficial interest. Because B repurchased the defaulted loan receivable, the securitization entity received $20 million and did not incur a loss on this loan receivable (i.e., the amount received equals the principal amount). As a result, B determines that the fair value of its beneficial interest has increased to $9 million. The $4 million increase equals the $4 million credit loss on the defaulted loan receivable that B purchased from the securitization entity. Entity B recognizes the following entry:

Because the beneficial interest is a residual interest, there is no need to reflect any reduction in the carrying amount of the beneficial interest for the $20 million prepayment on the loan receivable that has occurred from B’s repurchase of that receivable. If the beneficial interest had been a pro rata interest, the carrying amount of the beneficial interest would have been reduced because B would have received a portion of the amount paid to the securitization entity to repurchase the defaulted loan receivable.

Note that after all the entries above are recognized, B has recognized a total charge to earnings of $3.5 million. That loss can be explained as follows:

December 15, 20X1 (Default ROAP Option Expires Unexercised)

Assuming that the default ROAP option expires unexercised, B would recognize the following entry:

Entity B would not reverse the impairment loss recognized on its beneficial interest, but it would reflect the following entry to charge off a portion of the carrying amount of the beneficial interest:

Note that after all the entries above are recognized, B has recognized a total charge to earnings of $3.5 million. That loss can be explained as follows:

Regardless of whether B exercises the default ROAP option, it incurs the same loss in this example because the transferor’s interest in the loan receivables sold to the securitization entity absorbs the first $10 million of losses.

Footnotes

Amendments to the terms of the transfer must be substantive for previously sold financial assets to be rerecognized. See Section 3.1.3.2 for further discussion.

Although these examples were not codified, the concepts in them are still relevant.

The offsetting entry should not adjust the carrying amount of the financial assets that are rerecognized under ASC 860-20-25-10 because those financial assets must be initially recognized at fair value. In addition, ASC 860-20-25-10(c) prohibits combining a beneficial interest with rerecognized financial assets. Recognizing this offsetting entry as an adjustment to the obligation for the purchase price has the effect of adjusting that obligation for the transferor’s previously recognized interest in the financial assets for which the obligation is recognized.

In this discussion, it is assumed that the transferee is not liquidated as a result of the repurchase of the financial assets.

ASC 860-10-40-5(c)(1) states that “[a]n agreement that both entitles and obligates the transferor to repurchase or redeem [financial assets] before their maturity” represents effective control over those assets.

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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.