5.4 Examples
5.4.1 Secured Borrowings Involving Cash Payments
Example 5-1
Transfer of Loan
Receivables for Cash in a Secured Borrowing —
Transferor’s and Transferee’s Accounting
On February 1, 20X2, Entity A transfers a portfolio of
consumer loan receivables, carried at amortized cost, to
Entity B, a third party, on a nonrecourse basis. The
transfer does not qualify for sale accounting because A
has a unilateral right to repurchase any of the
transferred consumer loans at a purchase price equal to
105 percent of the unpaid principal amount. Therefore,
the transfer is accounted for as a secured borrowing.
The following are key details of the transfer:
-
Carrying amount of loans: $25 million.
-
Principal amount of loans: $25 million.
-
Proceeds from transfer: $26 million.
Entity A should recognize the transfer as follows:
No gain or loss is recognized by A as of
the transfer date. Entity A continues to recognize the
transferred consumer loans and should not change the
subsequent accounting for them (i.e., the loans would
continue to be subsequently measured at amortized cost).
Interest income and an allowance for credit losses
should continue to be recognized on the consumer loans.
Entity A should separately account for the liability for
the secured borrowing. If A does not elect the FVO, it
should apply ASC 835-30 and amortize the premium on the
initial recorded amount (i.e., $1 million) so that the
liability equals its principal amount on maturity of the
consumer loans. Entity A should also recognize interest
expense on the liability on the basis of the stated
interest on the consumer loans. This liability should
only be derecognized when one of the conditions in ASC
405-20-40-1 is met (e.g., A may not derecognize the
liability upon the occurrence of a default or write-off
of the consumer loans).
Entity B should recognize the transfer as follows:
Entity B should not recognize the
consumer loans as assets because the transfer is not
accounted for as a sale. Rather, B recognizes a
receivable from A and should apply other applicable U.S.
GAAP to subsequently account for this receivable. For
example, B could elect the FVO for the receivable or
account for it at amortized cost. If the FVO is not
elected, B should recognize interest income on the
receivable by using the interest method and should
record an appropriate allowance for credit losses.
Example 5-2
Transfer of Loan
Receivables for Cash and a Beneficial Interest in a
Secured Borrowing — Transferor’s Accounting
On April 15, 20X2, Entity C transfers a portfolio of
mortgage loan receivables, carried at amortized cost, to
a securitization entity on a nonrecourse basis. The
transfer does not qualify for sale accounting because C
has a unilateral right to repurchase any of the
transferred loans at a purchase price equal to 105
percent of the unpaid principal amount. As a result, C
accounts for the transfer as a secured borrowing with a
pledge of collateral. The following are key details of
the transfer:
-
Carrying amount of loans: $100 million.
-
Principal amount of loans: $100 million.
-
Proceeds from transfer: $75 million in cash and a $25 million subordinated beneficial interest in the transferred mortgage loan receivables.
Entity C should recognize the transfer as follows:
No gain or loss is recognized by C as of
the transfer date. Entity C should not recognize the
beneficial interest in the transferred mortgage loans as
an asset. Under ASC 860-30, the $100 million of
transferred mortgage loans represents the collateral
pledged in a secured borrowing. It would be
inappropriate for C to recognize a beneficial interest
in the transferred mortgage loans as an asset because
this instrument represents an interest in the $100
million mortgage loans that remain on C’s balance sheet.
If C recognized the beneficial interest as an asset, it
would count the same asset twice because the source of
cash flows on the beneficial interest is the cash
collections on the mortgage loans that remain recognized
by C.
Entity C should not change the
subsequent accounting for the transferred mortgage loans
(i.e., they would continue to be subsequently measured
at amortized cost). Interest income and an allowance for
credit losses should continue to be recognized on the
loans. Entity C should separately account for the
liability for the secured borrowing and should recognize
interest expense on the liability on the basis of the
stated interest on the mortgage loans provided that the
senior beneficial interests have the same rate as the
mortgage loans. Entity C should only derecognize this
liability when one of the conditions in ASC 405-20-40-1
is met (e.g., C may not derecognize the liability upon
the occurrence of a default or write-off of the mortgage
loans).
Example 5-3
Subsequent
Accounting for Loan Receivables Transferred in a
Secured Borrowing — Transferor’s Accounting
Entity D transfers mortgage loan
receivables, carried at amortized cost, to a
consolidated securitization entity. The transfer does
not meet the conditions for sale accounting because the
transferee is consolidated by D. Entity D should
continue to recognize the mortgage loan receivables at
amortized cost along with an appropriate allowance for
credit losses. Entity D cannot consider the existence of
the secured borrowing in estimating the allowance for
credit losses (i.e., the secured borrowing is not a form
of collateral on the mortgage loan receivables).
Entity D is not eligible to apply the
FVO to the mortgage loan receivables as of the transfer
date. Furthermore, D cannot recharacterize the mortgage
loan receivables as securities because the transfer is
not accounted for as a sale. That is, D continues to
recognize the mortgage loan receivables; it does not
recognize a beneficial interest issued by the
securitization entity as an asset. Entity D should not
change the carrying amount of the mortgage loans or the
subsequent accounting for them as a result of the
transfer.
Note that ASC 820-10-15-3(ee) contains a
practicability exception related to the initial and
subsequent measurement of “[f]inancial assets or
financial liabilities of a consolidated [VIE] that is a
collateralized financing entity [(CFE)] when the
financial assets or financial liabilities are measured
using the measurement alternative in paragraphs
810-10-30-10 through 30-15 and 810-10-35-6 through
35-8.” When a CFE meets the scope requirements in ASC
810-10-15-17D and this measurement alternative is
elected, the entity measures both the financial assets
and the financial liabilities of the CFE by using the
more observable of the fair value of the financial
assets or the fair value of the financial liabilities.
The fair value measurement guidance in ASC 820 applies
to the more observable of the fair value of the
financial assets or the fair value of the financial
liabilities. This use of the FVO applies only to the
financial assets and financial liabilities of a
consolidated CFE. It does not apply to secured
borrowings that do not reflect transfers to CFEs.
Furthermore, an entity may apply this practicability
exception to financial assets transferred to a CFE only
if they were measured at fair value, with changes in
fair value recognized in earnings, before the transfer
to the CFE.
Example 5-4
Subsequent
Accounting for Mortgage Loan Receivables Transferred
in a Secured Borrowing — Transferee’s
Accounting
On August 31, 20X4, Entity E enters into
a loan purchase agreement to acquire $115 million of
residential mortgage loan receivables from Entity F, a
third party. A sister company of F services the mortgage
loans in addition to providing E with a guarantee of the
timely payment of principal and interest on the loans.
Entity F further agrees to repurchase any transferred
mortgage loans upon the occurrence of a breach of
certain representations and warranties made by F as part
of the sale.
Because of the credit loss protection
provided by F and its sister entity, the transfer does
not meet the legal isolation condition in ASC
860-10-40-5(a). That is, E does not absorb credit risk
on the transferred mortgage loans as a result of the
guarantees provided in the transaction. (Note that since
the sister company of F is an affiliate of F, its
involvement in the transfer must be included in the
accounting analysis.) Since the transfer does not meet
the conditions to be accounted for as a sale by F, E is
not allowed to recognize the mortgage loan receivables.
Rather, E must recognize a loan receivable from F as the
offsetting entry for the amount paid to F. As discussed
in Section 5.1, ASC 860-10’s sale
accounting requirements are generally symmetrical. If
the transferor does not meet the conditions for sale
accounting, it cannot derecognize the transferred
financial assets and the transferee therefore cannot
recognize those assets.
Example 5-5
Subsequent
Accounting for Undivided Interests in Defaulted
Credit Card Loan Receivables — Transferee’s
Accounting
Entity G acquires from Entity H
undivided interests in delinquent credit card
receivables for which the customer’s ability to draw
additional amounts has been terminated. The purchase
price paid represents 10 percent of the stated amounts
due because significant credit losses are expected. The
transfer of the subordinated undivided interests from H
to G does not meet the conditions for sale accounting
because the interests transferred are not participating
interests and do not represent 100 percent
participations. As a result, G recognizes a receivable
from H rather than recognizing an interest in the credit
card receivables.
Entity G should not recognize interest
income on its receivable from H in accordance with ASC
326-20’s guidance on purchased deteriorated assets
because the receivable recognized is not a purchased
asset. Rather, G’s asset is considered to have been a
receivable originated with H. Entity G also should not
apply ASC 325-40 to recognize interest income since its
recognized receivable is not a beneficial interest in
securitized financial assets.
Entity G determines that ASC 310-20
applies to its receivable from H. In applying ASC
310-20, G determines that it is not appropriate to
recognize interest income on the basis of contractual
cash flows (i.e., the contractual amounts due on the
underlying credit card receivables) because those
amounts are not expected to be collected. As a result, G
applies the cost recovery method to subsequently account
for its receivable. Entity G also periodically assesses
the carrying amount of the receivable for credit losses
and recognizes an appropriate allowance for them.
5.4.2 Evaluation of Repurchase Features as Derivatives
Example 5-6
Fixed-Price,
Physically Settleable Call Option
Entity A transfers a debt security to a
third party. In conjunction with the transfer, A
receives a fixed-price call option that allows it to
repurchase the transferred debt security. This call
option causes A to maintain effective control over the
transferred financial asset; therefore, sale accounting
is not achieved. Entity A should not recognize that call
option as a derivative instrument in accordance with ASC
815-10-15-63. Entity A continues to recognize the debt
security related to the call option, and recognition of
the call option would cause A to count the same asset
twice.
Example 5-7
Fixed-Price,
Net-Settleable Put Option
Entity B transfers an equity security to
a third party as collateral for a loan that must be
repaid in 10 years. In accordance with the sale
agreement, the transferee is unable to pledge or
exchange the equity security received without B’s
consent, which may be withheld for any reason. As a
result, B does not meet the conditions for sale
accounting. In conjunction with the transfer of the
equity security, B grants the transferee an option that
allows it to put the transferred equity security back to
B at a fixed price at any time for the next 10 years.
The put option must be net-cash-settled. The settlement
of the put option does not affect B’s obligation to
repay the loan.
Entity B should recognize a derivative
liability for the put option. The scope exception in ASC
815-10-15-63 does not apply because the recognition of
the transferred equity security and the put option whose
underlying is the transferred equity security does not
cause the same asset to be counted twice. Recognizing a
liability for the put option does not result in counting
the same market risk exposure arising from the equity
security twice because B is exposed to changes in the
fair value of the equity security from both its
continued holding of the equity security and its
obligation to net-cash-settle the written put option.
That is, if the transferee decides to exercise the put
option, B is still required to repay the loan.
Note that ASC 860-10-15-63 would also
not apply in similar situations if, in lieu of writing a
net-cash-settleable put option on transferred financial
assets, an entity wrote a net-cash-settleable total
return swap on transferred financial assets or entered
into a net-cash-settleable call option on transferred
financial assets. In these cases, the settlement of the
derivatives over the transferred financial assets does
not result in the settlement of the secured borrowing
related to the loan that is secured by the transferred
financial assets.
5.4.3 Securities Lending Transactions
ASC 860-30-55-1 through 55-3 consist of an example illustrating
a securities lending transaction involving cash collateral.
ASC 860-30
Example 1: Securities Lending Transaction Accounted
for as a Secured Borrowing
55-1 This
Example illustrates the guidance in paragraph
860-30-25-8 related to accounting for a securities
lending transaction treated as a secured borrowing, in
which the securities borrower sells the securities upon
receipt and later buys similar securities to return to
the securities lender. This Example has the following
assumptions:
-
Transferor’s carrying amount and fair value of security loaned: $1,000
-
Cash collateral: $1,020
-
Transferor’s return from investing cash collateral at a 5 percent annual rate: $5
-
Transferor’s rebate to the securities borrower at a 4 percent annual rate: $4.
55-2 For simplicity, the fair
value of the security is assumed not to change during
the 35-day term of the transaction.
Below are additional examples illustrating securities lending
transactions.
Example 5-8
Securities Lending
Transaction With Noncash Collateral — Transferor and
Transferee Accounting
On June 1, 20X1, Entity A lends ABC securities,
classified as trading, to Entity B for 60 days. In
return for borrowing the ABC securities, B pledges U.S.
Treasury securities, classified as trading, to A. Entity
A has the right to sell the U.S. Treasury securities,
and Entity B has the right to sell the ABC securities.
In 60 days, B must return the ABC securities to A and
can redeem the U.S. Treasury securities from A. Entity B
must also pay $30,000 to A as a fee for borrowing the
ABC securities. On June 1, 20X1, the fair values are as follows:
-
ABC securities: $10,000,000.
-
U.S. Treasury securities: $10,500,000.
On June 1, 20X1, A sells the U.S. Treasury securities to
a third party for $10.5 million and incurs a transaction
cost of $25,000. In addition, B sells the ABC securities
for $10 million and incurs a transaction cost of
$25,000. On June 30, 20X1, the fair values are as follows:
-
ABC securities: $10,500,000.
-
U.S. Treasury securities: $10,600,000.
For simplicity, it is assumed that no additional
collateral postings are required for this securities
lending transaction.
On July 31, 20X1, the fair values are as follows:
-
ABC securities: $10,600,000.
-
U.S. Treasury securities: $10,400,000.
Entity A incurs a transaction cost of
$25,000 to repurchase the U.S. Treasury securities, and
B incurs a transaction cost of $25,000 to repurchase the
ABC securities.
Entity A should account for the above
transaction as follows (note that, for simplicity, this
example does not show the periodic accrual of fee income
or expense):
Note that in this example, A sold the U.S. Treasury
securities received as collateral. If A had not sold the
U.S. Treasury securities, it would have recognized them
as an asset and reflected interest income on these
securities.
Entity B should account for the above
securities lending transaction as follows:
Example 5-9
Customer Securities
Loaned to a Third Party
On March 1, 20X2, Entity C, a broker-dealer, executes the
following trades for a customer:
-
DEF stock — 500,000 shares at $20 per share ($10,000,000 total purchase price).
-
XYZ stock — 200,000 shares at $100 per share ($20,000,000 total purchase price).
Of the total $30 million purchase price, $10 million is
purchased on margin. For simplicity, assume that no
commissions are charged on the stock purchase
transactions.
Entity C recognizes the following for
the margin loan made:
On March 15, 20X2, C lends 100,000
shares of XYZ stock to a third party. In return, C
receives cash collateral of $10.5 million. Entity C
should recognize the following entries:
When an entity lends an owned security,
it does not derecognize the security unless the borrower
defaults on the terms of the secured contract.
Similarly, when the security loaned is not owned,
neither a receivable nor an offsetting obligation to
return the security to the customer is recognized.
Example 5-10
Customer Securities
Pledged as Collateral
Entity D, a broker-dealer, maintains
custody of securities for a customer that has an
outstanding margin loan with D. The securities include
U.S. Treasury securities. On May 15, 20X4, D enters into
a securities lending transaction with a third party. In
this transaction, D borrows a publicly traded stock that
has a fair value of $25 million. As collateral, D
pledges U.S. Treasury securities owned by the customer
that have a fair value of $26 million.
Unless D loses control of the pledged
securities, no entry is recognized.
Typically, when an entity borrows
securities in return for pledging noncash collateral,
the borrower does not recognize an entry at inception of
the securities lending arrangement. Similarly, when an
entity pledges a customer’s security as collateral in a
securities lending transaction, no entry is
recognized.
5.4.4 Repurchase Agreement
Example 5-11
Repurchase
Agreement
On June 1, 20X3, Entity A (the transferor) and Entity B
(the transferee) enter into a repurchase agreement that
is accounted for as a secured borrowing. (From A’s
perspective, the transaction represents a repurchase
agreement for which a liability must be recognized. From
B’s perspective, the transaction represents a reverse
repurchase agreement for which an asset is recognized.)
The key terms of the agreement are as follows:
-
Entity A sells an agency MBS with a fair value of $10 million to B in return for $9.6 million of cash.
-
In 120 days, A is required to repurchase the MBS for $9.7 million in cash. (Note that the implied interest cost is $100,000, or approximately 3.125 percent per annum.)
-
If the fair value of the MBS falls below $9.7 million, A is required to post additional collateral.
-
Entity B can sell the MBS. If B sells the MBS, it must return an MBS to A as of the settlement date that is the same or substantially the same as the MBS originally transferred.
Further assume the following:
-
The fair value of the MBS does not change during the term of the repurchase agreement.
-
Entity A invests the $9.6 million in cash received from B in a 5 percent corporate bond. During the 120-day holding period, A earns $200,000, consisting of $160,000 of interest income and a $40,000 gain on sale.
The journal entries A recognizes for this transaction are
shown below. (For simplicity, the entries are shown only
as of the transaction date and settlement date. In
practice, amounts of interest expense and income are
recognized periodically.)
Note the following about the accounting by A:
-
During the term of the repurchase agreement, the balance sheet is effectively “grossed up” because A continues to recognize the MBS pledged as collateral on the repurchase agreement in addition to recognizing the investment it made in the corporate bond from the proceeds on the repurchase agreement.
-
The MBS pledged as collateral was reclassified on the balance sheet to distinguish it from other securities not encumbered. If B did not have the right to sell or repledge the MBS, such reclassification would not be required; ASC 860-30-50-1A(b)(1)(i), however, would require disclosure in that case.
-
Although A has an obligation to repurchase the MBS at the end of the repurchase agreement, it does not recognize a forward contract (i.e., a derivative) for this repurchase because it did not derecognize the MBS that it must repurchase.
-
The interest expense on the repurchase agreement, interest income on the corporate bond, and gain on sale of the corporate bond should be presented and disclosed in accordance with applicable U.S. GAAP.
The journal entries recognized by B for this transaction
are shown below. (For simplicity, the entries are shown
only as of the transaction date and settlement date. In
practice, the interest income earned would be recognized
periodically.)
Note the following about the accounting by B:
-
The MBS was not recognized as an asset.
-
No liability was recognized by B. If B had sold the MBS, it would have recognized an obligation to return the MBS.