4.5 Variable-Rate Demand Notes
Variable-rate demand notes (VRDNs), also called “low floaters” or “seven-day
floaters,” generally are municipal securities that
have long-term stated maturities. However, they
also have certain economic characteristics of
short-term investments, such as their rate-setting
mechanism and their liquidity provisions. These
notes are normally secured by a letter of credit.
The rates on VRDNs are reset periodically (e.g.,
daily, weekly, monthly) through an auction
process. If there is a failed auction, the VRDNs
can be tendered (i.e., put) by the investor for
par plus accrued interest. The counterparty to the
put is typically the third party that provided a
letter of credit. However, in certain cases in
which no letter of credit is involved, the
counterparty may be the original issuer of the
VRDN itself (e.g., a state, municipality, county,
or other governmental entity).
In determining whether VRDNs may be classified as cash equivalents in an
entity’s balance sheet and statement of cash
flows, an entity should consider whether the
instruments are puttable back to the original
issuer (or to the issuer through the issuer’s
agent) within three months throughout the term of
the instrument. An entity should also consider the
creditworthiness of the issuer. In the limited
circumstances in which VRDNs are puttable back to
the original issuer within three months throughout
the term of the instrument and there is no
concern about the issuer’s creditworthiness (e.g.,
in the case of a highly rated state government),
an entity may classify VRDNs as cash
equivalents.
VRDNs that are puttable to parties other than the original issuer (e.g.,
insurer, remarketing agent, bank, dealer, or other
third party) should be accounted for under ASC
815-10-15-6, which states, in part, that a “put or
call option that is added or attached to a debt
instrument by a third party contemporaneously with
or after the issuance of the debt instrument shall
be separately accounted for as a derivative
instrument under this Subtopic by the investor
(that is, by the creditor).”
Therefore, if a VRDN is puttable to a party other than the original issuer, the put option should be accounted for separately from the note in accordance with ASC 815. The note would not be considered a cash equivalent unless it is acquired within three months of its maturity and there is no concern about the issuer’s creditworthiness.