7.10 Classification of Cash Flows for Repurchase Agreements and Reverse Repurchase Agreements
The ASC master glossary defines a “repurchase agreement” and “reverse repurchase agreement,” in part,
as follows:
- Repurchase agreement — An “agreement under which the transferor (repo party) transfers a financial asset to a transferee (repo counterparty or reverse party) in exchange for cash and concurrently agrees to reacquire that financial asset at a future date for an amount equal to the cash exchanged plus or minus a stipulated interest factor.”
- Reverse repurchase agreement accounted for as a collateralized borrowing — A “transaction that is accounted for as a collateralized lending in which a buyer-lender buys securities with an agreement to resell them to the seller-borrower at a stated price plus interest at a specified date or in specified circumstances.”
Most repurchase and reverse repurchase agreements are accounted for as secured borrowing and lending arrangements under ASC 860 because the transferor usually has retained effective control over the transferred securities. Because a repurchase agreement represents a collateralized borrowing (for the cash recipient) and a reverse repurchase agreement represents a collateralized lending (for the transferee of the security), the related cash flows should be classified as financing and investing activities, respectively.
On the basis of discussions with the FASB staff, another acceptable method for determining the appropriate classification of the cash flows related to repurchase and reverse repurchase agreements is to evaluate the specific facts and circumstances and the reasons for entering into each agreement to determine its nature and the entity’s intent. As a result, both repurchase agreements and reverse repurchase agreements could be classified in the same section of the statement of cash flows (i.e., operating, investing, or financing). For example:
- It is acceptable to classify the cash flows related to repurchase agreements
and reverse repurchase agreements as operating activities if the
transactions are entered into in connection with the entity’s principal
activities (e.g., broker-dealers or other entities with similar operations).
Such classification is further supported by a note in Exhibit 6-7 of the
AICPA Audit and Accounting Guide Brokers and Dealers in Securities,
which states:Depending on the nature of the activity, securities purchased under agreements to resell can be classified as operating or investing; likewise, securities sold under agreements to repurchase can be classified as operating or financing.
- It is acceptable to classify cash flows related to both repurchase agreements and reverse repurchase agreements as investing cash flows when the primary intent of entering into the transactions is to increase the return on an entity’s investment portfolio. For example, an entity may enter into a repurchase agreement to reinvest the cash proceeds in another investment because the entity believes it can earn a higher return than the spread on the repurchase side of the repurchase agreement. Therefore, even though funds were essentially a secured borrowing in the first leg of the repurchase agreement, the business purpose and substance of the transaction were to generate a higher yield on the investment portfolio and, accordingly, “both legs” could be classified as an investing activity.
- It is acceptable to classify the cash flows related to both repurchase agreements and reverse repurchase agreements as financing activities if the primary purpose of the arrangement is to provide funds to finance operations or raise working capital.