United States

Audit and Enterprise Risk Services

Effect of ASUs 2009-16 and 2009-17 on Presentation of Trade Receivable Financing Arrangements in the Statement of Cash Flows

Financial Reporting Alert 10-7

Updated May 12, 2010 (Originally released April 30, 2010)

We have recently become aware of a number of questions about how ASU 2009-16¹ and ASU 2009-17² will affect the presentation of trade receivable financing arrangements in the statement of cash flows. This alert addresses these questions.

Background

ASUs 2009-16 and 2009-17 amended the guidance in ASC 860 and ASC 810,³ respectively. Among other changes, ASU 2009-16 eliminated the concept of a qualifying special-purpose entity (QSPE) and amended the guidance pertaining to the unit of accounting for transfers of financial assets. ASU 2009-17 amended the guidance on consolidation of variable interest entities (VIEs) by requiring entities to assess consolidation on the basis of control over the VIE’s activities as opposed to a consolidation framework based on the assessment of risks and rewards. ASU 2009-17 also eliminated the exception from consolidation that applied to QSPEs.

The amendments in ASUs 2009-16 and 2009-17 will significantly affect the accounting for special-purpose financing entities, including those created to facilitate trade receivables financing. Application of the derecognition guidance in ASU 2009-16 and the consolidation guidance in ASU 2009-17 is often complex and depends on the particular facts and circumstances governing the form and substance of each trade receivable financing arrangement. In many cases, the new guidance will affect the recognition and presentation of trade receivable financing arrangements on the transferring entity’s financial statements. However, this alert only addresses certain matters related to the statement of cash flows.

Overview of Transaction Types

Although the terms and conditions of every trade receivable financing arrangement differ, two types of such arrangements prevail in practice. They can be summarized as follows:

1.   Financing arrangements that involve a transfer of an entire group of trade receivables (referred to herein as “Financing Arrangement 1”) — In a typical transaction, an entity periodically transfers an entire group of trade receivables to a consolidated bankruptcy-remote special-purpose entity (BRSPE), which then transfers the entire group of trade receivables to another special-purpose financing entity that issues commercial paper to finance the acquired receivables (the “CP SPE”). The transferring entity receives, for each transfer, cash and a junior beneficial interest issued by the CP SPE (the junior beneficial interest is often referred to as a “deferred purchase price” or DPP). The DPP is generally exposed to the first risk of loss on the transferred trade receivables that arises from credit risk and, in some cases, to interest rate risk on the CP SPE’s financing activities. The DPP is not held for sale by the transferring entity but is held for collection.

2.   Financing arrangements that involve a transfer of portions of an entire group of trade receivables (referred to herein as “Financing Arrangement 2”) — In a typical transaction, an entity periodically transfers an entire group of trade receivables to a consolidated BRSPE, which then transfers senior undivided interests in those trade receivables to a CP SPE. The transferring entity retains a junior undivided interest in the trade receivables held by the BRSPE. The junior undivided interest retained is generally exposed to the first risk of loss on the transferred trade receivables that arises from credit risk and, in some cases, to interest rate risk on the CP SPE’s financing activities. 

These two types of arrangements can be distinguished primarily by the way an entity determines the unit of accounting of the financial asset that is transferred from the BRSPE to the CP SPE.⁴ ASC 860-10-40-4A (as amended by ASU 2009-16) states that the legal form of the transferred financial asset, along with what it conveys to its holders, governs whether the transferred financial asset is an entire financial asset (or an entire group of financial assets) or a portion of an entire financial asset (or portions of an entire group of financial assets). Determining the unit of accounting for the transferred financial asset(s) is critically important because of the impact this conclusion has on the application of the derecognition guidance in ASU 2009-16 and the consolidation guidance in ASU 2009-17. Under ASC 860 (as amended by ASU 2009-16), the determination of whether sale accounting has been achieved depends, in part, simply on whether a transferor has transferred (1) an entire financial asset (or an entire group of financial assets) or (2) a portion of an entire financial asset (or portions of an entire group of financial assets).

In accordance with ASC 860 (as amended by ASU 2009-16), the transferring entity must first assess whether it is required to consolidate the CP SPE under ASC 810 (as amended by ASU 2009-17). If the transferring entity is required to consolidate the CP SPE, it will not qualify for sale accounting under ASC 860 (as amended by ASU 2009-16). If the transferring entity is not required to consolidate the CP SPE, it should assess whether the transfer meets the conditions for sale accounting in ASC 860 (as amended by ASU 2009-16).

The discussion below of statement of cash flows presentations is based on the unit of accounting of the transferred financial asset and whether the CP SPE is consolidated by the transferring entity upon adoption of ASU 2009-17. The facts in the scenarios are typical of those encountered in practice, and in each example the transferring entity reflected the transfers as sales under ASC 860 and did not consolidate the CP SPE before adopting ASU 2009-16 and ASU 2009-17. Although other situations could exist, they are not discussed herein.

Statement of Cash Flows Presentation When Consolidation of the CP SPE Is Not Required Upon Adoption of ASU 2009-17

Presentation Under Financing Arrangement 1

When an entity transfers an entire group of trade receivables to a nonconsolidated CP SPE (i.e., Financing Arrangement 1), and those transfers meet the conditions for sale accounting under ASC 860 (as amended by ASU 2009-16), it should present cash flows between the transferring entity and the CP SPE in the statement of cash flows as follows:

·       Cash received from sales of trade receivables to the CP SPE represents an operating activity in accordance with ASC 230-10-45-16(a). The DPP received upon sales of trade receivables to the CP SPE represents a noncash transaction that is disclosed in accordance with ASC 230-10-50-3 through 50-6.

·       Cash received from collections on the DPP represents an investing or an operating activity. The transferring entity will account for the DPP as a debt security or a receivable held for investment (or held for collection). A DPP is accounted for as a receivable if it is not certificated and does not have to be accounted for as a debt security under ASC 860-20-35-2. Typically, cash collections on an available-for-sale security represent an investing activity in accordance with ASC 230-10-45-11. Cash collections on a trading security that was not acquired specifically for resale also typically represent an investing activity in accordance with ASC 230-10-45-19. Cash collections on a trade receivable are typically classified as an operating activity. However, because of the nature of the DPP, the cash received from collections on the DPP may be classified as either operating or investing cash flows, on the basis of an accounting policy election made by the entity, regardless of whether the DPP is accounted for as a security or a receivable. Regardless of the cash flow statement classification, entities should present the cash flow activity on the DPP as a separate line item in the statement of cash flows and should disclose the accounting policy applied.

Presentation Under Financing Arrangement 2

When an entity transfers portions of an entire group of trade receivables to a nonconsolidated CP SPE (i.e., Financing Arrangement 2), it will not meet the conditions for sale accounting under ASU 2009-16 because the transferred portion does not meet the definition of a participating interest.⁵ Even though the CP SPE is not consolidated by the transferring entity, such transfers must be accounted for as a secured borrowing after the effective date of ASU 2009-16. The provisions of ASU 2009-16 must be applied prospectively to transfers that occur on or after the effective date of ASU 2009-16 (i.e., January 1, 2010, for a calendar-year company). Under this transition guidance, the historical accounting for these types of transfers is not affected (i.e., the portion of the trade receivables previously transferred that were historically reflected as derecognized financial assets for accounting purposes will continue to be reflected as such). After the effective date of ASU 2009-16, the entity will reflect these transfers as a secured borrowing (i.e., the portion of the trade receivables transferred will remain on the balance sheet of the transferring entity, and a liability will be recognized for the cash proceeds received upon transfer). Recognition of the adoption of ASU 2009-16 retrospectively, or as a cumulative effect of a change in accounting principle, is prohibited.

While the adoption of ASU 2009-16 will not affect previously reported amounts in the statement of cash flows, it will change the presentation on and after the effective date. The following presentation will be required after adoption of ASU 2009-16:

·       Cash received from the CP SPE upon transfers of senior undivided interests (which is reflected on the balance sheet as a secured borrowing) represents a financing activity in accordance with ASC 230-10-45-14(b).

·       Cash paid to the CP SPE to reflect the repayment of the principal amount of the senior undivided interests (i.e., the secured borrowing) represents a financing activity in accordance with ASC 230-10-45-15(b). This financing cash outflow can be netted with the financial cash inflow (discussed above) only if the requirements in ASC 230-10-45-7 through 45-9 are met.

·       Cash paid as interest on the senior undivided interests (i.e., the secured borrowing) represents an operating activity in accordance with ASC 230-10-45-17(d).

·       Cash received from customers upon payment of the trade receivables represents an operating activity in accordance with ASC 230-10-45-16(a).

Application of the amended guidance in ASC 860 will uniquely affect the statement of cash flows of the transferring entity during the period(s) between (1) the initial adoption date of ASU 2009-16 and (2) the date that full collection on receivables transferred before the adoption of ASU 2009-16 has occurred. During this period, the transferring entity will generally reflect a reduced amount of operating cash inflows from trade receivables. This phenomenon occurs because after adoption of ASU 2009-16, operating cash inflows are reflected only upon collection of trade receivables; before adoption of ASU 2009-16, operating cash flows were reflected upon transfers of senior undivided interests to the CP SPE. A timing difference will occur because cash received from collections on previously sold trade receivables will not be reflected as an operating cash inflow. Only cash received from collections on trade receivables transferred to the CP SPE after the adoption of ASU 2009-16 will be reflected as an operating cash inflow. In addition, in periods after adoption of ASU 2009-16, financing cash inflows and outflows will be reported that were not reported previously. For example, the establishment of a secured borrowing for the undivided senior interests transferred after the effective date of ASU 2009-16 will be reflected as a financing cash inflow.⁶ Entities should be cognizant of the requirements in SEC Regulations S-K and S-X to disclose significant transactions and items that may have a material impact on reported results or that have a material impact on the trends of reported information. 

Statement of Cash Flows Presentation When Consolidation of the CP SPE Is Required Upon Adoption of ASU 2009-17

Presentation Under Financing Arrangement 1

When an entire group of trade receivables is transferred to the CP SPE (i.e., Financing Arrangement 1), the transferring entity may conclude that it is required to consolidate the CP SPE upon adoption of ASU 2009-17. Under ASC 810-10-65-2, the entity can choose one of two transition methods to reflect this consolidation: (1) the change-in-accounting-principle method or (2) the retrospective method. The impact of each method on the statement of cash flows is addressed below.

1.     Change-in-accounting-principle method — Under this transition method, the entity must reflect the initial consolidation of the CP SPE as a cumulative effect of a change in accounting principle. As long as there is no unrestricted cash in the CP SPE, this cumulative-effect adjustment will not affect operating, investing, or financing activities in the statement of cash flows in the period recorded, but it should be disclosed as a noncash transaction in accordance with ASC 230-10-50-3 through 50-6. After initial consolidation, cash flows related to the trade receivable financing arrangement should be presented as follows:⁷ 

·       Cash received upon the CP SPE’s issuance of commercial paper will represent a financing activity in accordance with ASC 230-10-45-14(b).

·       Cash paid on principal amounts due to the third-party beneficial interest holders in the CP SPE (i.e., on the commercial paper) represents a financing activity in accordance with ASC 230-10-45-15(b). This financing cash outflow can be presented on a net basis with the financing cash inflow (discussed above) only if the requirements in ASC 230-10-45-7 through 45-9 are met.

·       Cash paid as interest on the commercial paper issued by the CP SPE represents an operating activity in accordance with ASC 230-10-45-17(d).

·       Cash received from customers upon payment of the trade receivables represents an operating activity in accordance with ASC 230-10-45-16(a).

2.     Retrospective method — Under this transition method, the entity must retrospectively reflect consolidation of the CP SPE in its historical financial statements. This will involve adjusting the historical statements of cash flows. The amounts should be adjusted retrospectively to reflect the presentations listed above for the change-in-accounting-principle method.

Note that although the presentation requirements for cash flows occurring after the effective date of ASU 2009-17 are similar under the two transition methods, the method adopted will affect the amounts reported on the entity’s statement of cash flows after the effective date of ASU 2009-17. First, under the change-in-accounting-principle method, collections on trade receivables previously considered sold before the adoption of ASU 2009-17 will be reflected as an operating cash inflow even though an operating cash inflow has already been reflected on those same trade receivables in periods before adoption of ASU 2009-17. Second, a financing cash outflow will be reflected upon repayment of the principal amount of the third-party beneficial interests in the CP SPE even though a financing cash inflow on the issuance of these third-party beneficial interests was not previously reflected. Entities should be cognizant of the requirements in SEC Regulations S-K and S-X to disclose significant transactions and items that may have a material impact on reported results or that have a material effect on the trends of reported information. 

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1   FASB Accounting Standards Update No. 2009-16, Accounting for Transfers of Financial Assets (originally issued as FASB Statement No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140).

2   FASB Accounting Standards Update No. 2009-17, Improvements to Financial Reporting by Enterprises Involved With Variable Interest Entities (originally issued as FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R)).

3   For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s "Titles of Topics and Subtopics in the FASB Accounting Standards Codification."

4   Financing Arrangements 1 and 2 contain BRSPEs that are used for legal isolation purposes. The BRSPE is consolidated by the transferring entity. Its existence does not affect the determination of the unit of accounting for the financial asset transferred to the CP SPE.

5   Under ASC 860-10-40-6A, only a transfer of a proportionate (pro rata) ownership interest in an entire financial asset satisfies the definition of a participating interest. A transfer of a senior undivided interest in trade receivables does not meet this requirement because the retained junior undivided interest held by the transferor is subject to the first risk of loss due to credit risk on the trade receivables and, in some cases, to interest rate risk. The financial asset transferred from the BRSPE to the CP SPE in Financing Arrangement 2 does not reflect a proportionate (pro rata) ownership interest as described in the “Overview of Transaction Types.”

6   In the absence of the adoption of ASU 2009-16, these cash flows would have been reflected as operating activities. This difference reflects the unique accounting outcome of the transition provisions of ASU 2009-16.

7   Before consolidation of the CP SPE, the transferring entity generally only reflected cash flows upon (1) transfers of the trade receivables to the CP SPE and (2) collection of cash on any retained interests