When is a sale of financial assets and liabilities really a sale?
A transfer of financial assets occurs when the transferor has surrendered control of the asset and has received consideration other than beneficial interests.
FASC 860-10-40-5 states that a transferor has surrendered control or sold an asset if and only if the following conditions are met:
1. The transferred assets have been isolated from the transferor and have presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.
All available evidence should be considered when determining if the assets have been isolated. For example whether the contract or circumstances permit the transferor to revoke the transfer, the kind of bankruptcy or other receivership into which a transferor or special-purpose entity might be placed or whether the transferor is affiliated with the transferee.
2. The transferee has the right to pledge or exchange the assets and thus obtain all or most of the cash inflows that are the primary economic benefits of financial assets.
The contract should not contain any conditions that both constrains the transferee (or holder) from taking advantage of its rights to pledge or exchange the assets and provides more than a trivial benefit to the transferor. For example: A provision in the transfer contract that prohibits selling or pledging a transferred loan receivable, allowing a transferee to pledge only on the day assets are obtained or only on terms agreed on with the transferor would take away the transferee’s right to pledge or exchange the assets.
On the other hand, a transferor's right of first refusal, requirement to obtain the transferor's permission, a prohibition on sale to the transferor's competitor if other potential willing buyers exist, a regulatory limitation or illiquidity in the absence of an active market would not remove the transferee’s right to pledge or exchange the assets.
3. The transferor does not maintain effective control over the transferred assets.
A transferor maintains effective control if the transfer agreement entitles and obligates the transferor to repurchase or redeem the assets before their maturity or has the ability to unilaterally cause the holder to return specific assets.
If the conditions in FASC 860-20-25 are met, then under this guidance an entity will recognize all assets obtained and liabilities incurred in consideration as proceeds of the sale. This consideration might include cash, put or call options held or written, forward commitments, swaps or servicing assets and servicing liabilities. Any gain or loss on the sale should be recognized in earnings.
If the transfer does not meet the above conditions, then many, many more rules apply. See FASC 860 for more guidance. Happy selling.
Linda is a CPA living in Southwestern Ohio, working as a research accountant for an investor-owned publicly traded utility company. She specializes in implementing new FASB and SEC requirements and FAS 133 derivative issues. In her role at the utility she has encountered many issues and written many memos, so send in your implementation and derivative issues and Linda will help figure out an answer.