ASC 860: Transfers and Servicing of Financial Assets

The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) 860 provides the guidelines for transfers of financial assets. The primary objective is to establish criteria for determining whether a transfer is a sale or a secured borrowing. This distinction dictates if the assets are removed from the transferor’s balance sheet or remain as collateral for a loan. The guidance uses a “financial components approach,” where a transfer is a sale only when the transferor has surrendered control over the asset. If control is not relinquished, the transaction is accounted for as a secured borrowing.

Determining a Sale vs a Secured Borrowing

ASC 860-10-40 outlines three conditions that must all be met for a transaction to be accounted for as a sale. The first condition is the legal isolation of the transferred assets from the transferor. This means the assets must be placed beyond the reach of the transferor and its creditors, even in bankruptcy, and the structure must provide assurance that the assets would not be consolidated with the transferor’s assets in a receivership. For example, transferring a loan portfolio to a separate, bankruptcy-remote entity likely meets this condition.

A second condition is that the transferee must have the right to pledge or exchange the assets. The transferee should be able to realize the economic benefits of the assets by selling them or using them as collateral for its own borrowings. For instance, if the transferee can only sell the assets back to the transferor, its rights are significantly limited.

The final condition is that the transferor does not maintain effective control over the transferred assets. Effective control can be maintained through agreements that allow or obligate the transferor to repurchase the assets before their maturity. A common example is a repurchase agreement, or “repo,” where the transferor agrees to buy back the assets at a fixed price at a future date.

Accounting for Transfers Qualifying as Sales

When a transfer of financial assets qualifies as a sale, the accounting involves derecognizing the assets and measuring the transaction’s components. The primary impact is the removal of the transferred assets from the transferor’s balance sheet, and any gain or loss on the sale is recognized. The gain or loss is calculated by comparing the carrying amount of the assets sold with the proceeds received.

The proceeds can consist of various components, including cash, other assets received, and any liabilities undertaken. For instance, if a company sells a loan portfolio with a carrying value of $1 million for $1.05 million in cash, it would recognize a gain of $50,000. The journal entry would involve debiting cash for $1.05 million, crediting the loan portfolio for $1 million, and crediting a gain on sale for $50,000.

The transferor might also retain an interest in the transferred assets, such as a portion of future cash flows, which are part of the proceeds and measured at fair value. Similarly, a servicing asset or liability created from the agreement must also be measured at fair value. For example, a company sells receivables with a carrying value of $500,000, receiving $480,000 in cash and a retained interest valued at $30,000. The total proceeds are $510,000, resulting in a $10,000 gain on the sale.

Accounting for Transfers as Secured Borrowings

When a transfer of financial assets does not meet the criteria for a sale, it is treated as a secured borrowing. The assets remain on the transferor’s balance sheet, and no gain or loss is recognized at the time of the transfer. The proceeds received from the transferee are recorded as a liability.

For example, a company transfers $200,000 of investment securities for $190,000 in cash in a transaction that does not qualify as a sale. The company would debit cash for $190,000 and credit a liability, such as “notes payable,” for the same amount. The securities would remain on the balance sheet but might be reclassified as “securities pledged as collateral” for transparency.

Interest on the borrowing is accrued over the life of the agreement and recognized as interest expense. Any payments made to the transferee reduce the liability.

Servicing Assets and Liabilities

Servicing assets and liabilities arise from contracts to service financial assets, where a servicer collects payments and manages accounts for a fee. When a company retains or acquires servicing rights, it must recognize a servicing asset or liability. A servicing asset exists if fees are expected to be more than adequate compensation for the work; a liability exists if fees are expected to be less than the cost.

Initially, servicing assets and liabilities are measured at fair value. This fair value is often determined using discounted cash flow models that consider expected future servicing fees, servicing costs, and other relevant factors. For subsequent measurement, the guidance provides two options: the amortization method or the fair value measurement method.

Under the amortization method, the servicing asset or liability is amortized in proportion to the estimated net servicing income or loss. The asset is also assessed for impairment at each reporting date.

The fair value measurement method involves remeasuring the servicing asset or liability to its fair value at each reporting date, with changes reported in earnings. This method provides a more current valuation but can lead to more volatility in reported earnings. The choice between the two methods is made on a class-by-class basis and must be applied consistently.

Required Disclosures

Disclosure requirements offer insight into the nature of transfers, any continuing involvement with the transferred assets, and the associated risks. Entities must disclose information about their securitization or asset-backed financing arrangements. This includes a description of the entity’s role in the transaction and the risks it retains, such as credit, interest rate, or liquidity risk.

For transfers accounted for as sales with continuing involvement, specific quantitative information is required. This includes the carrying amount and fair value of any retained interests and the key assumptions used in measuring the fair value. For secured borrowings, the entity must disclose the carrying amount of the transferred assets and the associated liabilities.

Disclosures for servicing assets and liabilities must include the amount recognized and amortized during the period. Entities must also provide a description of the valuation methods and key assumptions used to measure the fair value of these items. If the amortization method is used, the entity must disclose the activity in the valuation allowance for impairment of servicing assets.