What Was FASB 140? A Historical Accounting Overview

For many years, Financial Accounting Standards Board (FASB) Statement No. 140 governed the accounting for transfers of financial assets. This standard provided a framework for determining when a company could treat the transfer of assets, like mortgage loans, as a sale on its financial statements versus a secured borrowing. This distinction was important, as it dictated whether a company could remove the assets from its balance sheet and recognize a gain or loss. While this standard has since been superseded and is no longer active under U.S. GAAP, its principles offer a historical perspective on the evolution of accounting.

The Core Principle of Control Surrender

At the heart of FASB Statement 140 was the principle of control. The framework for distinguishing between a sale and a secured borrowing hinged on whether the entity transferring the assets—the transferor—had truly surrendered control over them. If the transferor gave up control, the transaction was treated as a sale. If it retained control, the transaction was accounted for as a secured borrowing.

For example, if you sell a car and hand over the keys and title with no strings attached, it is a sale. If the contract allows you to buy the car back for a fixed price, you have not fully relinquished control. The economic substance is more akin to borrowing money with the car as collateral.

FASB 140 applied this logic to complex financial transactions. It forced companies and their auditors to look beyond the legal form of an agreement and analyze the underlying economic reality. The standard recognized that arrangements like repurchase agreements or guarantees could allow a transferor to retain the risks and rewards of ownership, even if the assets were legally transferred.

Conditions for Sale Accounting

To apply the principle of control, FASB 140 established three conditions that had to be met to account for a transfer as a sale. Failure to meet even one of these conditions meant the transaction had to be recorded as a secured borrowing.

Isolation of Transferred Assets

The first condition required that the transferred assets be legally isolated from the transferor. This meant the assets had to be placed “presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.” The objective was to ensure that if the original owner of the assets went bankrupt, its creditors could not seize the assets that had been transferred.

Achieving this legal isolation was not a simple matter of drafting a contract. It often required detailed legal opinions confirming that the transfer would stand up to challenges in a bankruptcy court. The structure had to be robust enough to prevent a court from ordering the consolidation of the special entity’s assets with those of the struggling transferor.

Transferee’s Right to Pledge or Exchange

The second condition focused on the rights of the entity that received the assets, known as the transferee. The transferee had to possess the unrestricted right to pledge or exchange the assets it had received. This meant the transferee must be a free agent, able to sell, finance, or otherwise use the assets without significant constraints imposed by the original transferor.

If the transferor placed limitations on what the transferee could do with the assets, it indicated that the transferor had not fully relinquished its influence. The ability of the transferee to treat the assets as its own, with the full freedom to dispose of them in the open market, was a clear indicator that control had genuinely shifted from one party to another.

Transferor’s Lack of Effective Control

The final condition was a direct test of the transferor’s continuing influence. The transferor could not maintain effective control over the transferred assets through agreements that allowed it to repurchase or redeem them before their maturity. This rule specifically targeted arrangements that would allow the transferor to unilaterally take back the assets, thereby negating the sale.

A common example was a call option or a repurchase agreement that gave the transferor the right to buy back the assets at a fixed price. Such a linked transaction would not represent a true sale because the transferor never lost its connection to the assets. FASB 140 required that any ability for the transferor to reclaim the assets be extinguished for the transaction to qualify for sale accounting.

The Role of Qualifying Special Purpose Entities

A component of applying FASB 140, particularly in securitization, was the Qualifying Special Purpose Entity, or QSPE. A QSPE was a specific type of trust or other legal vehicle created to hold financial assets and issue securities backed by the cash flows from those assets. The concept was created to help companies achieve sale accounting by providing a structure that could satisfy the control-surrender conditions.

To be designated a QSPE, an entity had to meet a stringent set of criteria that rendered it a passive vehicle. Its permitted activities had to be significantly limited and spelled out in the legal documents that created it. For instance, a QSPE could generally only acquire specific assets, issue beneficial interests to investors, collect cash proceeds, and reinvest that cash in short-term instruments pending distribution.

The limitations on a QSPE’s powers were essential. It could not make discretionary decisions or actively manage the assets it held, such as selling underperforming loans to be replaced with new ones. This passive nature ensured the QSPE was not acting as an agent of the transferor, which would imply the transferor still maintained control.

Accounting for Servicing and Liability Extinguishment

Beyond asset transfers, FASB 140 also provided guidance on accounting for servicing rights and extinguishing liabilities. When a company sold financial assets like mortgages but retained the responsibility for servicing them, it had to recognize a “servicing asset” or “servicing liability” on its balance sheet. This represented the fair value of the future income or loss from the servicing contract. The initial value was determined by allocating the previous carrying amount of the assets between the portion sold and the servicing right retained, based on their relative fair values.

The standard also clarified when a company could remove a liability from its balance sheet. FASB 140 stated that a liability was extinguished only if the debtor paid the creditor and was relieved of its obligation, or the debtor was legally released from being the primary obligor. The standard noted that placing assets in a trust to repay a debt did not by itself constitute an extinguishment of the liability.

Supersession and Current Guidance

FASB Statement 140 is no longer the active accounting standard for asset transfers. Its guidance was superseded following the 2008 financial crisis, which exposed weaknesses in the accounting rules for securitizations. A primary criticism was that the QSPE model allowed companies to move risky assets off their balance sheets while retaining significant exposure to them, obscuring the true financial health of the entity.

In response, the FASB issued new standards that eliminated the QSPE concept. The updated guidance was incorporated into the FASB Accounting Standards Codification, primarily in ASC 860, “Transfers and Servicing,” and ASC 810, “Consolidation.” The most significant change was the removal of the QSPE framework. The new model requires a company to determine if it has a controlling financial interest in an entity, which involves evaluating factors like the power to direct the entity’s most significant activities and the obligation to absorb losses or the right to receive benefits.