Some financial institutions originate loans (primarily mortgage loans) and subsequently sell them to third parties (for example, government-sponsored entities that securitize large quantities of similar loan assets). When a financial institution sells the loan to a third party, it sometimes retains the right to service the financial asset. Additionally, entities may acquire or assume the rights to service financial assets.

The entity that services a loan (servicer) performs various services, such as communication with the borrower and collection of interest, principal, and escrow payments. The level of service provided by the servicer depends on the type of loan and contractually specified terms. In exchange for servicing the loan, the servicer receives a contractually specified servicing fee. The servicer also could be compensated for their servicing activities through late fees as well as interest income earned on cash received and held before being remitted to another party (sometimes referred to as float).

In addition, a servicer might engage another entity (sub-servicer) to perform certain servicing tasks based on a contractual agreement. Unless otherwise noted, references to servicing income contemplate both servicing and sub-servicing income.

Paragraph 606-10-15-2(c) contains a scope exception for financial instruments and other contractual rights or obligations within the scope of Topic 860, Transfers and Servicing. Subtopic 860-50 requires that an intangible asset or liability be initially recognized, at fair value, when the expected future servicing cash flows (that is, the benefits of servicing) are in excess of the going market rate for those services (defined as adequate compensation in Topic 860). If the servicing fees over the life of the servicing contract are expected to provide the servicer with more than adequate compensation, then the servicer recognizes an asset; if it is expected to be less than adequate compensation, then the servicer recognizes a liability. These assets or liabilities must be either remeasured at fair value each period or amortized over the course of the servicing contract. If an entity uses the amortization method, it must assess servicing assets or servicing liabilities for impairment or increased obligation at each reporting date. Total expected cash flows (which reflect expectations of collectibility) from the servicing fee are a key input into the measurement of the asset or liability.

Regardless of whether a servicing asset or liability exists (or is measured at zero because the servicing income is equal to adequate compensation), the servicer is entitled to the contractually specified servicing fee each period. The staff’s understanding is that under current practice, servicers generally record servicing income as it is received. In some situations, servicers consider the principles for revenue recognition in SEC Staff Accounting Bulletin (SAB) Topic 13, Revenue Recognition. For example, an entity may consider whether amounts are fixed or determinable and collectibility is reasonably assured before recognizing revenue.

While Topic 860 includes detailed guidance on the initial recognition and subsequent measurement of servicing assets and liabilities, it does not include explicit guidance describing the revenue recognition of contractually specified servicing fees. However, based on the guidance in Topic 860 that requires a fair value estimate (or evaluation of impairment) at each reporting date, some stakeholders noted that the subsequent measurement guidance in Topic 860 provides implicit guidance on how to account for the servicing cash flows; that is, they view the remeasurement of the asset/liability and the collection of servicing fees (which gives rise to recording of the servicing income) as being closely linked. In a typical servicing arrangement, the servicer generally receives and records servicing fees as income each period. During each period, an amortization or remeasurement entry is made for the mortgage servicing right (MSR) asset/liability, which contemplates the receipt (or nonreceipt) of the servicing income for that period. The servicing income, including expectations of future servicing cash flows, are inputs for the measurement of the MSR asset/liability. The net result on the income statement is that the servicer records the contractual cash received in each period as income, offset by the amortization or remeasurement of the MSR asset/liability. Topic 860 describes the subsequent measurement of the MSR asset/liability.

In the staff’s view, servicing arrangements that are within the scope of Topic 860 (which should not change as a result of Topic 606) are not within the scope of Topic 606. The staff acknowledges the different views about what those servicing cash flows represent (revenue versus realization of an intangible asset/liability) and thinks there is merit to the assertion that Topic 860 provides guidance on how to reflect the servicing cash flows via subsequent measurement of the MSR asset/liability. In reaching its view, the staff placed weight on the following factors:

However, in the staff’s view, it would not be concerning if an entity that applies Topic 860 refers to the accounting framework described in Topic 606 to assist with recognition conclusions for servicing income or to provide the disclosures required by Topic 606 to the extent they are applicable and incremental to the disclosure requirements of Topic 860.

The staff also considered other fact patterns raised by stakeholders in the context of this scoping question: