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When guarantees are embedded in other contracts, a reporting entity should assess whether the guarantee affects the accounting for that contract. For example, revenue recognition could be impacted in some situations. See RR 4.3.3.9 for more information.

2.8.1 Guarantee’s effect on the sale of a business

It is common for a business combination to include various indemnification agreements which may meet the definition of a guarantee in ASC 460. For instance, when a seller indemnifies the acquirer from past foreign tax exposure exceeding a specified threshold, the indemnification is typically a guarantee within the scope of ASC 460. See TX 15 for further information on tax-related indemnifications. See BCG 2 for further information on indemnifications arising in a business combination.
When a reporting entity (i.e., the seller) accounts for an indemnification established by the terms of the sale of a business as a guarantee, the seller should record the guarantee liability as of the sale date. If a reporting entity recognizes a guarantee liability in connection with the sale of a business, it is asserting that its noncontingent obligation has a fair value greater than zero at the date of the sale. Such a guarantee recorded in connection with the sale of a business will affect the seller’s gain or loss on the sale.
A reporting entity should also consider the likelihood of having to return any sales proceeds for violations of the representations and warranties not included in the scope of ASC 460. Absent evidence to the contrary, general representations and warranties provided as a part of the sale of a business are assumed to be valid as of the sale date, and release of the consideration from escrow is expected at the end of the escrow period. Therefore, in most cases, the amounts held in escrow for general representations and warranties would be considered part of the consideration received for the sale of the business and included in determining the gain or loss on sale.
Example FG 2-5 illustrates the effect of escrow arrangements on the accounting for the sale of a business.
EXAMPLE FG 2-5
Effect of escrowed proceeds on accounting for the sale of a business
LCD Corp sells its subsidiary, Subsidiary Inc, to FG Corp for cash proceeds of $10 million. One million of the proceeds is put into an escrow account to be used to compensate FG Corp for any violations of the general representations and warranties listed in the purchase agreement. LCD Corp is not aware of any potential claims that may exist and has determined that the probability of a violation is insignificant (i.e., it considers the fair value of the noncontingent guarantee to be approximately zero). Barring any violations, the escrowed proceeds will be distributed to LCD Corp one year after the date of the sale.
How should LCD Corp account for the $1 million of sales proceeds put into escrow?
Analysis
LCD Corp should recognize the $1 million of escrowed proceeds as part of the proceeds from the sale of Subsidiary Inc on the date of sale because it has determined the probability of a violation is insignificant. LCD Corp should use the entire sales price of $10 million (which includes the $1 million in escrow) to calculate its gain or loss on the sale of Subsidiary Inc.

2.8.2 Guarantee’s effect on accounting for financial asset transfers

A reporting entity may enter into a transaction to transfer a financial asset, a group of financial assets, or a participating interest in a financial asset. Transfers of financial assets may be accounted for by the transferor as sales or a secured borrowing. Whether a transfer of financial assets is accounted for as a sale or a secured borrowing depends on whether the transferor has relinquished control and the transferee has obtained control over the financial assets.
In assessing whether control has been transferred to the transferee, a reporting entity must consider whether the transferred financial assets have been isolated beyond the reach of the transferor, which requires assessing the continuing involvement of the transferor, if any. It is not unusual for a transferor to have continuing involvement in the form of a credit enhancement. This credit enhancement could be through a financial guarantee or retaining subordinated interests in assets sold to third parties. Having continuing involvement does not necessarily preclude a transferor from achieving sale accounting.
If a transfer of financial assets qualifies for sale accounting and the transferor provides a guarantee, it should be assessed under the guidance in ASC 460. A guarantee recorded in connection with the transfer of financial assets will affect the transferor’s gain or loss on the sale. As discussed in FG 2.3, providing subordination does not qualify as a guarantee under ASC 460 if the transferor is not required to make a payment. However, if the transferor is required to make a payment to the transferee, then the arrangement may qualify as a guarantee under ASC 460.
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