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When a transfer qualifies for sale accounting, the transferor should derecognize the transferred assets, record all assets received and liabilities assumed, and recognize any resulting gain or loss on the transfer. ASC 860 provides guidance on a transferor’s accounting for the sale of a participating interest and the sale of an entire or group of entire financial assets.

ASC 860-20-40-1A

Upon completion of a transfer of a participating interest that satisfies the conditions in paragraph 860-10-40-5 to be accounted for as a sale, the transferor (seller) shall:
  1. Allocate the previous carrying amount of the entire financial asset between both of the following on the basis of their relative fair values at the date of the transfer:
    1. The participating interest(s) sold
    2. The participating interest that continues to be held by the transferor
  2. Derecognize the participating interest(s) sold
  3. Apply the guidance in paragraphs 860-20-25-1 and 860-20-30-1 on recognition and measurement of assets obtained and liabilities incurred in the sale
  4. Recognize in earnings any gain or loss on the sale
  5. Report any participating interest(s) that continue to be held by the transferor as the difference between the following amounts measured at the date of the transfer:
    1. The previous carrying amount of the entire financial asset
    2. The amount derecognized.

ASC 860-20-40-1B

Upon completion of a transfer of an entire financial asset or a group of entire financial assets that satisfies the conditions in paragraph 860-10-40-5 to be accounted for as a sale, the transferor (seller) shall:
  1. Derecognize the transferred financial assets
  2. Apply the guidance in paragraphs 860-20-25-1 and 860-20-30-1 on recognition and measurement of assets obtained and liabilities incurred in the sale
  3. Recognize in earnings any gain or loss on the sale
If the transferred financial asset was accounted for under Topic 320 as available for sale before the transfer, item (a) requires that the amount in other comprehensive income be recognized in earnings at the date of transfer.

Regardless of whether a transfer involves a participating interest or an entire financial asset, the derecognition guidance in ASC 860 may be viewed as three steps:
  • Determine the recorded amounts of the transferred item to be derecognized
  • Identify, measure, and record all proceeds from the transfer (i.e., all assets obtained and liabilities incurred) at fair value
  • Measure and recognize any resulting gain or loss on the transfer
The remainder of this chapter discusses the application of these steps, supplemented by illustrative examples. For presentation in the statement of cash flows, see FSP 6.7.4.
Question TS 4-1 discusses the appropriate timing of recording a transfer transaction.
Question TS 4-1
At what point in a transfer of financial assets that qualifies for sale accounting should a transaction be recorded?
PwC response
As a general rule, most transfers of financial assets are recorded at the settlement date. The settlement date is the date on which consideration is legally exchanged between the transacting parties. Said differently, it is the point in time at which all rights in and title to the underlying asset (or an interest in that asset) are conveyed to the transferee and the transferor receives corresponding consideration. However, ASC 860-20-25-2 clarifies that the recognition guidance in ASC 860-20 does not modify other GAAP (e.g., that applicable to investment companies and broker-dealers) that requires trade date accounting.

4.2.1 Determining the carrying amount of a transferred item

Whether a transfer involves the derecognition of a participating interest or of an entire financial asset, the transferor must first determine the transferred asset’s carrying amount. If the transfer involves a participating interest, ASC 860-20-40-1A(a) requires the transferor to allocate the previous carrying amount of the underlying entire financial asset between the interest sold and portion retained, based on their relative fair values at the transfer date.
Question TS 4-2 discusses the term “carrying amount” in the context of ASC 860 sale accounting.
Question TS 4-2
What is the “carrying amount” in the context of ASC 860’s sale accounting model? When derecognition involves a participating interest, what should the transferor consider when allocating the underlying asset’s carrying amount between the interest sold and the interest retained?
PwC response
The carrying amount of a financial asset consists of its recorded investment (amortized cost adjusted for any fair value-related measurements, including those recognized in OCI) and allowances for credit losses and lower-of-cost-or-market adjustments.
ASC 860 states that the transferor should allocate the carrying amount of the underlying financial asset between the interest sold and portion retained based on the relative fair value of the two items at the transfer date. However, in certain instances, it may be appropriate to allocate the underlying financial asset’s carrying amount based on each participating interest holder’s relative ownership interest as the relative fair value of each interest should presumably equal or closely approximate its proportionate, pari passu ownership interest (an essential characteristic of a participating interest). This approach will not be appropriate in all cases, however. For example, if a participating interest’s transferee is the sole beneficiary of a third-party guarantee, an allocation based solely on each interest’s percentage ownership would be inappropriate, as only the transferred interest has credit enhancement. Additional analysis will be required in instances like these to establish the fair values of the guaranteed transferred interest and the unguaranteed interest retained by the transferor on a standalone basis.

4.2.2 Transaction costs in transfers that qualify as sales

As discussed in ASC 860-20-35-10, transaction costs incurred in connection with a sale are not an asset, and thus should be included in the measurement of the transfer’s gain or loss on sale. However, a potential exception to this rule involves transaction costs incurred in connection with revolving securitization structures, when receivables will be transferred over a period of time. In those instances, ASC 860-20-35-10 allows transaction costs to be deferred and amortized in a rational and systematic manner over the reinvestment period (the period deemed to benefit from costs incurred at inception) unless the transactions result in a loss.
Although ASC 860 does not define “transaction costs,” we believe they should be limited to amounts paid to external parties that clearly relate to the transaction in question. These costs may include legal, accounting and consulting fees, underwriter and rating agency fees, and other service provider-related expenses (e.g., costs to print offering materials).

4.2.3 Gain or loss recognition on transfers that qualify as a sale

As discussed in ASC 860-20-25-6, it is not appropriate for a transferor to defer any portion of a gain or loss resulting from a sale of a financial asset (or otherwise fail to observe gain-on-sale accounting, as it is sometimes described in practice), measured in accordance with ASC 860.

4.2.4 Sale accounting examples–cash proceeds

Example TS 4-1 and Example TS 4-2 illustrate how the derecognition accounting model is applied to a transfer of a participating interest and to a transfer of an entire asset that in each instance meets the requirements in ASC 860-10-40-5 for sale accounting. In these examples, the transferor receives only cash consideration; see Example TS 4-3 and Example TS 4-4 for an illustration of the accounting when the transferor receives other forms of sale proceeds.
EXAMPLE TS 4-1
Sale of a participating interest
Transferor Corp transfers a participation in a $100 loan to Transferee Inc for a cash purchase price of $55. The participation entitles Transferee Inc t0 50% of the loan’s cash flows. The loan’s carrying amount is $98, which includes deferred origination fees that Transferor Corp has been amortizing. The transfer of the loan qualifies for derecognition.
Transferor Corp concludes that the fair value of its retained portion of the loan (a 50% interest) closely approximates the exchange price of the portion sold to Transferee Inc ($55).
Since the fair value of both the participating interest sold and the portion retained by Transferor Corp is $55, the implied fair value of the entire loan is $110.
How should Transferor Corp record the sale of the participating interest?
Analysis
Transferor Corp would first allocate the carrying amount of the underlying loan between the participating interests sold and retained, based on their relative fair values.
Fair value
Percentage of total fair value
Allocated carrying value
Participating interest sold
$55
50%
$49
Participating interest retained
55
50%
49
Total
$110
100%
$98
Transferor Corp would record the following journal entry to derecognize the transferred participating interest at the transfer date.
Dr. Cash
$55
Dr. Deferred loan fees
$1
Cr. Loan
$50
Cr. Gain on sale
$6
Since the participation interest retained by Transferor Corp is not considered proceeds of the sale, its allocated carrying amount ($49) may not be remeasured to its implied fair value of $55 in connection with the transaction.
EXAMPLE TS 4-2
Sale of an entire financial asset
Transferor Corp transfers an entire $100 loan to Transferee Inc for a cash purchase price of $55 and a beneficial interest in the transferred loan that entitles Transferor Corp to 50% of the transferred loan’s cash flows. The beneficial interest has a fair value of $55. The loan’s carrying amount is $98, which includes deferred origination fees that Transferor Corp has been amortizing. The transfer of the loan qualifies for derecognition.
How should Transferor Corp record the sale of the loan?
Analysis
In accordance with the guidance in ASC 860-20-40-1B, Transferor Corp would derecognize the entire carrying amount of the transferred loan and recognize the consideration received at fair value by recording the following journal entry at the transfer date.
Dr. Cash
$55
Dr. Beneficial interest in loan
$55
Dr. Deferred loan fees
$2
Cr. Loan
$100
Cr. Gain on sale
$12

The transferor (Transferor Corp) in Example TS 4-1 and Example TS 4-2 is in the same economic position after the transfer (i.e., it has received $55 of cash and has a 50% interest in the loan’s subsequent cash flows). Nevertheless, the gain on the sale of the participating interest in Example TS 4-1 is less than the gain that would be reported upon the transfer of the entire loan in Example TS 4-2. This difference is the result of not remeasuring the carrying amount of the participating interest retained by a transferor under the participating interest derecognition rules because the retained interest is not considered proceeds of the sale. Its carrying amount is determined based on the relative fair value allocation calculation illustrated in Example TS 4-1. However, if the financial asset was previously carried at fair value with unrealized gains and losses included in earnings that measurement convention would continue to apply to the retained participating interest.
In contrast, when an entire financial asset is transferred and qualifies for sale accounting, no allocation of carrying amounts between the portion sold and retained is necessary; the entirety of the carrying amount associated with the transferred item is derecognized. In addition, all assets obtained and liabilities incurred by the transferor in connection with a sale must be initially recognized at fair value. The FASB has acknowledged that, depending on their legal form, transfers having similar economic effects could be accounted for differently.

4.2.5 Recognition of assets obtained and liabilities incurred in the transfer

As discussed in ASC 860-20-25-1 and ASC 860-20-30-1, upon completion of a transfer that qualifies for derecognition, the transferor (seller) should recognize, at fair value, all proceeds from the sale. Proceeds include all assets obtained and liabilities incurred in connection with a transfer, and may include:
  • Cash
  • Servicing assets
  • Servicing liabilities
  • In a sale of an entire financial asset or a group of entire financial assets, any of the following:
    • The transferor’s beneficial interest in the transferred financial assets
    • Put or call options held or written (e.g., guarantee or recourse obligations)
    • Forward commitments (e.g., commitments to deliver additional receivables during the revolving periods of some securitizations)
    • Swaps (e.g., provisions that convert interest rates from fixed to variable).
If a transfer involves only a portion of an entire financial asset intended to qualify as a participating interest, only cash and a servicing asset (or liability) may be obtained as part of the transfer. Beneficial interests, put or call options, forward commitments, and swaps generally may not be obtained in a transfer of a portion of a financial asset to comply with the definition of a participating interest. See TS 2.4 for exceptions to this rule.
As discussed in TS 4.2.1, a retained participating interest is initially measured based on an allocation of the underlying financial asset’s carrying amount between the participating interest sold and the participating interest retained. A retained participating interest is not considered proceeds of a sale.
All consideration received in a sale constitutes, by definition, proceeds required to be measured at fair value in accordance with ASC 820, Fair Value Measurement. ASC 860-20-25-4 clarifies that any asset obtained constitutes proceeds from a sale -- even if the asset is a beneficial interest in the transferred asset that entitles the transferor to certain of the transferred asset’s economics subsequent to the exchange. Similarly, the fair value of any liability incurred reduces proceeds, even if it relates to the transferred assets. ASC 860-20-25-4 also clarifies that any derivative entered into concurrent with a transfer of financial assets is also considered part of the transaction’s proceeds, and should be recognized at fair value.
The values ascribed to assets obtained or liabilities incurred in a transfer accounted for as a sale will impact the amount of gain or loss booked on derecognition. Determining the fair value of assets received and liabilities assumed may involve judgment, and may require the use of specialists.
The remainder of this section discusses the more common forms of sale proceeds.

4.2.5.1 Servicing rights

A transferor may retain the contractual right to service transferred financial assets that have been derecognized. In that case, ASC 860-50-25 requires the transferor to recognize a separate servicing asset or servicing liability at the date of the exchange, measured at fair value. Thereafter, the recognized servicing asset or liability should be accounted for separately in accordance with the guidance in ASC 860-50.
If a transfer involves a participating interest, ASC 860-50-25-1 clarifies that a recognized servicing asset or liability should relate only to the participating interest sold.
See TS 6 for information on accounting for servicing assets or servicing liabilities.

4.2.5.2 Beneficial interests obtained in a transfer

As part of the proceeds from a sale, the transferor may obtain rights to receive specified cash inflows from (collections on) a transferred financial asset or group of transferred financial assets held by the transferee. These rights to cash inflows can take various legal forms (e.g., a provision in a contract, a debt instrument and/or equity interests), and are collectively referred to in ASC 860 as “beneficial interests” in the underlying transferred asset. Beneficial interests obtained are considered part of the proceeds on a sale transaction and should be initially recognized at fair value.
See LI 3.2.2.1 and LI 6.7 for information on the accounting for beneficial interests subsequent to initial recognition after the adoption of ASC 326 (CECL).
Beneficial interests may be derivative instruments within the scope of ASC 815 in their entirety or may contain embedded derivatives requiring separate accounting under ASC 815. See DH 2 for information on determining whether an instrument meets the definition of a derivative in its entirety and DH 4.4.6 for information on determining whether a beneficial interest contains an embedded derivative that should be accounted for separately.

4.2.5.3 Credit enhancements to transferred assets

Certain transfers may require the transferor to provide credit enhancement to the transferee. Under these arrangements, the transferor retains exposure to a portion of the transferred asset’s credit risk – thus reducing the credit risk that the transferee is exposed to, or in other words “enhancing” (from the transferee’s perspective) the credit risk profile of the acquired financial asset. Some transactions require a cash reserve account (funded by the transferor using proceeds from the sale) as a form of credit enhancement. If the transferee subsequently suffers credit losses on the transferred assets, it is entitled to reimbursement from the reserve account. Depending on the contractual arrangements, amounts in the account may be remitted to the transferor at periodic intervals or only upon extinguishment of the underlying assets.
Another type of credit enhancement sometimes seen in securitization structures requires cash flows that would be payable to the residual tranche to be collected and held by the transferor (and potentially other investors) in a cash reserve account for potential distribution to the other beneficial interest holders if specified collection targets (or other metrics, such as overcollateralization ratios) are not met. If those targets or metrics are satisfied, periodic distributions are made from the cash reserve account to the holders of the residual tranche in accordance with the entity’s priority of payments waterfall.
ASC 860-20-25-6 provides guidance on determining whether any credit risk retained by a transferor (credit enhancement provided by the transferor) should be reported as a separate liability or, alternatively, considered when measuring the initial carrying amount of a beneficial interest (asset) obtained by the transferor. If the transferee can look only to the cash flows from the underlying financial assets, then the transferor has retained a portion of the credit risk through its beneficial interest and should not recognize a separate obligation. In contrast, if the transferor could be required to reimburse the transferee for credit-related losses on the underlying assets – that is, the transferor may be required to “write a check” to the transferee – the transferor should record a separate liability for that contingent obligation.
When estimating the fair value of a credit enhancement, a transferor should consider inputs and assumptions that would be used by market participants, consistent with the guidance in ASC 820. If the credit enhancement is embedded in a transferor’s beneficial interest, the determination of the fair value of that interest should consider the credit enhancement that the beneficial interest implicitly provides to the transferee (or other beneficial interest holders).

4.2.5.4 Derivatives obtained in a transfer

Derivatives obtained in a transfer of an entire financial asset should be recognized at fair value. Those derivatives can be either assets (i.e., proceeds on the sale) or liabilities (i.e., reduction of proceeds on the sale). Derivatives obtained in sale transactions often include call options, put options, and swaps.
Even if no formal derivative contract is involved, the structure of a transfer transaction may imply a derivative within the scope of ASC 815. For example, a securitization may involve the transfer of fixed-rate receivables to a trust that issues variable-rate certificates. The transferor may enter into an agreement with the trust to periodically receive the fixed-rate interest collections on the receivables in exchange for paying a floating rate that corresponds to the certificates’ interest rate. This type of agreement is a swap subject to ASC 815.
See DH 2 for information on the ASC 815 definition of a derivative and DH 4.4.6 for information on determining whether a beneficial interest contains an embedded derivative that should be accounted for separately.

4.2.5.5 Forward sale agreements in a transfer

Under certain securitization arrangements, the transferor is obligated to transfer all eligible receivables originated during the program’s reinvestment period to the securitization entity. These provisions are most commonly seen in revolving securitization arrangements involving credit card receivables and trade accounts receivable. Cash collections on receivables previously transferred to the securitization entity are used to purchase new receivables, sometimes daily. To the extent that cash collections are insufficient to pay the transferred receivables’ purchase price, the remainder of the purchase price is funded by the transferor’s receipt of a beneficial interest in the transferred items.
Typically, the purchase price required to be paid by the securitization entity under these revolving programs is the transferred receivables’ then-current fair value. If so, it may be appropriate to conclude that the forward arrangement conveys little or no value to either party; therefore, from a materiality perspective, no related asset or liability need be recognized by the transferor despite the arrangement potentially meeting the definition of a derivative. However, there may be instances when the terms of the forward could result in the transferor receiving purchase price consideration that may not equal or closely approximate the transferred receivables’ fair value. Accordingly, when receivables are first sold to the securitization entity under a revolving program, the transferor should consider whether it is appropriate to record an asset or liability arising from any forward commitment (that is, the contract’s fair value at that date), as called for in ASC 860-20-25-1(d)(3).
See DH 2 for information on the ASC 815 definition of a derivative.

4.2.5.6 Recourse obligations in a transfer

ASC 860-10-20 provides a definition of recourse.

Definition from ASC 860-10-20:

Recourse: The right of a transferee of receivables to receive payment from the transferor of those receivables for any of the following:
  1. Failure of debtors to pay when due
  2. The effects of prepayments
  3. Adjustments resulting from defects in the eligibility of the transferred receivables.

Recourse obligations can arise from a variety of contractual obligations assumed by a transferor. For example, a credit enhancement that potentially obligates a transferor to “write a check” to compensate a transferee for credit losses on transferred financial assets is a form of recourse. A transferee’s right to be compensated due to defects in a transferred asset’s eligibility typically stems from representations and warranties made by the transferor about the characteristics of the asset at the transfer date. As noted in TS 3.4.1, most recourse arrangements are considered a form of continuing involvement by a transferor with a transferred financial asset.
Recourse obligations related to the sale of an entire financial asset (or group of such assets) should initially be recognized on the transfer date as a liability at fair value.
As noted in TS 2, transfers of portions of entire financial assets cannot retain any recourse obligations (exclusive of standard representations and warranties, servicing obligations and obligations to share in any set-off benefits) and assert that the transferred portion meets the definition of a participating interest. ASC 860-20-55-24A explains that any other forms of recourse assumed by a transferor in connection with a transfer of a portion of an entire financial asset will cause the exchange to be reported as a secured borrowing.
Provisions in financial asset purchase and sale agreements should be analyzed to determine whether they involve recourse. Though sometimes termed nonrecourse, “early payment default” programs require the seller to repurchase any loan sold that becomes delinquent during a specified time period (e.g., during the first 90 days following the sale). If the borrower is not delinquent on its loan payments during the specified time period, the repurchase provision becomes void and the loan transfer becomes fully nonrecourse. However, during the specified time period, the contingent repurchase obligation is effectively a form of recourse.
Depending on their nature and extent, recourse arrangements may jeopardize the ability of a transferor to satisfy ASC 860’s legal isolation requirement. For example, standard representations and warranties written by a transferor subject to the US Bankruptcy Code typically will not, in and of themselves, prevent counsel from rendering a true sale opinion. On the other hand, counsel may be unable to provide a true sale opinion if a transferor is obligated to absorb subsequent credit losses on the financial assets sold.
Subsequent accounting for recourse obligations
ASC 860 does not provide guidance on the how a transferor should subsequently measure recourse obligations; other GAAP should be applied. The transferor may need to assess whether a recourse obligation meets the definition of a derivative in ASC 815. If it does, it should also assess whether the recourse obligation qualifies for the financial guarantee scope exception in ASC 815-10-15-58. If a recourse obligation meets the definition of a derivative but fails to meet the financial guarantee scope exception, it should be subsequently accounted for at fair value, with changes in value recognized in earnings. If the recourse obligation is outside the scope of ASC 815, it should be evaluated to determine whether the arrangement qualifies as a guarantee that should be remeasured based on the guidance in ASC 460. See DH 2 for information on the ASC 815 definition of a derivative and FG 2 for information on guarantees.

4.2.6 Sale accounting examples–various forms of proceeds

Example TS 4-3 and Example TS 4-4 illustrate the application of the recognition guidance in ASC 860-20 to a transfer that qualifies as a sale when the transferor receives other forms of proceeds in addition to cash consideration.
EXAMPLE TS 4-3
Sale of entire financial assets
Transferor Corp sells a group of loans having an aggregate carrying amount of $1 million in a transaction that qualifies for sale accounting. Transferor Corp receives cash of $940,000 and a senior beneficial interest in the transferred loans with a fair value of $110, 000.
Transferor Corp will continue to service the loans in exchange for compensation that is more than adequate. In addition to retaining an option to purchase certain of the transferred loans at fair value (each of which is readily obtainable in the marketplace), Transferor Corp also assumes a limited recourse obligation to repurchase delinquent loans at par.
The following table summarizes the fair value of the assets received and liabilities incurred by Transferor Corp.
Item
Fair value
Cash
$940,000
Beneficial interest
$110,000
Call option
$2,000
Servicing asset
$30,000
Recourse obligation
$20,000
How should Transferor Corp record the sale of the group of loans?
Analysis
Transferor Corp would calculate the net proceeds received (fair value of the assets obtained in the transfer less the fair value of the liabilities incurred) and the gain on sale as follows.
Cash
$940,000
Plus: beneficial interest
110,000
Plus: call option
2,000
Plus: servicing asset
30,000
Less: recourse obligation
(20,000)
Net proceeds
$1,062,000
Less: carrying amount of loans sold
(1,000,000)
Gain on sale
$62,000
Transferor Corp would record the following journal entry at the transfer date.
Dr. Cash
$940,000
Dr. Call option
$2,000
Dr. Beneficial interest
$110,000
Dr. Servicing asset
$30,000
Cr. Loans
$1,000,000
Cr. Recourse obligation
$20,000
Cr. Gain on sale
$62,000
EXAMPLE TS 4-4
Sale of participating interest
Transferor Corp transfers a portion of an entire loan in exchange for cash consideration of $980,000, the portion’s presumed fair value. The portion of the loan retained by Transferor Corp has a fair value of $110,000. The carrying amount of the entire loan prior to the transfer is $1 million.
Transferor Corp will continue to service the loan after the transfer, and will deduct its servicing fee from the periodic interest payment to be remitted to the transferee. Although the servicing contract provides compensation that is more than adequate, the servicing fee is not significantly above the amount that would fairly compensate a substitute service provider. In accordance with ASC 860-50-55-4, Transferor Corp estimates that the fair value of the servicing asset attributable to the portion sold is $10,000.
The transferred portion meets the definition of a participating interest in ASC 860-10-40-6A and the transfer qualifies for sale accounting under ASC 860-10-40-5.
The following table summarizes the fair values of the transaction’s sale proceeds (cash and a servicing asset) and the participation interest retained by Transferor Corp.
Item
Fair value
Cash
$980,000
Participating interest retained
$110,000
Servicing asset
$10,000
How should Transferor Corp record the sale of the participating interest?
Analysis
Transferor Corp should first allocate the carrying amount of the underlying loan between the participating interests sold and retained, based on their relative fair values.
Fair value
Percentage of total fair value (nearest whole percent)
Allocated carrying value
Participating interest sold
$980,000
90%
$900,000
Participating interest retained
110,000
10%
100,000
Total
$1,090,000
100%
$1,000,000
Transferor Corp would then calculate the proceeds received and the gain on sale as shown in the following table.
Cash
$980,000
Plus: servicing asset
10,000
Proceeds
$990,000
Less: allocated carrying amount of the interest sold
(900,000)
Gain on sale
$90,000
Transferor Corp would record the following journal entry at the transfer date.
Dr. Cash
$980,000
Dr. Servicing asset
$10,000
Cr. Loan
$900,000
Cr. Gain on sale
$90,000
After the sale, Transferor Corp would report a loan on its balance sheet having a carrying value of $100,000, along with a servicing asset initially measured at $10,000.
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