In its continuing quest to sort out when a financial asset transaction is a sale vs. a repurchase agreement or a secured borrowing, the Financial Accounting Standards Board tentatively agreed to a slightly narrower definition of when a transaction qualifies for sale treatment, which enables an asset to be removed from the balance sheet.
During a recent meeting, FASB tentatively decided it will extend an exception to the rules for financial asset sale accounting for certain sale and repurchase agreements. It will require secured borrowings accounting for transactions that involve the sale and purchase of not only identical financial assets, but also financial assets that are substantially similar. The board also decided it will clarify the criteria for determining whether the financial assets to be repurchased are substantially similar to the assets initially transferred. Ultimately, that will have the effect of requiring more transactions to be treated as secured borrowings, which keeps more of them on the balance sheet.
It's a touchy subject in the financial services sector particularly as FASB continues to work through an accounting solution that will prevent another Lehman-like accounting headache. Before it collapsed, Lehman Brothers used repurchase transactions to shuttle some $50 billion in assets on and off the balance sheet around period closing dates to mask the true measure of its debt, according to the firm's bankruptcy examiner.
FASB has decided a secured borrowing transaction can be distinguished by six critical criteria. In addition to the transfer of identical or similar assets, it involves a transfer of existing financial asset at its inception, and the agreement involves both a right and an obligation to repurchase the financial assets. The initial transfer and forward repurchase agreement involves the same counterparty, and the repurchase agreement is linked to the initial transfer.
In addition, the repurchase price is fixed and easily determined, and the financial assets specified under the agreement are identical to the financial assets initially transferred, or at least substantially similar. As for what to do when a given transaction fits most but not all the criteria for a secured borrowing, the board decided it will rely on existing guidance to determine when transactions should be described as secured borrowings vs. sales with forward repurchase agreements.
And, of course, there will be disclosure requirements. The board decided all repurchase agreements and similar transactions should be described in the notes to financial statements with three specific disclosures: the reasons for concluding whether a transaction is a secured borrowing or a sale with a forward repurchase commitment, and the accounting reasoning behind a transaction involving substantially similar but not identical financial assets.