FASB issued an Accounting Standards Update (ASU) that it said is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.
The board said the amendments in ASU no. 2011-03 , Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements, remove from the assessment of effective control the requirement that the transferor have the ability to repurchase or redeem the financial assets, as well as implementation guidance related to that requirement.
“The new guidance improves transparency by eliminating consideration of the transferor’s ability to fulfill its contractual rights and obligations from the criteria in determining effective control,” FASB Chairman Leslie Seidman said in the press release announcing the ASU.
The ASU does not change other criteria applicable to the assessment of effective control. Those criteria indicate that the transferor is deemed to have maintained effective control over the financial assets transferred (and thus must account for the transaction as a secured borrowing) for agreements that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity if all of the following conditions are met:
- The financial assets to be repurchased or redeemed are the same or substantially the same as those transferred.
- The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price.
- The agreement is entered into contemporaneously with, or in contemplation of, the transfer.
In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. Accounting Standards Codification Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets.
The ASU is effective for the first interim or annual period beginning on or after Dec. 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted.
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