Receivables can be used to generate cash through two general categories of transactions: 1 . A secured borrowing 2 . A sale of the receivables. Both of these types of transactions require a transfer of the receivables to a new holder, typically a

Question

financial institution. A sale of receivables results in the receivables being removed from the books of the transferor and the recognition of gain or loss. From the transferee's standpoint, a sale of receivables results in the receivables being recorded on its books at their fair value. Required: Identify the conditions that must exist for a transfer of receivables to be accounted for as a sale.

Answer 1

A transfer of receivables is accounted for as a sale only if the transferor surrenders control over the assets transferred. The transferor must receive consideration other than the right to receive cash flows from the receivables. If the transferor retains the right to receive cash flows from the receivables, then transferee may not be able to sell the receivables, suggesting that control has not been completely relinquished by the transferor.

A transfer of receivables must meet the following conditions prescribed by Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities":

1 . The transferred assets must have been isolated from the transferor--put beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.
2 . The transferee has the right to pledge or exchange the assets, free of conditions that restrain it from taking advantage of that right.
3 . The transferor does not maintain effective control over the transferred assets through either
a . an agreement that the transferor repurchase or redeem the transferred assets before their maturity, or
b. entitles the transferor to repurchase assets that are not readily obtainable.

A recourse obligation alone does not prevent a transfer from being recorded as a sale. An option held by the transferor to repurchase the receivables does not necessarily require recording a transfer as loan.

For the first condition to be met, neither the transferor nor the creditors of the transferor can retain a claim to the transferred receivables. Additionally, the transferor cannot retain the right to revoke the transfer.

The second condition suggests that if a transferee can sell or pledge the receivables without interference from the transferor or other parties, then the transferor has control over the future cash flows underlying the receivables, as a result of a past transaction.

The third condition pertains to a requirement that the transferor repurchase the receivables (a "call" option). If the transferor must repurchase the receivables, then control has not passed to the transferee.

A transferor may wish to reacquire interest-bearing receivables when interest rate changes would be favorable to someone holding the receivable. Such an option may seem to violate the requirement for control to pass to the transferee. Nonetheless, such an option does not entitle the transferor to receive interest or other benefits from the transferred receivables. The transferor does not have custody of the assets, does not control the disposition of the assets, and cannot access the assets unless the option is exercised.

The transferee must be capable of fulfilling the option, if exercised. The transferred assets, or similar assets, must be readily obtainable. If the assets are not readily obtainable, then the transferee would be unable to sell the assets originally transferred, and thus would not have effective control over the assets.