reconsideration and clarification of certain of its provisions, even beyond the guid-
ance provided in the FAS 125 Implementation Guide. In response to the growing
need for reconsideration and clarification, the FASB agreed that amendments to FAS
125 were necessary and decided that a replacement would be more user friendly than
simply amending the FAS 125 guidance. As a result, FASB Statement No. 140, “Ac-
counting for Transfers and Servicing of Financial Assets and Extinguishment of Lia-
bilities” (FAS 140) was issued in September 2000.
FAS 140 retained the concepts of FAS 125 but the ground rules for determining
whether a transfer of financial assets constitutes a sale or secured borrowing were
clarified.
(b) U.S. Accounting Overview. FAS 140 is based on a financial-components ap-
proach that focuses on control of the financial components of the assets. Under this
approach, the accounting for a financial asset is determined for each of the compo-
nents that are contractually created and accounted for based on the interests trans-
ferred and interests retained. Following a transfer of financial assets, an entity recog-
nizes the assets it controls and liabilities it has incurred, and derecognizes financial
assets for which control has been surrendered and all liabilities that have been extin-
guished. Transfers of nonfinancial assets are governed by other accounting literature
discussed below.
For example, if an entity transfers a loan receivable in a transaction in which a third
party has acquired control over the future principal payments but the seller retains
control over future interest payments, FAS 140 would consider the entity to have sold
the “principal” component of the loan and to have retained the “interest” component.
If the seller in this example also has guaranteed the third-party investor that the debtor
will make all contractually required principal payments, the seller would recognize a
liability for the financial guarantee contract it has provided the investor.
Under this model, components of the transferred asset, or newly created instru-
ments require separate accounting recognition. For example, an interest rate swap
might exist in a transfer of financial assets that qualifies as a sale even though no for-
mal interest rate swap agreement exists. This can occur in situations in which finan-
cial assets are securitized and the rate paid to investors is determined on a basis dif-
ferent than the rate paid by the debtor. For example, a swap is deemed to exist where
a fixed rate receivable is sold to an investor that receives all payments made by the
debtor except that the interest payments are converted to a variable rate of interest.
In this situation, the economic components of the transfer result in the creation of an
interest rate swap.
The components of a financial asset are determined based on the contractual com-
ponents that are created as a result of the transfer. For example, consider a transfer of
a portfolio of fixed rate receivables in which the buyer is to receive the first 90% of
all principal collections, a variable rate of interest, and receives a guarantee of prin-
cipal and interest collections. In this case, the transferor would be viewed as retain-
ing a single retained interest that represents a combined principal-only strip, interest
rate swap, and financial guarantee contract. It would not separately account for the
three financial components retained. However, each of the three components that are
combined into the retained interest will impact the cash flow that will result from the
retained interest and, therefore, its fair value. Therefore, the importance of carefully
understanding each aspect of a transfer involving financial instruments cannot be
overemphasized.
21 • 8 ASSET SECURITIZATION