Repurchase agreements (often referred to as "repos") are transactions in which a transferor transfers a financial asset (typically a high-quality debt security) to a transferee in exchange for cash. Simultaneously, the transferor enters into an agreement to reacquire the security on a specified future date for an amount equal to the cash received plus interest.
Banks, dealers, other financial institutions, and corporate investors commonly use repos to finance their securities inventories, obtain short-term funding and/or meet regulatory requirements. The term of a repo is relatively flexible (i.e., can be shorter or longer as needed) compared to other short-term financing arrangements, such as commercial paper or certificates of deposit.
Parties to repo transactions are referred to in a variety of ways. Figure TS 5-3 lists the terms commonly used to identify them.
Figure TS 5-3Repurchase agreements are designed to minimize counterparty credit risk during their term. Accordingly, the market value of the securities subject to repurchase is determined daily. Changes in the market value of these positions can give rise to a "margin deficit" or a "margin excess" that, in turn, may require the transferor to transfer consideration (cash or securities) to the transferee (secured party) or obligate the transferee to transfer cash or certain of the purchased securities back to the transferor, respectively. Margin calls may be (1) on a transaction-by-transaction basis or (2) considering all transferred securities and related collateral in the aggregate.
The accounting for repos depends on whether (1) it is a repurchase-to-maturity transaction and (2) the transfer of the underlying financial asset qualifies for sale accounting under ASC 860-10-40-5. All repurchase-to-maturity transactions, as defined, should be accounted for as secured borrowings, as mandated by ASC 860-10-40-24A.
Most other repos are also accounted for as secured borrowings because the terms of the underlying repurchase agreement fail (by design) the "effective control" requirements in ASC 860-10-40-24. Specifically, they obligate the transferor to repurchase a financial asset at a fixed or determinable price, and the financial asset is the same or substantially the same as the one transferred.
When the transferee to a repurchase agreement can satisfy its resale obligation by delivering a similar (but not identical) financial asset, additional analysis is necessary to determine whether the transferor has, in fact, maintained effective control over the transferred asset. If so, consistent with the secured borrowing accounting model, the transferor should recognize the cash received, record the obligation to repurchase the transferred financial asset, and apply the collateral-related accounting and reporting provisions in ASC 860-30-25-5.
Although rare, a repo transaction may qualify for sale accounting. For example, a repurchase agreement may not obligate the transferee to return to the transferor a financial asset that meets all of ASC 860-10-40-24’s "substantially the same" conditions. In these circumstances, the transferor is not considered to have retained effective control over the transferred asset. As discussed in ASC 860-10-55-51, in these instances, the repo transaction may qualify for derecognition, but only if the exchange meets the two remaining sale accounting criteria in ASC 860-10-40-5. If these conditions are satisfied, sale accounting is appropriate, in which case the transferred financial assets should be derecognized, accompanied by the recognition of proceeds received and liabilities assumed, including the forward purchase contract, at their current fair value. The forward purchase contract may be subject to derivative accounting under ASC 815, Derivatives and Hedging.
Figure TS 5-4 illustrates the general sequence of decisions applicable to transferors of financial assets subject to repurchase arrangements, exclusive of repurchase-to-maturity agreements, which are required to be reported as secured borrowings in all cases.
Figure TS 5-4
Transferor’s accounting for repurchase agreements (excluding repurchase-to-maturity agreements)
In a custodial or tri-party arrangement, control over the assets is not surrendered and a reclassification entry from securities to securities pledged to creditors is not required, as the secured party (transferee) does not have the right to pledge or sell the collateral held in the account.
Question TS 5-9
Can a repo party and a reverse-repo party to the same transaction account for that transaction differently? For instance, can the transferor account for the transaction as a financing, while the transferee accounts for it as a buy/sell arrangement?
No. A transferor and transferee should account for the transfer of a financial asset transfer in a consistent and symmetrical manner. Therefore, if a transferor concludes that a transfer should be reported as a secured borrowing transaction, the transferee should apply the same accounting in its financial statements, consistent with the guidance in ASC 860-30-25-2.
Despite ASC 860’s symmetrical accounting model, it is possible that certain transfers may be reported differently by the transferor and transferee. This may stem from the two parties reaching different judgments when evaluating whether a condition for derecognition has been satisfied. For example, the counterparties may conclude differently about the sufficiency of evidence obtained in connection with the legal isolation assertion in ASC 860-10-40-5(a). However, we would expect instances of such asymmetrical accounting to be rare.
Question TS 5-10
Would it be appropriate for a reporting entity to include gains and losses arising from repurchase agreements reported as sales in the same line item as interest cost attributable to other repurchase agreements reported as secured borrowings?
ASC 860-20-50-1B mandates that any gain or loss arising from a transfer reported as a sale be included in earnings. However, ASC 860 does not address how a transferor should present those gains or losses in its income statement. As a general rule, we believe that the classification of such amounts should conform to the characterization of the underlying transfer under ASC 860. For example, the cost associated with a repurchase agreement accounted for as a financing (i.e., the difference between the cash proceeds received at inception and the amount paid to repurchase the transferred security upon the agreement’s maturity) should be characterized as interest expense in the transferor’s income statement.
On the other hand, in practice, most companies that sell non-interest bearing trade accounts receivable to a bank or commercial paper conduit characterize the resulting loss as a loss on sale in its entirety – even though, arguably, a component of that loss is attributable to the investor’s imputation of a financing cost into the purchase price paid. ASC 860-20-50-5 requires that the aggregate amount of gains or losses on sales of loans or trade receivables (including related lower of cost or market and fair value adjustments) be presented separately in the financial statements or be disclosed in a note.
Example TS 5-3, Example TS 5-4, and Example TS 5-5 illustrate the accounting for various repurchase agreements reported as secured borrowings.
EXAMPLE TS 5-3Transferor Corp and Transferee Corp enter into a repurchase agreement accounted for as a secured borrowing. The terms of the agreement and other relevant facts are as follows:
The following journal entries illustrate the accounting treatment for this arrangement. For the sake of simplicity, the example does not include journal entries to recognize and update the allowance for credit losses for the reverse repo receivable. Also, interest income and expense are recorded at the conclusion of the transaction. In practice, these amounts are accrued over the term of the repurchase transaction.