Question

Accounting for the transfer of receivables with recourse remains problematic. At issue is whether such a transaction is, in substance, a sale, in which case a gain/loss is recognized, or a financing transaction, in which case any gain/loss is amortized over the original life of the receivable. (The receivable could be long-term; for example, a sale of an interest-bearing note.) SOP 74-6 concluded that most transfers with recourse are financing transactions based on the argument that a transfer of risk (i.e., no recourse) must exist for a sale to have occurred. In 1983, the FASB reached a different conclusion in SFAS No. 77. A sale is now recognized if (a) the seller surrenders control of future economic benefits embodied in the receivable and (b) the seller ' s obligation under the recourse provisions can be reasonably estimated. If these conditions are not met, the proceeds from a transfer are reported on the balance sheet as a liability.

Required:

a.       What is the critical issue in interpreting the nature of this transaction? How does interpretation of the critical issue lead to the two different viewpoints?

Answer 1

a. What is the critical issue in interpreting the nature of this transaction? How does interpretation of the critical issue lead to the two different viewpoints?

Answer:-

key issue is whether the existence of recourse is a relevant circumstance to distinguish the transaction from a normal factoring of receivables in which there is no recourse to the seller in the event that there is default on the receivables. SOP 74-6 takes a very narrow interpretation and holds that recourse defeats the sale. By contrast, SFAS No. 77 takes a broad view that a sale of receivables has occurred, even though there is recourse, if the two tests are satisfied. The tests concern the transfer of economic benefits (note that tie-in to SFAC definitions of elements) and the ability to measure (estimate) the sellers obligations under recourse.