ASC 860 Transfers and Servicing: Securitization Transaction Explained with Journal Entries

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Accounting Standards Codification (ASC) Topic 860, "Transfers and Servicing," provides guidance on accounting for securitization transactions, which involve the transfer of financial assets to a special purpose entity (SPE) that issues securities backed by the transferred assets. Securitization is a common practice used by financial institutions to diversify their funding sources, manage risk, and improve liquidity. This article will explain the concept of securitization transactions under ASC 860 and provide examples of journal entries that illustrate the proper accounting treatment for these transactions.

 

Securitization Transaction

A securitization transaction typically involves the following steps:

 

  1. A financial institution (the originator) pools a group of financial assets, such as loans or receivables.
     

  2. The originator transfers the pooled assets to an SPE, which is a separate legal entity created for the purpose of the securitization.
     

  3. The SPE issues securities, such as asset-backed securities (ABS) or mortgage-backed securities (MBS), to investors. The cash flows generated by the underlying assets are used to make principal and interest payments to the investors.
     

  4. The originator may retain an interest in the securitized assets or provide servicing functions, such as collecting payments from borrowers.

 

Under ASC 860, the originator must determine whether the transfer of financial assets to the SPE qualifies as a sale, in which case the assets are derecognized from the originator's balance sheet. If the transfer does not qualify as a sale, the originator must continue to recognize the assets on its balance sheet and record a liability for any proceeds received from the SPE.

 

Journal Entries for Securitization Transaction

To better understand the accounting treatment for securitization transactions, let's look at a hypothetical example.

 

Example:

 

Company I, a financial institution, pools $10 million in mortgage loans and transfers them to an SPE as part of a securitization transaction. The SPE issues $9.5 million in MBS to investors and Company I retains a $500,000 interest in the securitized assets.

 

Journal Entry 1: Record the transfer of mortgage loans

Assuming the transfer qualifies as a sale under ASC 860, Company I would record the following journal entry:

 

Debit: Cash $9.5 million

Debit: Retained Interest in Securitized Assets $500,000

Credit: Mortgage Loans $10 million

 

The debit to cash represents the proceeds received from the SPE, while the debit to retained interest in securitized assets represents the value of the interest retained by Company I. The credit to mortgage loans removes the transferred assets from the originator's balance sheet.

 

Journal Entry 2: Record servicing fees (if applicable)

If Company I provides servicing functions for the securitized assets, it may be entitled to receive servicing fees. When the servicing fees are collected, the company would record the following journal entry:

 

Debit: Cash (amount of servicing fees collected)

Credit: Servicing Fee Income (amount of servicing fees collected)

This entry records the receipt of servicing fees as income in the income statement.
 

ASC 860 provides guidance on accounting for securitization transactions, ensuring that the financial statements accurately reflect the transfer of financial assets and the associated risks and rewards. By following the principles outlined in ASC 860, companies can properly account for and disclose securitization transactions, providing useful information to investors and other stakeholders. It is essential for accountants and financial professionals to understand and apply the principles of ASC 860 when dealing with securitization transactions in order to maintain compliance with accounting standards and provide accurate financial information.