Question

On December 1, 2014, Eva Corporation, a mortgage bank, has the following amounts on its balance sheet (in millions):
Assets
Cash ........... $ 10
Mortgage receivables ...... 58
Investments .......... 27
Other assets ......... 13
Total ........... $108
Liabilities and Shareholders’ Equity
Notes payable ........ $ 50
Common stock .......... 11
Retained earnings ......... 47
Total ............ $108

Also on December 1, 2014, Eva transfers mortgage receivables with a book value of $20,000,000 to a securitization entity (SE). The average interest rate on the mortgages is 7%. Under the terms of the agreement, the SE is legally separate from Eva. After the transfer, Eva securitizes the mortgages and sells them to investors. Because the securities are considered to be less risky than the original mortgages, the investors are willing to receive a lower rate of return and consequently remit $20,750,000 to the SE. The SE then transfers the $20,750,000 to Eva Corporation. Eva does not direct the activities of the SE and will not participate in any of the SE’s gains or losses.

Required:
1. Explain why this securitization qualifies for accounting treatment as a sale.
2. What entries should Eva make at the time of the securitization?
3. Show how the securitization will affect Eva’s balance sheet at December 1, 2014, and compute the new debt/equity ratio.
4. Show the balance sheet effects and how the debt/equity ratio would be different if the securitization did not qualify for accounting treatment as a sale.





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  • CreatedSeptember 10, 2014
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