Accounting for the transfer of receivables with recourse has been problematic. At issue is whether such a transaction is, in substance, a sale, in which case a gain/loss would be recognized, or a financing transaction, in which case any gain/loss should be 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 (1) the seller surrenders control of future economic benefits embodied in the receivable and (2) 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?
b. Explain why the SOP 74-6 view represents a revenue-expense orientation, while the SFAS No. 77 represents an asset-liability orientation.