DrugKing This case study involves determining the effects of call options and put options on the
accounting for transfers of financial assets under ASC 860, Transfers and Servicing:
Overall (ASC 860) (FASB Statement No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishment of Liabilities (Statement 140)). The specific topics,
highlighted in the examples below, include (1) attached call options on specific assets and
freestanding call options on specific assets readily obtainable elsewhere, (2) conditional
call options on transferred assets, and (3) in-the-money put options on transferred assets.
Example 1
DrugKing transfers two financial assets, its investments in the Series A and Series B
preferred stock of Tip-Top, to InsureAll, a substantive third party (i. e., the transaction
does not involve a qualifying special-purpose entity (QSPE)). The Series A and Series B
preferred stock are traded publicly (i. e., they are readily obtainable in the marketplace).
DrugKing holds a call option, written by InsureAll, on the Series A preferred stock,
which will allow it to repurchase the asset from InsureAll two years after the transfer
date. DrugKing attaches a call option directly to the Series B preferred stock that will
allow it to repurchase the asset from whoever owns the asset up to two years after the
transfer date. Both options have a fixed exercise price.
Outside counsel for DrugKing concludes that both transfers isolate the transferred assets
(i. e., the assets have been put presumptively beyond the reach of DrugKing and its
creditors, even in bankruptcy or other receivership).
Example 2
DrugKing transfers a financial asset, its investment in a debt security, to InsureAll, a
substantive third party (i. e., the transaction does not involve a QSPE). The asset is traded
publicly (i. e., it is readily obtainable in the marketplace).
DrugKing holds a conditional call that is attached to the asset. This call will permit
DrugKing to repurchase the asset if LIBOR ever decreases below 4 percent (LIBOR was
6.5 percent as of the date of transfer). The option has a fixed exercise price and provides
more than a trivial benefit to DrugKing.
Outside counsel for DrugKing concludes that the transfer isolates the transferred asset
(i. e., the assets have been put presumptively beyond the reach of DrugKing and its
creditors, even in bankruptcy or other receivership).
Example 3
DrugKing transfers two financial assets, its trade receivables and its credit card
receivables, to InsureAll, a substantive third party (i. e., the transaction does not involve a
QSPE). Neither asset is readily obtainable in the marketplace.
The trade receivables have a fair value of $100 (book value is $99) and were transferred
to InsureAll for $103. The transfer includes an option for InsureAll to put the assets back
to DrugKing for up to one year after the transfer date at $102.50. The transfer price of
$103 represents the fair values of the trade receivables ($100) and the put option ($3).
The credit card receivables have a fair value of $100 (book value is $99) and were
transferred to InsureAll for $150. The transfer includes an option, which expires in 10
days, for InsureAll to put the assets back to DrugKing at $151. The possibility of the fair
value of the asset increasing to $151 in 10 days is considered remote and, therefore,
exercise of the option appears virtually ensured at inception. The transfer price of $150
represents the fair values of the credit card receivables ($100) and the put option ($50).
Outside counsel for DrugKing concludes that both transfers isolate the transferred assets
(i. e., the assets have been put presumptively beyond the reach of DrugKing and its
creditors, even in bankruptcy or other receivership).
Required:
How should DrugKing account for each of the asset transfers in the examples above (i. e.,
may the asset transfers be accounted for as a sale)?
Note to Participants:
None of the examples above involve the sale of financial assets to a QSPE, as defined by
accounting literature. Therefore, the accounting for QSPEs, or other issues related to
QSPEs, does not require consideration in this case study.