To short-circuit any further Lehman-like treatment of repurchase agreements, the Financial Accounting Standards Board has published a proposed accounting standards update that would more explicitly explain how to account for transactions with an obligation to repurchase an asset.

In Proposed ASU: Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements, the FASB proposes amendments to existing guidance that would affect all companies that transfer a financial asset with both a right and an obligation to repurchase or redeem the asset before maturity. FASB is accepting comments through Jan. 15, 2011.

Companies, mainly financial institutions, commonly use repurchase agreements to manage liquidity. In a typical transaction, a company transfers a financial asset to another party in exchange for cash with an agreement to essentially reverse the transaction at a future date for an agreed price.

The Lehman Brothers bankruptcy examiner exposed some aggressive accounting treatment of repurchase agreements as the financial institution plunged into its epic bankruptcy in 2008. According to the examiner’s report, Lehman treated such transactions as true asset sales and timed them around key reporting dates to mask as much as $50 billion in debt.

Four months later, the FASB opened a project to take a fresh look at the rules around repurchase agreements. FASB Acting Chairman Leslie Seidman said in a statement that during the economic crisis, “concerns were expressed about a narrow aspect of existing guidance for determining whether a repo should be accounted for as a sale or as a secured borrowing.” The proposal intends to address that concern by simplifying the guidance, she said.

The existing rules in Accounting Standards Codification Topic 860 prescribe when an entity may or may not recognize a sale related to a repurchase agreement, with the determination focused at least in part on whether a company has effectively maintained control over a transferred financial asset. The proposed amendments would change the criteria and modify the implementation guidance to make the threshold for sale treatment more clear.

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