Following on Tom Selling’s post at the Accounting Onion yesterday, Lynn E. Turner, former SEC chief accountant, offers the following explanation for the key problems with repo accounting:
I have dealt with accounting for and auditing of repo’s now for three decades. This is not the first time they have been a problem. Back in the early ’80’s they were a problem with S&L’s and credit unions as well, and new guidance was issued that put them on the balance sheet. Unfortunately, the FASB, as they did with financings done as securitizations, issued guidance allowing them to be taken off the balance sheet.
The key problem has been, is, and will be if not fixed, that these are nothing short of short term financings and sources of liquidity. They should be reflected that way on the balance sheets.
The securities “sold” overnight should remain on the balance sheet and segregated out onto a separate line, with the detail as to those securities provided in the footnote.
Those securities should be reported on the balance sheet at their fair value so investors can tell how close the value of the collateral is to the amount of debt that must be repaid. By putting the details on these securities in the footnotes, investors can judge just how much risk exists in the collateral.
The cash obtained from the counterparty lender should be reflected as short term debt, with the significant terms disclosed in the footnotes, including how the fees and spreads are charged and work.
Currently, accounting standards require that repurchase agreements appear on balance sheets this way: First, repo borrowings are netted with repo loans when conducted with the same company, and only the net amount appears on the balance sheet. Then (1) the borrower reports the net new cash as an addition to cash assets, (2) it keeps the repoed securities in the investments section of its assets, and (3) it reports the net new debt as an addition to collateralized financing liabilities. Some companies supply more information.