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This transaction should be recorded as a lease in accordance with CSA 840 guidelines. The option is considered an appeal option, since the company has the right to exercise this option. At first glance, it appears that the redemption price is higher than the original sale price, but the present value of the redemption price, which is amortized at 5 percent for three years, is US$1.123. Since the repurchase price is lower than the original sale price and the transaction is not part of a sale-sale agreement, the transaction is a financial lease. If the repurchase price is higher than the initial sale price and higher than the market price, the transaction should be accounted for as a financing contract. While Lehman is an extreme example of the aggressive use of rest for balance sheet management, it is unlikely that the 2014 accounting rule changes avoided its collapse or the broader financial crisis of September 2008. First, the regulations already in place at the time of the collapse excluded U.S. sales accounting for the deposit Lehman made, which led the company to circumvent the rules by returning the securities to its British broker. Second, Lehman`s bankruptcy was largely due to a precipitous drop in the market value of subprimes, in which it was heavily invested. If Lehman had used secured credit accounting and provided the bond information required by the new rules, the increased utility of the balance sheet would likely have drawn the attention of market participants more quickly to the company`s excessive borrowing, but might not divert the resulting problems for Lehman or the market as a whole. To explain the difference between sales accounting and secured borrowing, we look at the example of Lehman Brothers, which implemented extensive repo programs before finally filing for bankruptcy in 2008. Its practices are described in more detail in “How Lehman Brothers and MF Global`s Misuse of Repurchase Agreements Reformed Accounting Standards” on page 44 of this issue. In short, Lehman`s goal in using repo operations was to reduce the overall size of its balance sheet and reduce its debt ratios, both of which are critical to maintaining a good credit rating.

Secured credit accounting does not achieve this objective and would lead to unchanged debt ratios. Therefore, Lehman participated in sales accounting with a buyback agreement. This treatment does not reveal any contractual obligation to buy back in the balance sheet. Securities are debited upon returns, the call option is waived, and cash returned to the lender includes an interest payment. Presentations 1 and 2 illustrate this approach. In total, Repos Lehman helped remove up to $50 billion in debt from its balance sheet, with a very small impact, if any, on other accounts. In 2014, the AFSB published changes to the accounting rules and information on certain types of repo transactions. Under the new guidelines, certain repo transactions previously recorded as sales must now be accounted for as secured loans. The new rules also require enhanced disclosures.

As a result, companies may be asked to reduce or eliminate the use of rest as a means of achieving off-balance-sheet financing. While stricter accounting rules are designed to prevent repo races such as those that lead to the failure of Lehman Brothers, lower use of the rest market could lead to increased volatility in short-term interest rates.