IFRS 9 Financial instruments – Derecognition

An entity shall derecognise a financial asset when, and only when: (a) the contractual rights to the cash flows from the financial asset expire, or (b) it transfers the financial asset under certain criteria and the transfer qualifies for derecognition in accordance
with other criteria.

Derecognition of financial assets

Derecognition of financial assets has drawn a lot of attention in the Enron scandal. Enron used special purpose entities—limited partnerships or companies created to fulfil a temporary or specific purpose to fund or manage risks associated with specific (financial and/or non-financial) assets.

On October 16, 2001, Enron announced that restatements to its financial statements for years 1997 to 2000 were necessary to correct accounting violations. The restatements for the period reduced earnings by $613 million (or 23% of reported profits during the period), increased liabilities at the end of 2000 by $628 million (6% of reported liabilities and 5.5% of reported equity), and reduced equity at the end of 2000 by $1.2 billion (10% of reported equity).

So doing Read more

The Risk and Rewards test and the Control test

Based on criteria in previous steps it has been concluded that an entity has transferred a financial asset (see IFRS 9 B3.2.1).

The central questions here are:

1) has the entity transferred or retained substantially all risks and rewards?

and

2) has the entity retained control of the asset(s)?

Which leads to 3 possible outcomes, or in a diagram:

The risk and rewards test

These steps are set out in paragraphs IFRS 9 3.2.6(a)-(b). The three potential outcomes of this evaluation are (see diagram above):

  1. transfer of substantially all risks and rewards of ownership (what normally would be called a (true) sale), derecognise the asset. If there are any rights and obligations created or retained in the
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Pass-through testing

Here are some examples to learn which types of financial instruments/transactions qualify for accounting for a pass-through arrangement. An explanation of a pass-through arrangement and the three conditions a vehicle has to meet in qualifying for a pass-through are provided in ‘Pass-through arrangements‘  If the originator/transferor meets these three conditions the assets transferred are derecognised by the transferror.

Transfer of disproportionate share in pass-through

Question

Can the transfer of a disproportionate share of the cash flows from a loan meet the conditions for a pass-through arrangement?

Background

Entity M originates a five-year interest-bearing loan of 100. M then enters into an agreement with entity N in which, in exchange for a cash payment of 85, M Read more

Derecognise a transfer of a financial instrument or not?

Here are some examples regarding transfers of financial instruments and the question of whether or not these should be derecognised (and why)?

Transfer versus agency relationship

Question

Is the transfer of securities to a custodian a transfer of the contractual rights under IFRS 9 3.2.4(a)?

Background

Entity K enters into an arrangement with bank L whereby L will manage K’s securities. K transfers the securities to a safe custody account of L. L will receive a management fee for its service. K can decide when and which assets should be sold and can require a surrender of the securities at any time.

Solution

No. The transfer of securities to a custodian is not a transfer under IFRS 9 Read more

Derecognise a sale of a financial instrument or not?

Here are some examples regarding sale transactions of financial instruments and whether or not these should be derecognised or not (and why)?

Sale of disproportionate interest

Question

Can the sale of the rights to the first of any cash collections from a group of similar financial assets be considered a part of those assets for derecognition purposes?

Background

Entity A originates a portfolio of similar five-year interest-bearing loans of 10,000. A then enters into an agreement with entity B. A agrees to pay to B the first 9,000 of cash collected from the portfolio plus interest in exchange for an upfront cash payment from B. A retains the rights to the last 1,000 plus interest, representing a subordinated interest in … Read more

Control and continuing involvement

Under IFRS 9, control is different from the notion of control in IAS 27 – the power to govern so as to obtain benefits. The notion in IAS 27 focuses on the powers of the entity (transferor) and implies an ability to manage the asset actively. In contrast, in the context of derecognition under IFRS 9, control is based on whether the transferee has the practical ability to sell the asset. This IFRS 9 notion addresses the extent that the transferor continues to be exposed to the cash flows of the particular asset that was the subject of the transfer as opposed to be exposed to risks of a more general nature, similar to a derivative.

IFRS 9 explains Read more

Pass-through arrangements

If there is no transfer of contractual rights under IFRS 9 3.2.4 (a), an entity should determine if there is an obligation to pass on the cash flows of the financial asset under a pass-through arrangement. For example, a transferor that is a trust or SPE may issue beneficial interests in the underlying financial assets to investors but continue to own those financial assets.

All the following conditions have to be met to conclude that such pass-through arrangements meet the criteria for a transfer: [IFRS 9 3.2.5]

  • The entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original asset. Short-term advances by the entity with the right of
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Securitisation – all in interest rate swap retained

This is an illustration of how derecognition is applied in practice. The objective is to present the mechanics of applying the IFRS 9 requirements for derecognition of financial assets, starting with an analysis of the transaction using the flowchart [IFRS 9 B3.2.1], and culminating with the initial and subsequent accounting entries for both the transferor and transferee.

Background and assumptions

Bank Q assigns 10-year 10% fixed rate pre-payable mortgages with a notional principal of €10 million to an SPE for €10 million of cash on 1 January 20X1.

The SPE issues 10-year floating-rate (Libor based) notes to investors (with quarterly interest payment dates) in various credit-rated tranches that are repaid as the mortgages themselves are repaid. Q does Read more

Sale of loans – guarantee retained

This is an illustration of how derecognition is applied in practice. The objective is to present the mechanics of applying the IFRS 9 requirements for derecognition of financial assets, starting with an analysis of the transaction using the flowchart [IFRS 9 B3.2.1], and culminating with the initial and subsequent accounting entries for both the transferor and transferee.

Background and assumptions

Entity P has originated a group of similar five-year fixed rate corporate loans for €9,980,000 with the intention of selling them to a bank in the near future. It is, therefore, accounting for these loans at fair value through profit or loss before the sale. Subsequently, P assigns the loans to a third-party bank for €10.1 million but Read more

Securitisation – revolving structure

This is an illustration of how derecognition is applied in practice. The objective is to present the mechanics of applying the IFRS 9 requirements for derecognition of financial assets, starting with an analysis of the transaction using the flowchart [IFRS 9 B3.2.1], and culminating with the initial and subsequent accounting entries for both the transferor and transferee.

Background and assumptions

Bank N assigns €100 million of its credit card receivables to a Special Purpose Vehicle (SPV) on a revolving basis for five years. The SPV is formed for the purpose of this securitisation; its activities are limited to holding the credit card receivables, issuing notes to investors and associated activities. To fund the assignment of Read more