IFRS 9 Assume obligation to pay cash flow

IFRS 9 Assume obligation to pay cash flow

IFRS 9 Assume obligation to pay cash flow was the first part of Step 4 of the below decision tree. Now you are in the second part of Step 4,

IFRS 9 Assume obligation to pay cash flow is part of a decision model for the derecognition of financial assets. The derecognition can be a full derecognition, a full continued recognition, a full derecognition with recognition of new assets or liabilities retained or a continued involvement. The model is starting here. Derecognition of financial assets IFRS 9 Assume obligation to pay cash flow

The principles from IAS 39 for recognition and derecognition of financial assets/liabilities were carried forward to IFRS 9. However, IFRS 9 explicitly states that write-offs constitute a derecognition event (IFS 9.5.4.4).

In summaryFlash light focus
  • A financial asset (or part of a financial asset) is derecognised when:
    • The rights to the cash flows from the asset expire.
    • The rights to the cash flows from the asset and substantially all risks and rewards of ownership of the asset are transferred.
    • An obligation to transfer the cash flows from the asset is assumed and substantially all risks and rewards are transferred.
    • Substantially all the risks and rewards are neither transferred nor retained but control of the asset is transferred.
  • If the entity retains control of the asset but does not retain or transfer substantially all the risks and rewards, the asset is recognised to the extent of the entity’s continuing involvement.
  • A financial liability is removed from the balance sheet only when it is extinguished – that is, when the obligation specified in the contract is discharged or cancelled – or expires.
  • A transaction is accounted for as a collateralised borrowing if the transfer does not satisfy the conditions for derecognition.

Derecognition of financial assets

In many cases it is not difficult to assess whether or not a financial asset is derecognised. For example, when a manufacturer receives a payment from a customer for the delivery of spare parts, the manufacturer no longer has any rights to further cash flows from the receivable and should remove it from the balance sheet.

Where a company sells a portfolio of trade receivables or mortgages in order to receive finance, it is less obvious whether those financial assets should be derecognised. Examples of such arrangements are debt factoring and IFRS 9 securitisation schemes.

Something else -   Full derecognition with new assets liabilities best of 1

The following flow chart summarises the criteria for derecognition in IFRS 9 (IFRS 9B.3.2.1)

Derecognition step by step of financial assets


IFRS 9 Derecognition decision tree: Step 4 Assumed an obligation to pay the cash flows

Step 4 Has the entity assumed an obligation to pay the cash flows from the asset that meets the conditions in IFRS 9 3.2.5? [IFRS 9 3.2.4(b)]

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 an IFRS 9 pass-through arrangement. [IFRS 9 3.2.4(b)] 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:

  1. 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 full recovery of the amount lent plus accrued interest at market rates do not violate this condition. IFRS 9 Assume obligation to pay cash flow
  2. The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows. IFRS 9 Assume obligation to pay cash flow
  3. The entity has an obligation to remit any cash flows that it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to reinvest such cash flows, except in cash or cash equivalents (as defined in IAS 7, ‘Cash flow statements’) during the short settlement period from the collection date to the date of required remittance to the eventual recipients, with any interest earned on such investments being passed to the eventual recipients [IFRS 9 3.2.5].

The financial assets remain on the balance sheet if any one of these conditions is not met. IFRS 9 Assume obligation to pay cash flow

If a transfer meets the pass-through requirements, the transferor is deemed to have transferred the asset. However, the transferor will still then need to assess whether it has transferred sufficient risks and rewards associated with the asset to achieve derecognition.

Something else -   Amortised Cost

These pass-through conditions follow from the definitions of assets and liabilities in the Conceptual Framework.IFRS 9 Assume obligation to pay cash flow

The first condition ensures that the transferor is not obliged to transfer any cash flows to the transferee other than those it has collected from the transferred asset. This implies that the transferor has no liability arising from the transaction, as it has no obligation to pay cash.

The second condition regarding the transferor’s ability to sell or pledge the financial assets highlights that the transferor does not control access to the future economic benefits associated with the transferred cash flows and therefore may not have an asset.

The third condition ensures that the transferor does not have use of or benefit from the specific cash flows it collects on behalf of the transferee and is required to remit to them ‘without material delay’. Again, this condition helps ensure that the transferor does not have an asset.

An immaterial delay is permitted for practical reasons. For example, in some pass-through arrangements, such as a securitisation of a portfolio of mortgages, it is not practical for the entity to transfer the relatively small amount of cash collected from many individual accounts as and when they arise. Instead, for administrative convenience, the contractual arrangement may provide for cash flows to be remitted in aggregate on a monthly or quarterly basis. IFRS 9 Assume obligation to pay cash flow IFRS 9 Assume obligation to pay cash flow

The third condition also restricts any investment made for the transferee’s benefit to cash or cash equivalents as defined in IAS 7. This means that the transferor is not allowed to invest the funds in other high-yielding medium-term investments, even for the benefit of the transferee.

Furthermore, the transferor is not permitted to retain any interest from such short-term highly liquid investments. All such interest received is remitted to the transferee. In practice, the funds are often paid into a trustee bank account for the transferee’s benefit.

The effect of meeting all three pass-through conditions above is that the transferor does not have the rights to particular cash flows arising from the asset (second and third conditions) or a liability to pass on those particular cash flows (first condition), as defined in the Conceptual Framework. In these situations, the transferor may act more as an agent of the eventual recipient than the owner of the asset.

Something else -   The credit adjusted approach

Therefore, when those conditions are met, the arrangement is treated as a transfer of the contractual rights to the cash flows and considered for derecognition (ie, is subject to the risks and rewards and control tests – see step 5 and step 6).

When the conditions are not met, the transferor acts more as an owner of the asset, with the result that the asset should continue to be recognised. In this case, the transferor still has the rights to the particular cash flows arising from the asset. IFRS 9 Assume obligation to pay cash flow

THE QUESTION WAS: Step 4 Has the entity assumed an obligation to pay the cash flows from the asset that meets the conditions in IFRS 9 3.2.5?

Yes | No

 

Continue using this decision tree to evaluate whether and to what extent a financial asset is derecognised…. Document the IFRS questions (including IFRS references) and your answers and your derecognition file is ready for review and authorisation. IFRS 9 Assume obligation to pay cash flow IFRS 9 Assume obligation to pay cash flow IFRS 9 Assume obligation to pay cash flow

Also read: IFRS Community – Derecognition


Links for more on each IFRS referenced in the decision tree: IFRS 9 3.2.3(a) Rights to cash flows expired, IFRS 9 3.2.4(a) Transferred rights, IFRS 9 3.2.4(b) Assumed an obligation, IFRS 9 3.2.6(a) Transfer risk and rewards test,  IFRS 9 3.2.6(b) Retained risks and rewards test,  IFRS 9 3.2.6(c) Retained control, IFRS 9 B 3.2.13 Continuing involvement

IFRS 9 Assume obligation to pay cash flow

Annualreporting provides financial reporting narratives using IFRS keywords and terminology for free to students and others interested in financial reporting. The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.

Something else -   IFRS 9 Transfer right to receive cash flows

Leave a comment