IFRS 9 Retain all risks and rewards 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 Retain all risks and rewards IFRS 9 Retain all risks and rewards
Step 5 Has the entity retained substantially all risks and rewards? [IFRS 9 3.2.6(b)]
If this comparison demonstrates that the entity’s exposure to the variability in the present value of the future net cash flows (discounted at the appropriate current market interest rate) from the financial asset does not change significantly as a result of the transfer, the entity is regarded as having retained substantially all the risks and rewards of ownership of the asset. The computational comparison for derecognition is a relative and not an absolute test: the significance of the entity’s exposure to variability in the amounts and timing of the net cash flows of the transferred asset is measured in relation to the total variability of that asset. IFRS 9 Retain all risks and rewards IFRS 9 Retain all risks and rewards
Example – Variability in the amounts and timing of cash flows
An entity sells a portfolio of short term 30-day receivables with a nominal value of C1 billion to a third party. The entity guarantees first losses on the portfolio up to 1.25% of the loan volume. The average loss on similar receivables over the last 10 years amounts to 2%.
The expected losses are C20m, and the entity has guaranteed C12.5m. It might therefore appear that, as the entity has guaranteed 62.5% of all the expected losses, it has retained substantially all the risks and rewards of ownership. This is not so, as the calculation cannot be done in this manner. The test looks to who absorbs variability in the asset’s cash flows, rather than who has most of the expected losses.
By giving a guarantee, the entity has effectively retained a subordinated interest in the receivables. If the subordinated retained interest absorbs all of the likely variability in net cash flows, the entity retains the risks and rewards of ownership and continues to recognise the receivables in their entirety. However, this is not the case in this example.
Therefore, in order to perform a risk and rewards analysis, it is necessary to determine the variability in the amounts and timing of the cash flows both before and after the transfer on a present value basis.
One way in which such a determination can be made is outlined below:
The above steps are repeated for cash flows that remain after the transfer.
The expected variance after the transfer is compared with the variance before the transfer to determine whether there has been a significant change in the amounts and timing of cash flows as a result of the transfer. If the change is not significant, it can be concluded that there has been no substantial transfer of the risks and rewards of ownership. If the change is significant, it can be concluded that the risks and rewards of ownership have been substantially transferred.
An illustration of the above modelling is shown below. For illustrative purposes, only six scenarios are included in this example. More scenarios may be required in practice to adequately model the variability in net cash flows of the asset. IFRS 9 Retain all risks and rewards
The relative variability retained after the transfer = 638/6,470 = 9.86%. This implies that the entity has transferred substantially all of the risks and rewards of ownership of the receivables.
In the above example, the cash flows’ present value with their associated probabilities constitutes a discrete random variable, for which it is possible to derive an absolute value for the variability, as indicated above. A better measure would be to calculate the variance. However, in this example, that would also produce the same conclusion. Retain all risks and rewards
THE QUESTION WAS: Step 5 Has the entity retained substantially all risks and rewards?
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.
Something related: The basic legal definition of Sale
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 Retain all risks and rewards
IFRS 9 Retain all risks and rewards IFRS 9 Retain all risks and rewards IFRS 9 Retain all risks and rewards
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