Repurchase agreement

Repurchase agreement – 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 E enters into an agreement with bank F to sell a debt security classified as asset at amortised cost. The security is traded in an active market. At the same time, E agrees to repurchase the security from F at a specified fixed price on a fixed date. F pays E €1 million for the debt security, and E agrees to repurchase the security in six months’ time for €1.03 million. F can sell or repledge the debt security under this agreement. The 00.03 million is a lender’s return – that is, current six-month interest rates are 3%.

Additional information:

• Fair value of debt security at date of transfer – €1 million
• Fair value of forward purchase agreement on date of transfer – €0 million
• Carrying value at date of transfer – €0.95 million

Analysis using the flowchart [IFRS 9 B3.2.1]

Step 1 Consolidate all subsidiaries

This step is not applicable in this example.

Step 2 Determine whether the derecognition model should be applied to part of a financial asset (or a group of similar financial assets) or a financial asset (or a group of similar financial assets) in its entirety.

The asset being transferred is the debt security in its entirety.

Step 3 Have the rights to the cash flows expired?

No, the debt security has not yet reached maturity so the rights to the cash flows still exist.

Step 4 Is there a transfer?

Yes, bank E has sold the debt security to bank F.

Step 5 Risks and rewards analysis

E has retained substantially all the risk and rewards of the debt security. F is receiving only a lender’s return on the cash it has provided to E. Therefore, the transaction fails derecognition, and E treats this transfer as a collateralised borrowing.

Helpful hint – alternatives relating to repurchase agreements If the repurchase price is the market price of the asset at the time of repurchase, the transferor has transferred substantially all of the risks and rewards of ownership of the asset and consequently derecognises the asset. If a financial asset is sold under an agreement to repurchase substantially the same asset at a fixed price (usually equal to sales price plus lender’s return), or provides the transferee with a right to substitute assets that are similar and of equal fair value to the transferred asset at the repurchase date, the transferor retains substantially all the risks and rewards of ownership of the asset and consequently fails derecognition.

Transferor’s accounting

On the date of the transfer

As a result of the failed derecognition, bank E continues to recognise the transferred asset. E also recognises a financial liability for the consideration received for the transferred asset from F. As F has the right to sell or repledge the debt security, E presents the asset separately in the balance sheet (for example, as a loaned asset, or pledged securities).

Accounting entries on the date of the transfer

(in € millions)	DR	CR
Cash	1
Repurchase obligation liability To recognise the transfer as a collateralised borrowing		1
Asset at amortised cost (IAS 39 Held to maturity asset)		1
Loaned asset To recognise the transfer as a collateralised borrowing	1

Helpful hint As there is no derecognition, bank E has not tainted its at amortised cost portfolio as a result of this transaction.

Subsequent accounting

Subsequently, bank E will continue to account for the transferred asset as it previously had as held to maturity; however, it will be reclassified on the balance sheet to loaned asset. E will account for the liability at amortised cost, with the difference between the sales and repurchase prices being accrued as an expense over the six-month term of the agreement using the effective interest rate method.

(in € millions)	DR	CR
Interest expense	0.03
Repurchase obligation liability (repo liability)		0.03

To accrue interest on the repo liability.

On the date the repurchase obligation liability matures the entries would be as follows:

(in € millions)	DR	CR
Repurchase obligation liability	1.03
Cash		1.03

To record the settlement of the repurchase obligation liability.

Transferee’s accounting

On the date of the transfer

As the transfer does not qualify for derecognition, the transferee does not recognise the transferred asset as its asset. The transferee derecognises the cash or other consideration paid and recognises a receivable from the transferor.

(in € millions) Repurchase agreement of sold assets	DR	CR
Loan to bank E (reverse repurchase obligation)	1
Cash Repurchase agreement of sold assets		1

To recognise the transfer as a collateralised lending.

Subsequent accounting

Subsequently, bank F will account for this loan at amortised cost using the effective interest method, unless it elects to classify it as at fair value through profit or loss.

(in € millions) Repurchase agreement of sold assets	DR	CR
Loan to bank E (reverse repurchase obligation)	0.03
Interest income Repurchase agreement of sold assets		0.03

To record interest income on the loan to bank E.

On the date the repurchase obligation matures the entries would be as follows:

(in € millions) Repurchase agreement of sold assets	DR	CR
Cash Repurchase agreement of sold assets	1.03
Loan to bank E (reverse repurchase obligation)		1.03

To record the repayment of the loan by bank E to bank F.

Repurchase agreement