Restrictions on transferred assets

Restrictions on transferred assets – Stipulations that limit or direct the purposes for which a transferred asset may be used, but do not specify that future economic benefits or service potential is required to be returned to the transferor if not deployed as specified.

Stipulations on transferred assets are terms in laws or regulation, or a binding arrangement, imposed upon the use of a transferred asset by entities external to the reporting entity.

This is part of IFRS 9 and the derecognition of financial assets (IFRS 9 3.2), more specific: Restrictions on transferred assets

IFRS 9 3.2.9 – Whether the entity (the selling entity) has retained control (see IFRS 9 3.2.6(c)) of the transferred asset depends on the transferee’s ability to sell the asset. If the transferee (the acquiring or purchasing entity) has the practical ability to sell the asset in its entirety to an unrelated third party and is able to exercise that ability unilaterally and without needing to impose additional restrictions on the transfer, the entity has not retained control. In all other cases, the entity has retained control.

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A customer that can redirect or determine how goods are used, or that can otherwise benefit from the goods, is likely to have obtained control of the goods. Limitations on the use of the goods, or other restrictions on the benefits the customer can receive from those goods, indicates that control of the goods may not have transferred to the customer.

Contractual restrictions on an entity’s ability to redirect an asset are common in some industries. A contractual restriction exists if the customer has the ability to enforce its right to a specific product or products in the event the entity attempts to use that product for another purpose, such as a sale to a different customer. Restrictions on transferred assets

Consider, for example, real estate contracts whereby contractual restrictions may restrict redirecting the asset to another customer. Again, facts and circumstances must be carefully analyzed since contractual restrictions do not automatically prevent “alternative use” to an entity (e.g., if, for example, they represent a protective right or if the contractual restriction is non-substantive). This assessment must be completed at contract inception. There may also be practical limitations (i.e., the entity may not be able to redirect the asset for another use without incurring significant costs to rework the asset). If this is the case, then the entity is incurring a significant economic loss, which would result in a practical limitation in redirecting the asset.

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Example

Entity P, a property development company, enters into contracts to sell properties (for example, stand-alone residential or commercial properties, or individual units in apartment blocks) to its customers. The arrangements have the following features: Restrictions on transferred assets

• On date X, customers enter into a binding contract for the property and pay a deposit of 10% of the contractually agreed purchase price;
• If the property is incomplete at date X (for example, it may have been sold ‘off plan’ or some, but not all, construction activities may have been completed), Entity P completes the construction of the property; Restrictions on transferred assets
• From the point construction of a property, which is subject to a sales contract with a customer, is complete (date Y, which could be the same as date X) the customer assumes certain ownership risks, including risks associated with damage to the property caused by an event (such as severe weather) or by unrelated third parties;
• On date Z, which is typically a few weeks after date Y (the point at which Entity P has completed its construction activities), customers pay the balance of consideration and take ownership, with legal title passing from Entity P to its customer. Restrictions on transferred assets

From date X, because the customer has entered into a binding sales contract, the customer is exposed to subsequent changes in the market value of the property.

However, even though the construction activities are completed on date Y, up to date Z the customer is not permitted to occupy or sublet the property, and may have either limited or no rights to access the property. The customer also has no right to make any changes to the property or to pledge it as security in transactions such as a lending arrangement.

If a customer does not fulfil its contractual obligation to pay the balance of consideration on date Z, Entity P will retain the 10% deposit that was paid on date X. The contract also requires the customer to pay compensation to Entity P for any loss of profit. This means that if Entity P sells the property to another customer, but is unable to obtain a price of at least 90% of the original contractually agreed price with the original customer, the original customer is required to pay the shortfall to Entity P. There is substantial past history in Entity P’s jurisdiction that the courts will enforce this compensation clause. Restrictions on transferred assets

Prior to the adoption of IFRS 15, Entity P recognised revenue from the sale of properties on the date on which all construction activities were complete (date Y). This was because Entity P considered that, at that point, substantially all of the risks and rewards of property ownership had passed to its customer. Restrictions on transferred assets

Applying IFRS 15, Entity P first considers whether it meets any of the criteria to recognise revenue over time. It concludes that it does not, meaning that revenue will be recognised at a point in time.

Entity P then considers whether the contractual terms and the legal environment mean that the transfer of control of the properties (the point at which revenue is recognised in accordance with IFRS 15) is different from the point at which revenue has previously been recognised (which is the point at which it had been considered that substantially all of the risks and rewards of ownership had passed to the customer). Although the customer assumes certain risks associated with the property at dates X and Y, Entity P concludes that the restrictions over the customer’s physical and other use of the property up to date Z mean that control does not pass until that date.

Consequently, Entity P will recognise revenue from the sale of properties on date Z and not the earlier date Y under IFRS 15.

Restrictions on transferred assets