IFRS 10 Special control approach

IFRS 10 Special control approach

– determines which entities are consolidated in a parent’s financial statements and therefore affects a group’s reported results, cash flows and financial position – and the activities that are ‘on’ and ‘off’ the group’s balance sheet. Under IFRS, this control assessment is accounted for in accordance with IFRS 10 ‘Consolidated financial statements’.

Some of the challenges of applying the IFRS 10 Special control approach include:

  • identifying the investee’s returns, which in turn involves identifying its assets and liabilities. This may appear straightforward but complications arise when the legal ownership of assets diverges from the accounting depiction (for example, in financial asset transfers that ‘fail’ de-recognition, and in finance leases). In general, the assessment of the investee’s assets and returns should be consistent with the accounting depiction in accordance with IFRS
  • it may not always be clear whether contracts and other arrangements between an investor and an investee
    • create rights or exposure to a variable return from the investee’s performance for the investor; or
    • transfer risk or variability from the investor to the investee IFRS 10 Special control approach
  • the relevant activities of an SPE may not be obvious, especially when its activities have been narrowly specified in its purpose and design IFRS 10 Special control approach
  • the rights to direct those activities might also be difficult to identify, because for example, they arise only in particular circumstances or from contracts that are outside the legal boundary of the SPE (but closely related to its activities).

IFRS 10 Special control approach sets out requirements for how to apply the control principle in less straight forward circumstances, which are detailed below:  IFRS 10 Special control approach

  • when voting rights or similar rights give an investor power, including situations where the investor holds less than a majority of voting rights and in circumstances involving potential voting rights
  • when an investee is designed so that voting rights are not the dominant factor in deciding who controls the investee, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements IFRS 10 Special control approach
  • involving agency relationships IFRS 10 Special control approach
  • when the investor has control only over specified assets of an investee
  • franchises. IFRS 10 Special control approach

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Pass through testing

Pass through testingPass through testing provides some examples to learn which types of financial instruments/transactions qualify for accounting for a pass-through arrangement. 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 full recovery of the amount lent plus accrued interest at market rates do not violate this condition. Pass-through arrangements
  • 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
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The best 1 – Risk and Rewards Test and Control Test

Risk and Rewards Test and Control Test are, in combination, used to validate the accounting for a transfer of a financial asset under IFRS 9 Financial instruments. Based on criteria in previous steps it has been concluded that an entity has transferred a financial asset using the following decision tree (see IFRS 9 B3.2.1): Risk and Rewards Test and Control Test

Risk and Rewards Test and Control Test

 

The central questions here are: Risk and Rewards Test and Control Test

1) has the entity transferred or retained substantially all risks and rewards (the ‘Risk and rewards test’)?

and Risk and Rewards Test and Control Test

2) has the entity retained control of the asset(s) (the ‘Control test’)? 

Which leads to 3 possible outcomes, or in … Read more

Derecognise a transfer of a financial instrument or not?

Derecognise a transfer of a financial instrument or not – to quickly grow comfortable and get a gut feeling for derecognising a financial instrument read this page. Small cases with different inputs with a analysing comment on the case provide a fruitful learning ground. Here are some examples regarding transfers of financial instruments and the question of whether or not these should be derecognised (and why)? Derecognise a transfer of a financial instrument or not

Transfer versus agency relationshipDerecognise a transfer of a financial instrument or not

Question Derecognise a transfer of a financial instrument or not

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

Background Derecognise a transfer of a financial instrument or not

Entity K Read more

Derecognise a sale of a financial instrument or not?

Derecognise a sale of a financial instrument or not – to quickly grow comfortable and get a gut feeling for derecognising a financial instrument read this page. Small cases with different inputs with a analysing comment on the case provide a fruitful learning ground. Here are some examples regarding sale transactions of financial instruments and whether or not these should be derecognised or not (and why)?

Suggestion to read: Best Guide IFRS 9 Derecognition of financial assets

Here is the decision tree where it all comes down to:


Derecognise a sale of a financial instrument or not


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 … Read more

Control and continuing involvement

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. Control and continuing involvement

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 Read more

1 Best Complete Read – Pass through arrangements

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. Pass through arrangements

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 Pass through arrangementsasset. Short-term advances by
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Securitisation all in interest rate swap retained

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 Read more

Sale of loans guarantee retained

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 guarantees one-third of any default losses associated with the loans (under the terms of the guarantee, if a payment on a loan is 180 days overdue, the loan is considered to have defaulted and payment becomes due under the guarantee).

There is no active market in these loans. Credit risk is the only significant risk. There is no late-payment risk, as interest is charged on late payments.

Note that continuing involvement is a unique accounting model for which little guidance is provided in IFRS 9. There may therefore be other acceptable ways to account for the following transaction.

Additional information:

  • Fair value of loans €10 million (fair value = book value, originated for €9,980,000, so the fair value has increased by €20,000 since origination)
  • Fair value of guarantee obligation €100,000 Sale of loans guarantee retained
  • Fair value of guarantee fee €57,000 (PV of 13bp fee on OPB) Sale of loans guarantee retained
  • The servicing fee is expected to adequately compensate entity P for servicing the loans
  • The debtors have not been notified that their loans are being transferred Sale of loans guarantee retained

Analysis using the flowchart [IFRS 9 B3.2.1]

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Securitisation revolving structure

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