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The derecognition flow chart
The flow chart on the following page, reproduced
from the Application Guidance in IAS 39, summarises
the criteria for derecognition in IAS 39. A detailed
explanation of each step follows after the flow
chart [IAS39R.AG36].
Step 1 - Consolidation of all subsidiaries
Many derecognition structures use entities (e.g.
trusts, partnerships, etc.) that have been specifically
set up for the acquisition of the transferred assets.
The transfer of assets to such an entity might qualify
as a legal sale. However, if the relationship between
the transferor and the transferee suggests that
the transferor controls the transferee the transferor
needs to consolidate the transferee. The derecognition
principles therefore have to be applied at a consolidated
level. An entity first consolidates all subsidiaries
and special purpose entities in accordance with
IAS 27 and SIC-12 and then applies the derecognition
principles to the resulting group [IAS39R.15].
Step 2 - Identification of part that shall
be derecognised
The next step is to identify the assets (or parts
of assets) which should be tested for derecognition.
The tests may be applied to any of the following
[IAS39R.16]:
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an entire asset
(for example, an unconditional sale of a financial
asset), |
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a fully proportionate share of the
cash flows from an asset (for example, a sale
of 10 percent of all principal and interest
cash flows), |
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specifically identified
cash flows from an asset (for example, a sale
of an interest-only strip of a loan), or |
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a fully proportionate share
of specifically identified cash flows from an
asset (for example, a sale of 10% of an interest-only
strip of a loan). |
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Step 3 - Expiry of contractual rights
A financial asset should be derecognised if the
contractual rights to the cash flows from the financial
asset (or part of the asset) have expired or are
forfeited. This is the case when a debtor discharges its obligation
by paying the holder of the financial asset or when
the debtor's obligations to the holder have ceased
(for example, when the rights under an option expire).
The asset has no value and should be derecognised
if there are no longer cash flows accruing to the
entity [IAS39R.17(a)].
Step 4 - The transfer of contractual rights
Some transactions clearly involve the transfer of
rights to another party. An entity that has sold
a financial asset has transferred its rights to
receive the cash flows from the asset. An example
of this is a legal sale of a bond. The transfer
then has to be assessed in Step 5 to determine whether
it meets the derecognition criteria [IAS39R.17(b)]
[IAS39R.18(a)] .
Pass through arrangements
An entity that retains its contractual rights to
receive cash flows from a financial asset may still
assume a contractual obligation to pass on the cash
flows to one or more entities (pass through arrangements).
A transferor that is a trust or SPE may issue beneficial
interests in the underlying financial assets that
it owns to investors but continue to service those
financial assets (that is custody of the underlying
asset remains with the transferor). Additional requirements
have to be fulfilled to conclude that such pass-through
arrangements meet the criteria for a transfer [IAS39R.18(b)].
The entity has to perform the derecognition tests
in Step 5 if the following requirements for pass
through are met [IAS39R.19]:
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The entity
has no obligation to pay cash flows to the transferee
unless it collects equivalent cash flows from
the transferred asset. |
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The entity is prohibited from selling
or pledging the original asset other than
as security to the eventual recipients for
the obligation to pass through cash flows. |
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The entity is obliged to
remit any cash flows without material delay
and subject to certain investment restrictions. |
The financial assets remain on the balance sheet
if the conditions are not met .
Step 5 - The derecognition tests
An entity derecognises an asset if it transfers
substantially all the risks and rewards of ownership
of the asset (for example, in an unconditional sale
of a financial asset) [IAS39R.20(a)].
Examples of when an entity has transferred substantially
all the risks and rewards of ownership are:
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An unconditional
sale of a financial asset; |
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A sale of a financial asset together
with an option to repurchase the financial
asset at its fair value at the time of repurchase;
and |
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A sale of a financial asset
together with a put or call option that is deeply
out of the money (an option so far out of the
money it is highly unlikely to go into the money
before expiry). |
The transfer of risks and rewards is evaluated on
the entity's exposure, before and after the transfer,
to the variability in amount and timing of the cash
flows that are likely to occur. It will be clear
in most cases whether the entity has transferred
substantially all the risks and rewards without
the need for a calculation [IAS39R.21] .
The entity continues to recognise the asset if
it retains substantially all the risks and rewards
of ownership of the asset. Derecognition requires
the transferor's exposure to the risks and rewards
of ownership to change substantially [IAS39R.20(b)].
Examples of when an entity has retained substantially
all the risks and rewards of ownership are:
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A sale and
repurchase transaction where the repurchase
price is a fixed price or the sale price plus
a lender's return; |
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A securities lending agreement; |
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A sale of a financial asset
together with a total return swap that transfers
the market risk exposure back to the entity; |
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A sale of a financial asset
together with a deep in-the-money put or call
option (that is an option that is so far in
the money that it is highly unlikely to go out
of the money before expiry); and |
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A sale of short-term receivables
in which the entity guarantees to compensate
the transferee for credit losses that are likely
to occur . |
The entity has to determine whether it has retained
control of the asset. Control is based on the transferee's
practical ability to sell the asset [IAS39R.20(c)]
[IAS39R.23]. The transferee has this ability if
it can sell the asset in its entirety unilaterally
to an unrelated third party without needing to impose
further restrictions on the transfer. The key issue
is what the transferee is able to do and not what
contractual rights the transferee has . A transferee has the practical ability to
sell the asset if it is traded in an active market
because the transferee could purchase the asset
in the market if it needs to return the asset to
the transferor. The transferor has lost control
if an asset subject to a call option can be readily
obtained by the transferee in the market although
he has retained some of the risks and rewards in
relation to the asset [IAS39R.AG42]. However, the
contractual right to dispose of an asset is of little
practical use if there is no market for the asset
[IAS39R.AG43]. The asset is derecognised if the
entity has lost control. The entity continues to
recognise the asset to the extent of its continuing
involvement if it has retained control [IAS39R.30]
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Continuing involvement
The entity continues to recognise the asset (to
the extent of its continuing exposure) if the entity
has neither transferred nor retained substantially
all the risks and rewards of ownership and control
has not passed to the transferee. A liability must
also be recognised in those circumstances. IAS 39
contains detailed guidance on how to account for
a range of different scenarios. The combined presentation
of the asset and liability should result in the
recognition of the entity's net exposure to the
asset on the balance sheet either at fair value,
if the asset was previously held at fair value,
or at amortised cost, if the asset was accounted
for on that basis. The treatment of the changes
in the liability should be consistent with the treatment
of changes in the asset. Consequently, when the
transferred asset is classified as available-for-sale,
gains and losses on both the asset and the liability
are taken to equity [IAS39R.33] .
Failed derecognition
A transaction is accounted for as a collateralised
borrowing if the transfer does not satisfy the conditions
for derecognition. The entity recognises a financial
liability for the consideration received for the
transferred asset. If the transferee has the right
to sell or repledge the collateral the asset is
presented separately in the balance sheet (for example,
as a loaned asset, pledged securities, or repurchased
receivable). The entity recognises income relating
to the transferred assets and any expense incurred
on the financial liability in subsequent periods
[IAS39R.36] .
Successful derecognition
An entity that derecognises a financial asset in
its entirety includes the difference between the
carrying amount and the consideration received (including
any cumulative gain or loss that had been recognised
directly in equity) in the income statement. An
entity that derecognises only a part of a financial
asset allocates the previous carrying amount of
the financial asset between the part that continues
to be recognised and the part that is derecognised
based on relative fair values at the date of transfer.
The difference between the carrying amount allocated
to the part derecognised (including any cumulative
gain or loss relating to the part derecognised that
had previously been recognised in equity) and the
consideration received is included in the gain or
loss on derecognition [IAS39R.34] .
Retained servicing assets and liabilities
An entity shall recognise either a servicing asset
or a servicing liability for a servicing contract
at fair value if it transfers a financial asset
that qualifies for derecognition and retains the
right to service the financial asset for a fee.
A liability for the servicing obligation shall be
recognised if the fee to be received is not expected
to compensate the entity adequately for performing
the servicing. An asset shall be recognised for
the servicing right if the fee to be received is
expected to be more than adequate compensation for
the servicing [IAS39R.AG45].
Presentation and disclosure
A transferred asset that continues to be recognised
is not offset against the associated liability.
Similarly, the entity shall not offset any income
arising from the transferred asset with any expense
incurred on the associated liability [IAS39R.33].
The accounting for non-cash collateral provided
by the transferor depends on whether the transferee
has the right to sell or repledge the collateral
and on whether the transferor has defaulted. The
transferor shall present the transferred asset separately
from other assets (for example, as loaned assets)
if the transferee has the right to sell or repledge
the transferred assets. The transferor shall derecognise
the asset if it defaults under the terms of the
contract and is no longer entitled to redeem the
collateral.
An entity shall, for each class of financial assets,
disclose the carrying amounts of the assets, the
nature of the assets and risks and rewards of ownership
to which the entity remains exposed if a transfer
does not qualify for derecognition in its entirety.
The total amount of the entire asset, the amount
of the asset that the entity continues to recognise
and the corresponding liability must be disclosed
as well [IAS32R.94(a)]. There are additional disclosure
requirements if transferred assets that did not
qualify for derecognition have been pledged as collateral
[IAS32R.94(b)-(c)].
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