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IFRS Derecognition of financial instruments

IFRS Derecognition of financial instruments: Derecognition is the term used for the removal of an asset or liability from the balance sheet. IAS 39 sets out the criteria for derecognition of financial assets and liabilities and the consequential accounting treatment.

IFRS Derecognition of financial instruments: OVERVIEW

  • A financial asset (or part of a financial asset) is derecognised when:
    • The rights to the cash flows from the asset
    • The rights to the cash flows from the asset and substantially all risks and rewards of ownership of the asset are
    • An obligation to transfer the cash flows from the asset is assumed and substantially all risks and rewards are
    • Substantially all the risks and rewards are neither transferred nor retained but control of the asset is
  • If the entity retains control of the asset but does not retain or transfer substantially all the risks and rewards, the asset is recognised to the extent of the entity’s continuing involvement.
  • A financial liability is removed from the balance sheet only when it is extinguished – that is, when the obligation specified in the contract is discharged or cancelled – or
  • A transaction is accounted for as a collateralise borrowing if the transfer does not satisfy the conditions for

Derecognition of financial assets

In many cases it is not difficult to assess whether or not a financial asset is derecognised. For example, when a manufacturer receives a payment from a customer for the delivery of spare parts, the manufacturer no longer has any rights to further cash flows from the receivable and should remove it from the balance sheet.

Where a company sells a portfolio of trade receivables or mortgages in order to receive finance, it is less obvious whether those financial assets should be derecognised. Examples of such arrangements are debt factoring and securitisation schemes.

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The following flow chart summarises the criteria for derecognition in IAS 39. A detailed explanation of each step follows after the flow  chart.

IFRS Derecognition of financial instruments

Consequences of derecognition or failed derecognition

Derecognition of a financial asset – gain recognition

On derecognition of a financial asset in its entirety, the difference between the carrying amount and the consideration received (including any cumulative gain or loss that had been recognised directly in equity) is included in the income  statement.

If only a part of a financial asset is derecognised, the previous carrying amount of the financial asset is allocated 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.

Failed derecognition of a financial asset – substantially all risks and rewards of ownership retained

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.

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If the transferee has the right to sell or repledge the collateral the asset is presented separately in the balance sheet (for example, as loaned asset, pledge securities or repurchase receivable).

Failed derecognition – not substantially all risks and rewards of ownership retained

If the asset is not derecognised because the entity has neither transferred nor retained substantially all the risks and rewards of ownership and control has not passed to the transferee, the entity continues to recognise the asset to the extent of its continuing exposure to the asset. Consequently, to that extent a liability is also recognised. IAS 39 contains detailed guidance of how to account for a range of different scenarios. The principle is that 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 asset subject to the transfer is classified as available for sale, gains and losses on both the asset and the liability will be taken to  equity.

Derecognition of financial liabilities

A financial liability (trading or other) is removed from the balance sheet when it is extinguished – that is, when the obligation is discharged, cancelled or  expired.

The condition is met when the liability is settled by paying the creditor, or when the debtor is released from primary responsibility for the liability either by process of law or by the   creditor.

A payment to a third party, including a trust (sometimes called ‘in-substance defeasance’) does not, by itself, relieve the debtor of its primary obligation to the creditor, in the absence of legal release.

Management will frequently negotiate with the entity’s bankers or bond-holders to cancel existing debt and replace it with new debt on different terms. For example, an entity may decide to cancel its exposure to high-interest fixed-rate debt, pay a fee or penalty on cancellation, and replace it with variable-rate debt. IAS 39 provides guidance to distinguish between the settlement of debt that is replaced by new debt, and the restructuring of existing  debt.

IFRS Derecognition of financial instruments

The distinction is based on whether or not the new debt has substantially different terms from the old debt. Terms are substantially different if the present value of the net cash flows under the new terms discounted using the original effective interest rate is at least 10 per cent different from the present value of the remaining cash flows under the original debt. This distinction is important for gain or loss recognition. A gain or loss on extinguishment of a financial liability is recognised in  the income statement. Any net cash flow in relation to the restructuring of financial liabilities is an adjustment to the debt’s carrying amount and is amortised over the remaining life of the   liability.

IFRS Derecognition of financial instruments

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