they apply consistently to the derecognition of groups of financial assets.
3.3.2.A
The IASB’s view and the Interpretations Committee’s tentative
conclusions
Although the Interpretations Committee initially tended to the view that the IASB
intended a single test to be undertaken,2 the IASB itself indicated that derivatives
transferred together with non-derivative financial assets were not ‘similar’ to non-
derivative financial assets for the purposes of what is now paragraph 3.2.2 of IFRS 9.
Therefore, an entity would apply the derecognition tests in IFRS 9 to non-derivative
financial assets (or groups of similar non-derivative financial assets) and derivative
financial assets (or groups of similar derivative financial assets) separately, even if they
were transferred at the same time.3 The IASB also indicated that, in order to qualify for
derecognition, transferred derivatives that could be assets or liabilities (such as interest
rate swaps) would have to meet both the financial asset and the financial liability
derecognition tests4 – see the further discussion of this issue at 6.4 below. Whilst the
IASB’s published decision referred only to derivatives transferred with the main non-
derivative assets, observers of the relevant meeting reported that the IASB also took the
view that the derecognition tests must also be applied separately to other financial
assets, such as guarantees and credit insurance, transferred with the main assets.
This could have had practical effects on many securitisations as currently structured
(see 3.6 below). The interpretation could have made it easier to derecognise certain
items (particularly non-derivative assets) than at present. Many derivatives themselves
might not meet the appropriate derecognition criteria at all and would continue to be
recognised. By contrast, a transaction might achieve a transfer of substantially all the
risks and rewards (see Box 6 in Figure 48.1 at 3.2 above, and 3.8 below) of a transferred
asset considered separately from any associated derivatives or guarantees, but not if the
asset and the associated derivatives or guarantees are considered as a whole. However,
the interpretation could well have resulted in far more arrangements falling into the
category of ‘continuing involvement’, where the entity has neither retained nor disposed
of substantially all of the risks and rewards of ownership.
Suppose that an entity transfers a fixed rate loan subject to prepayment risk and a credit
guarantee, but retains prepayment risk through an amortising interest rate swap, linked
to the principal amount of the transferred loan, with the transferee. On the view that
the loan and guarantee should be considered for derecognition as a whole, there was no
real credit risk prior to the transfer because of the guarantee. The entity was exposed
to prepayment risk and the risk of failure by the counterparty to the guarantee. On the
assumption that the latter risk could be considered negligible, the only real risk was
prepayment risk. Thus, on the view that the loan and guarantee should be considered
for derecognition as a whole, they would probably not be derecognised because the
entity would retain the only substantial risk (prepayment risk) to which it was exposed
before the transfer – i.e. the transaction would fail the test of transferring substantially
all risks and rewards in Box 6 in Figure 48.1.
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Following the IASB’s decision, the implication is that the derecognition criteria would
be applied separately to the loan and the guarantee. Considered individually, the loan
gives rise to prepayment risk and credit risk. On this analysis, the transfer would leave
the entity with only one of the two substantial risks (i.e. prepayment risk, but not credit
risk) that it bore previously. This could lead to the conclusion that the entity had neither
transferred nor retained substantially all the risks of the loan, and that the loan would
therefore be recognised only to the extent of the entity’s continuing involvement (in this
example, the interest rate swap) – see Box 9 in Figure 48.1 at 3.2 above, and 5.3 below.
(This assumes the transferor had retained control of the asset, which would normally be
the case in a transaction such as this.)
3.3.2.B
What are ‘similar assets’?
There are a number of different derivative and derivative-like instruments that can be
transferred together with a non-derivative, including:
• hedging instruments that are always assets, e.g. interest rate caps;
• hedging instruments that are always liabilities, e.g. written options;
• hedging instruments that may be an asset or liability at any point in time, e.g.
interest rate swaps;
• purchased financial guarantee contracts and credit insurance; and
• guarantees that are not financial guarantee contracts but are commonly accounted
for as derivatives, e.g. mortgage indemnity guarantee contracts.
The IASB’s interpretation, repeated in its Exposure Draft – Derecognition – referred to
at 2 above, would require each of the first three to meet different derecognition treatments.
Derivatives that could be financial assets or financial liabilities depending on movements
in market value (e.g. interest rate and credit default swaps) would need to meet both the
financial asset and financial liability derecognition requirements of IFRS 9 (even though at
any one time they would be either an asset or a liability). The derecognition of liabilities
requires inter alia legal release by the counterparty (see 6 below). In many securitisations
there is no cancellation, novation or discharge of swaps ‘transferred’ to a structured entity,
in which case the transferor would not be able to derecognise the instrument. This would
raise issues regarding the treatment of the retained swap, as it does not actually expose the
entity to risks and rewards. This is discussed further at 3.6.5 below.
The interpretation raises the difficulty of allocating the single cash flow received from
the transferee to the various financial instruments transferred. This is discussed further
at 3.5.1 below.
Given the withdrawal of the Interpretations Committee ‘non-interpretation’, there is no
underlying principle that would prevent any of the instruments described above being
considered ‘similar’ to the main non-derivative. Therefore, an entity must establish an
accounting policy that it applies consistently to all transactions involving the
derecognition of assets, not only to those associated with securitisation arrangements.
It must bear in mind that a narrow concept of ‘similar’, in which instruments are treated
as separate assets, may make it easier to derecognise some of them but more likely to
have to engage with the problems of continuing involvement and more difficult to
achieve pass through (see 3.5.2 below). Regardless of the accounting policy followed, a
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derivative that involves two-way payments between parties (i.e. the payments are, or
could be, from or to either of the parties) should be derecognised only when both the
derecognition criteria for a financial asset and the derecognit
ion criteria for a financial
liability are met (see 6.4 below).
Once an entity has determined what is ‘similar’, it must consider the derecognition tests
(pass through and transfer of risk and rewards) by reference to the same group of
‘similar’ assets (see 3.5 below).
3.3.3
Transfer of asset (or part of asset) for only part of its life
The examples given in IFRS 9 implicitly appear to have in mind the transfer of a tranche
of cash flows from the date of transfer for the remainder of the life of an instrument.
This raises the question of the appropriate accounting treatment where (for example)
an entity with a loan receivable repayable in 10 years’ time enters into a transaction
whereby all the interest flows for the next 5 years only (or those for years 6 to 10) are
transferred to a third party. There is no reason why such a transaction could not be
considered for partial derecognition.
3.3.4
‘Financial asset’ includes whole or part of a financial asset
In the derecognition provisions in IFRS 9, as well as the discussion at 3 to 5 of this
chapter, the term ‘financial asset’ is used to refer to either the whole, or a part, of a
financial asset (or the whole or a part of a group of similar financial assets). [IFRS 9.3.2.2].
It is therefore important to remember throughout the following discussion that a
reference to an asset being derecognised ‘in its entirety’ does not necessarily mean
that 100% of the asset is derecognised. It may mean, for example, that there has been
full derecognition of, say, 80% of the asset to which the derecognition rules have applied
separately (in accordance with the criteria above).
3.4
Have the contractual rights to cash flows from the asset expired?
The discussion in this section refers to Box 3 in the flowchart at 3.2 above.
The first step in determining whether derecognition of a financial asset is appropriate is
to establish whether the contractual rights to the cash flows from that asset have
expired. If they have, the asset is derecognised. Examples might be:
• a loan receivable is repaid;
• the holder of a perpetual debt, whose terms provide for ten annual ‘interest’
payments that, in effect, provide both interest and a return of capital, receives the
final payment of interest; or
• a purchased option expires unexercised.
If the cash flows from the financial asset have not expired, it is derecognised when, and
only when, the entity ‘transfers’ the asset within the specified meaning of the term in
IFRS 9 (see 3.5 below), and the transfer has the effect that the entity has either:
• transferred substantially all the risks and rewards of the asset (see 3.8 below); or
• neither transferred nor retained substantially all the risks and rewards of the asset
(see 3.8 below), and has not retained control of the asset (see 3.9 below).
[IFRS 9.3.2.3].
Financial
instruments:
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3.4.1
Renegotiation of the terms of an asset
It is common for an entity, particularly but not necessarily when in financial difficulties,
to approach its major creditors for a restructuring of its debt commitments. The
restructuring may involve a modification to the terms of a loan or an exchange of one
debt instrument issued by the borrower for another. In these circumstances, IFRS 9
contains accounting requirements for the borrower to apply which address whether the
restructured debt should be regarded as:
• the continuation of the original liability, albeit with recognition of a modification
gain or loss in profit or loss (see 6.2 and particularly 6.2.2 below) ; or
• a new financial liability which replaces the original liability that is hence
derecognised. In this case the borrower would recognise a gain or loss based on
the difference between the fair value of the restructured debt and the carrying
amount of the original liability (see 6.2 below).
However, IFRS 9 does not contain substantive guidance on when a modification of a
financial asset should result in derecognition from a lender’s perspective. Rather, the
basis for conclusions simply states that some modifications of contractual cash flows
result in derecognition of a financial instrument and the recognition of a new
instrument, but frequently they do not. [IFRS 9.BC5.216, BC5.227].
The Interpretations Committee has acknowledged that determining when a
modification of an asset should result in its derecognition is an issue that arises in
practice and considered undertaking a narrow-scope project to clarify the requirements
of IFRS 9 and IAS 39. However, in May 2016 the committee concluded that the broad
nature of the issue meant it could not be resolved in an efficient manner and decided
not to further consider such a project.5 Consequently, given the limited guidance as to
which modifications of financial assets should lead to derecognition, there will be
diversity in practice in this area.
Derecognition is more likely to be considered appropriate when, for instance, there is a
change in currency or a basis of interest calculation (such as moving from fixed to
floating) so that the original effective interest rate (EIR) would no longer provide an
appropriate measure of interest income. Derecognition is also more likely to be
considered appropriate when significant new features are introduced into the
instrument, such as adding a profit participation to a loan agreement, particularly where
the characteristics of the asset would no longer satisfy the criteria of IFRS 9 to be
recorded at amortised cost (see Chapter 44 at 6.4.5).
IFRS 9 introduced additional, more specific, requirements on accounting for the
modification of a financial asset when its contractual cash flows are renegotiated or
otherwise modified and the asset is not derecognised that were not included in IAS 39.
In those cases the entity should recalculate the gross carrying amount of the financial
asset and recognise a modification gain or loss in profit or loss. The gross carrying
amount is recalculated as the present value of the renegotiated or modified contractual
cash flows, discounted at the financial asset’s original effective interest rate (or credit-
adjusted effective interest rate for purchased or originated credit-impaired financial
assets) or, when applicable, the revised effective interest rate calculated in accordance
with paragraph 6.5.10 of IFRS 9. Any costs or fees incurred adjust the carrying amount
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of the modified financial asset and are amortised over the remaining term of the
modified financial asset. [IFRS 9.5.4.3]. These requirements are considered in more detail
in Chapter 46 at 3.8.
3.4.2
Interpretations Committee discussions on asset restructuring in the
context of Greek government debt
In February 2012, the Greek government announced the terms of a restructuring of
certain of its issued bonds. One aspect involved the exchange of 31.5% of the principal
amount of the bonds for twenty new bonds with different maturities and interest rates.
The remaining portions of the bonds were either forgiven or exchanged for other
securities issued by the European Financial Stability Facility, a special purpose entity
established by Eurozone states.
Soon afterwards, the Interpretations Committee was asked to address the appropriate
accounting treatment for certain aspects of the restructuring, which they did initially in
May 2012. One question the Committee considered was whether the exchange of 31.5%
of the principal amount of the original bonds for new bonds could be regarded as a
continuation of that portion of the original asset or whether that portion should also be
derecognised (it being widely accepted that the remaining portions of the bonds should
be derecognised).
The committee first addressed whether the exchange should be regarded as a transfer.
They noted that the bonds were transferred back to the issuer rather than to a third
party and, as a consequence, concluded this particular restructuring should not be
regarded as a transfer (see 3.5.1 below). Instead, it should be evaluated to determine
whether it amounted to an actual or in-substance expiry or extinguishment of the
original cash flows.
The staff analysis was clear that a modification of terms can result in expiry of the asset’s
original rights to cash flows, although it would not always do so. This is because it is
implicit within the requirements for measuring impairment losses that a modification
would sometimes be regarded as a continuation of the original, albeit impaired, asset.
Therefore an entity would assess the modifications made against the notion of ‘expiry’
of the rights to the cash flows.6
The staff analysis indicated that the ‘hierarchy’ in IAS 8 – Accounting Policies, Changes
in Accounting Estimates and Errors – would be applied in developing an appropriate
accounting policy. Whilst this requires the application of judgement, it is not an absolute
discretion. Consequently, it would be appropriate to analogise, at least to some extent,
to those requirements in IAS 39, which are now contained in IFRS 9, applying to
modifications and exchanges of financial liabilities, particularly the notion of ‘substantial
modification’ and the fact that modifications and exchanges between an existing lender
and borrower are seen as equivalent (see 6.2 below). However, applying the ‘10% test’
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 770
