will include neither the transferred asset nor the finance raised from noteholders. This
may well mean that the financial statements show nothing apart from the relatively small
amount of equity of the entity and any related assets. This analysis is likely to be
Financial
instruments:
Derecognition
3907
applicable only for relatively simple transfers, and not, for example, when derivatives
are transferred along with the non-derivative assets.
3.7 Client
money
A number of financial institutions and other entities hold money on behalf of clients.
The terms on which such money is held can vary widely. In the case of normal deposits
with a bank, the bank is free to use the client’s money for its own purposes, with the
client being protected by the capital requirements imposed by the regulatory
authorities. By contrast there are cases (e.g. in the case of certain monies held by legal
advisers on behalf of their clients in some jurisdictions) where funds held on behalf of
clients must be kept in a bank account completely separate from that of the depositary
entity itself, with all interest earned on the account being for the benefit of clients. There
are also intermediate situations where, for example:
• funds are required to be segregated in separate bank accounts but the depositary
entity is allowed to retain some or all of the interest on the client accounts; or
• client funds are allowed to be commingled with those of the depositary entity, but
some or all income on the funds must be passed on to clients.
This raises the question of how client monies should be accounted for in the financial
statements under IFRS. In particular, whether the assets should be recognised in the
first place, and if so whether, in the absence of specific guidance, the rules for the
treatment of funds received under a pass-through arrangement (see 3.6.4 above) should
be applied.
The types of arrangement to deal with client money are so varied that it is impossible
to generalise as to the appropriate treatment. Key considerations include:
• which party is at risk from the failure of assets, such as bank accounts, in which the
client money is held;
• the status of the funds in the event of the insolvency of either the reporting entity
or its client;
• whether the reporting entity can use the cash for its own purposes as opposed to
administering the cash on behalf of the client in its capacity as an agent; and
• which party has the benefit of income from the assets.
The analysis for the two extreme cases seems relatively straightforward. In the case of
a bank deposit (or any arrangement where the entity may freely use client cash for its
own benefit), the general recognition criteria of IFRS 9 indicate that an asset and a
liability should be recognised. Conversely, where the entity is required to hold funds
held on behalf of clients in a bank account completely separate from that of the entity
itself, with all interest earned on the account being for the benefit of clients, it is hard to
see how such funds meet the general definition of an asset under the Conceptual
Framework for Financial Reporting. Whilst the entity administers such funds in its
capacity as an agent on behalf of the client, it can derive no economic benefits from
them. The intermediate cases may be harder to deal with.
Sometimes the appropriate analysis will be that the depositary entity enjoys sufficient
use of the client money that it should be recognised as an asset with a corresponding
3908 Chapter 48
liability due to the client. This will be the case, for example, if the client money is
commingled with the reporting entity’s cash for a short period of time. During this
period the reporting entity is exposed to the credit risk associated with the cash and is
entitled to all income accruing. Hence, the reporting entity would recognise the cash as
an asset and a corresponding liability. If the cash is later moved to a segregated client
trust account, an analysis should be performed to determine whether or not the cash
and the corresponding liability should be removed from the reporting entity’s statement
of financial position.
3.8
Has the entity transferred or retained substantially all the risks
and rewards of ownership?
The discussion in this section refers to Boxes 6 and 7 in the flowchart at 3.2 above.
Once an entity has established that it has transferred a financial asset (see 3.5 above),
IFRS 9 then require it to evaluate the extent to which it retains the risks and rewards of
ownership of the financial asset. [IFRS 9.3.2.6].
If the entity transfers substantially all the risks and rewards of ownership of the financial
asset, the entity must derecognise the financial asset and recognise separately as assets
or liabilities any rights and obligations created or retained in the transfer. [IFRS 9.3.2.6(a)].
Examples of such transactions are given at 3.8.1 and 4.1 below. If an entity determines
that, as a result of the transfer, it has transferred substantially all the risks and rewards
of ownership of the transferred asset, it does not recognise the transferred asset again
in a future period, unless it reacquires the transferred asset in a new transaction.
[IFRS 9.B3.2.6].
If the entity retains substantially all the risks and rewards of ownership of the financial
asset, the entity continues to recognise the financial asset. [IFRS 9.3.2.6(b)]. Examples of
such transactions are given at 3.8.2, 4.1 and 4.3 below.
If the entity neither transfers nor retains substantially all the risks and rewards of
ownership of the financial asset (see 3.8.3 below), the entity determines whether it has
retained control of the financial asset [IFRS 9.3.2.6(c)] (see 3.9 below).
IFRS 9 clarifies that the transfer of risks and rewards should be evaluated by comparing
the entity’s exposure, before and after the transfer, to the variability in the amounts and
timing of the net cash flows of the transferred asset. [IFRS 9.3.2.7]. Often it will be obvious
whether the entity has transferred or retained substantially all risks and rewards of
ownership. In other cases, it will be necessary to determine this by computing and
comparing the entity’s exposure to the variability in the present value (discounted at an
appropriate current market interest rate) of the future net cash flows before and after
the transfer. All reasonably possible variability in net cash flows is considered, with
greater weight being given to those outcomes that are more likely to occur. [IFRS 9.3.2.8].
3.8.1
Transfers resulting in transfer of substantially all risks and rewards
An entity has transferred substantially all the risks and rewards of ownership of a financial
asset if its exposure to the variability in the amounts and timing of the net cash flows of the
transferred asset is no longer significant in relation to the total such variability. IFRS 9 gives
Financial
instruments:
Derecognition
3909
the following examples of transactions that transfer substantially all the risks and rewards
of ownership:
• an unconditional sale of a
financial asset;
• a sale of a financial asset together with an option to repurchase the financial asset
at its fair value at the time of repurchase (since this does not expose the entity to
any risk of loss or give any opportunity for profit);
• a sale of a financial asset together with a put or call option that is deeply out of the
money (i.e. an option that is so far out of the money it is highly unlikely to go into
the money before expiry); or
• the sale of a fully proportionate share of the cash flows from a larger financial asset
in an arrangement, such as a loan sub-participation, that satisfies the criteria for a
‘transfer’ in 3.5.2 above. [IFRS 9.3.2.7, B3.2.4].
Such transactions are discussed in more detail at 4 below.
It is important to note that, in order for derecognition to be achieved, it is necessary that
the entity’s exposure to the variability in the amounts and timing of the net cash flows
of the transferred asset is considered not in isolation, but ‘in relation to the total such
variability’ (see above). Thus derecognition is not achieved simply because the entity’s
remaining exposure to the risks or rewards of an asset is small in absolute terms. It has
also become clear, from the Interpretations Committee and IASB’s discussions
described at 3.3.2 above, that derecognition also depends on the interpretation of ‘asset’
and of groups of similar assets that is applied by the entity.
3.8.2
Transfers resulting in retention of substantially all risks and rewards
An entity has retained substantially all the risks and rewards of ownership of a financial
asset if its exposure to the variability in the present value of the future net cash flows
from the financial asset does not change significantly as a result of the transfer. IFRS 9
gives the following examples of transactions in which an entity has retained substantially
all the risks and rewards of ownership:
• a sale and repurchase transaction where the repurchase price is a fixed price or
the sale price plus a lender’s return;
• a securities lending agreement;
• a sale of a financial asset together with a total return swap that transfers the market
risk exposure back to the entity;
• a sale of a financial asset together with a deeply in the money put or call option
(i.e. an option that is so far in the money that it is highly unlikely to go out of the
money before expiry). It will be in the holder’s interest to exercise such an option,
so that the asset will almost certainly revert to the transferor; and
• a sale of short-term receivables in which the entity guarantees to compensate the
transferee for credit losses that are likely to occur. [IFRS 9.3.2.7, B3.2.5].
Such transactions are discussed in more detail at 4.1 below.
3910 Chapter 48
3.8.3
Transfers resulting in neither transfer nor retention of substantially
all risks and rewards
IFRS 9 gives the following examples of transactions in which an entity has neither
transferred nor retained substantially all the risks and rewards of ownership:
• a sale of a financial asset together with a put or call option that is neither deeply in
the money nor deeply out of the money. [IFRS 9.B3.2.16(g)-(h)]. The effect of such an
option is that the transferor will have either (in the case of purchased call option)
capped its exposure to a loss in value of the asset but have potentially unlimited
access to increases in value or (in the case of a written put option) capped its
potential access to increases in value in the asset but assumed potential exposure
to a total loss in value of the asset; and
• a sale of 90% of a loan portfolio with significant transfer of prepayment risk, but
retention of a 10% interest, with losses allocated first to that 10% retained interest.
[IFRS 9.B3.2.17].
Such transactions are discussed in more detail at 4 below.
3.8.4
Evaluating the extent to which risks and rewards are transferred –
practical example
The following example illustrates one approach to evaluating the extent to which risks
and rewards associated with a portfolio of assets have been transferred.
Example 48.1: Risks and rewards analysis – variability in the amounts and
timing of net cash flows
Entity X sells a portfolio of trade receivables with a face value of £1 million and an average due date of
45 days from the issuance of the invoice to Entity Y, an unrelated third party. After the sale, X does not retain
any residual beneficial interests in the receivables. However, X guarantees losses on the transferred portfolio
up to a percentage of the total face value. Default losses, including late payments, as a percentage of face
value ranged historically from 3% to 5%.
Assume the following two hypothetical situations:
• Fact pattern 1 – Entity X guarantees first losses on the portfolio up to 3.5% of the total face value.
• Fact pattern 2 – Entity X guarantees first losses on the portfolio up to 4% of the total face value.
The following calculations illustrate one possible approach for calculating the exposure to the variability in
the amounts and timing of net cash flows.
Under this approach the reporting entity (Entity X) determines a number of reasonably possible scenarios that
reflect the expected variability in the amounts and timing of net cash flows; these scenarios are then assigned
a probability, with greater weighting being given to those outcomes that are more likely to occur. Next,
Entity X calculates the expected future net cash flows for each scenario, discounted using an appropriate
current market rate. The expected variability is then calculated using an appropriate statistical technique. The
above steps are duplicated for net cash flows that the transferor, Entity X, remains exposed to after the
transfer. Finally, the exposure to expected variability of net cash flows post transfer is compared to the
corresponding expected variability before the transfer.
In this example, the expected variability is calculated by adding up the individual (negative or positive)
deviations of the expected discounted future net cash flows for each scenario from the total expected value
of the net cash flows for all possible scenarios. As the receivables are relatively short-term, the calculations
below focus primarily on credit risk, including delinquency risk. For simplicity, the calculations below ignore
the effect of discounting.
Financial
instruments:
Derecognition
3911
Fact pattern 1: Entity X guarantees first losses on the portfolio up to 3.5% of total face value.
Based on historical experience and supportable expectations Entity X has defined five scenarios of
possible variability, each of which has been assigned a probability based on historical experience and
current market information. These scenarios and probabilities are set out below.
Before Transfer
Face value = £1,000,000 = A
Probability
Probability
Probability
Possible
Discounted
weighted
weighted
weighted
credit loss expected cash
discounted
negative
flows
Probability
cash flows
Variability
variability
variability
B C= D
E=C×D
F=C–Σ(E)
G= F×D
H=F×D
A – [A×B]
if F<0
if F>0
£
£
£
£
£
3.0% 970,000
3.5%
33,950
11,550
– 404.25
3.5% 965,000 20.0%
193,000
6,550
–
1,310.00
4.0% 960,000 30.0%
288,000
1,550
– 465.00
4.5% 955,000 35.0%
334,250
(3,450)
(1,207.50) –
5.0% 950,000 11.5%
109,250
(8,450)
(971.75) –
100.0%
958,450
(2,179.25)
2,179.25
K K
I
£41,550
=A – Σ(E)
After Transfer
Face value = £1,000,000 = A
Probability
Probability
Probability
Possible
Discounted
weighted
weighted
weighted
credit loss expected cash
discounted
negative
positive
flows
Probability
cash flows
Variability
variability
variability
B C=[A×(B)], D
E=C×D
F=C–Σ(E)
G=F×D
H=F×D
max 35,000
if F<0
if F>0
£
£
£
£
£
3.0% 30,000 3.5%
1,050
(4,825)
(168.88)
–
3.5% 35,000 20.0%
7,000
175
– 35.00
4.0% 35,000 30.0%
10,500
175
– 52.50
4.5% 35,000 35.0%
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 773
