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control.
The transferor has transferred substantially all risks and rewards—
situation 2. above.
Derecognition. The transferor recognizes any resulting gain or loss.
Pass-Through Arrangements
It is not always necessary for an entity actually to transfer its rights to receive cash flows from a financial asset in order for the asset to qualify for derecognition
under IAS 39. Under certain conditions, contractual arrangements where an entity continues to collect cash flows from a financial asset it holds, but immediately
passes on those cash flows to other parties, may qualify for derecognition if the entity is acting more like an agent (or “postbox”) than a principal in the arrangement.
Under such circumstances, the entity’s receipts and payments of cash flows may not meet the definitions of assets and liabilities.
Thus, IAS 39 specifies that when an entity retains the contractual rights to receive the cash flows of a financial asset (the “original asset”), but assumes a contractual
obligation to pay those cash flows to one or more entities (the “eventual recipients”), the entity treats the transaction as a transfer of a financial asset if, and only if, all
of these three conditions are met:
1. 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.
2. 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 for the
obligation to pay them cash flows.
3. The entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to
reinvest such cash flows, except for investments in cash or cash equivalents during the short settlement period from the collection date to the date of required
remittance to the eventual recipients, and interest earned on such investments is passed to the eventual recipients.
For arrangements that meet these conditions, the requirements regarding evaluating transfer of risks and rewards just described are applied to the assets subject to
that arrangement to determine the extent to which derecognition is appropriate. If the three conditions are not met, the asset continues to be recognized.
Consolidation
In consolidated financial statements, the derecognition requirements are applied from the perspective of the consolidated group. Before applying the derecognition
principles in IAS 39, therefore, an entity applies IAS 27 and SIC 12, Consolidation—Special-Purpose Entities, to determine which entities should be consolidated.
Special-purpose entities (SPEs) are entities that are created to accomplish a narrow and well-defined objective and often have legal arrangements that impose strict and
sometimes permanent limits on the decision-making powers of the governing board, trustee, or management of the SPEs. For instance, SPEs often are created by
transferors of financial assets to effect a securitization of those financial assets. Under SIC 12, the evaluation of whether an SPE should be consolidated is based on an
evaluation of whether the substance of the relationship indicates that the SPE is controlled. Four indicators are: (1) the activities are conducted according to specific
business needs, so that the entity obtains benefits; (2) decision-making powers including by autopilot to obtain the majority of the benefits; (3) the rights to obtain the
majority of the benefits; and (4) the majority of the residual or ownership risks. Where an SPE is required to be consolidated, a transfer of a financial asset to that SPE
from the parent or another entity within the group does not qualify for derecognition in the consolidated financial statements. The assets are derecognized only to the
extent the SPE in turn sells the transferred assets to a third party or enters into a pass-through arrangement and that sale or arrangement meets the condition for
derecognition.
Summary
The eight steps that are involved in the evaluation of whether to derecognize a financial asset under IAS 39 are
1. Consolidate all subsidiaries (including any SPE).
2. Determine whether the derecognition principles are applied to a part or all of an asset (or group of similar assets).
3. Have the rights to the cash flows from the asset expired? If yes, derecognize the asset. If no, go to step 4.
4. Has the entity transferred its rights to receive the cash flows from the asset? If yes, go to 6. If no, go to step 5.
5. Has the entity assumed an obligation to pay the cash flows from the asset that meets the three conditions? As discussed in the previous section, the three
conditions are that (a) the transferor has no obligation to pay cash flows unless it collects equivalent amounts from the original asset, (b) the transferor is
prohibited from selling or pledging the original asset, and (c) the transferor has an obligation to remit the cash flows without material delay. If yes, go to step 6.
If no, continue to recognize the asset.
6. Has the entity transferred substantially all risks and rewards? If yes, derecognize the asset. If no, go to step 7.
7. Has the entity retained substantially all risks and rewards? If yes, continue to recognize the asset. If no, go to step 8.
8. Has the entity retained control of the asset? If yes, continue to recognize the asset to the extent of the entity’s continuing involvement. If no, derecognize the
asset.
The flowchart illustrates these steps.