Under IFRS 9, control is different from the notion of control in IAS 27 – the power to govern so as to obtain benefits. The notion in IAS 27 focuses on the powers of the entity (transferor) and implies an ability to manage the asset actively. In contrast, in the context of derecognition under IFRS 9, control is based on whether the transferee has the practical ability to sell the asset. This IFRS 9 notion addresses the extent that the transferor continues to be exposed to the cash flows of the particular asset that was the subject of the transfer as opposed to be exposed to risks of a more general nature, similar to a derivative. Control and continuing involvement
IFRS 9 explains that the transferee has the ‘practical ability’ to sell the transferred asset if: Control and continuing involvement
- The transferee can sell the asset in its entirety to an unrelated third party; and
- The transferee is able to exercise that ability unilaterally and without imposing additional restrictions [IFRS 9 3.2.9]. Control and continuing involvement
In the context of the first bullet point above, the transferee has the practical ability to sell the transferred asset if it is traded in an active market because the transferee could repurchase an identical asset in the market if it needs to return the asset to the entity. For example, an entity (the transferor) may transfer security with an option (neither deeply in nor out of the money) attached that allows the entity to repurchase the security at some future date. If there is an active market in the security, the transferee is able to sell the security to a third party, knowing that it will be easy to obtain a replacement asset and fulfill its obligation if the transferor exercises the option.
The concept of control focuses on what the transferee is able to do in practice; in this case, it is important that an active market exists. If there is no market, as is commonly the case for many kinds of loans and receivables, the transferee is unable to ensure that it can fulfill its obligation to return the asset to the transferor if it sells the asset with no right to repurchase it. Whether the transferee intends to sell the transferred asset is of no relevance as long as it has the practical ability to do so. Similarly, a contractual right to dispose of the transferred asset has little practical effect if there is no market for the transferred asset.
In the context of the second bullet point above, the transferee should also be able to exercise its ability to transfer the asset independent of the actions of others and without having to impose additional restrictions or ‘strings’ to the transfer. For example, if the transferor has imposed obligations on the transferee concerning the servicing of a loan asset, the transferee should attach a similar provision to any transfer that it makes to a third party. Such ‘additional restrictions’ or ‘strings’ impede the free transfer of the asset and fail the ‘practical ability to sell’ test.
Where the transferor writes a put option or provides a guarantee of the original asset, the transfer will also often fail the control test. In these cases, the transferee has effectively bought two assets: the asset that is subject to the transfer and either a guarantee or a put option. Selling the transferred asset on its own immediately invalidates the remaining asset, as the transferee immediately loses any ability to realise its value. Control and continuing involvement
In the absence of an active market, the transferee will only be able to realise the value of the asset by selling a similar guarantee or put option with the assets. Put another way, if the put option or guarantee is valuable enough for significant risk to be retained by the transferor, it precludes the transfer of control. That is, it will be so valuable to the transferee that the transferee would not, in practice, sell the transferred asset to a third party without attaching a similar option or guarantee, or otherwise mirroring the conditions attached to the original transfer. Under these circumstances, as the transferee is constrained from selling the asset without attaching additional strings, the ‘practical ability’ test is failed. The result is that control of the transferred asset is retained by the transferor.
If the transferee has the practical ability to sell the transferred asset, the transferee has control over the asset and the transferor has lost control. The transferor derecognises the asset. On the other hand, if the transferee does not have the practical ability to sell the transferred asset, the transferor has retained control of the transferred asset and continues to recognise the asset to the extent of its continuing involvement. Control and continuing involvement
Why is control so important? This concept helps determine how the transferor’s remaining interest in the asset will be presented: if the transferor has retained control, it still has an interest in the specific assets that have been transferred; therefore, it continues to show that interest on the balance sheet, gross of an offsetting liability. If control has been lost, the transferor still shows its remaining economic interest on the balance sheet, but it is presented net. This recognises that the transferor’s interest is a net exposure (ie, more akin to a derivative) rather than an interest directly related to the specific assets that have been transferred.