IFRS 9 Assume obligation to pay cash flow is part of a decision model for the derecognition of financial assets. The derecognition can be a full derecognition, a full continued recognition, a full derecognition with recognition of new assets or liabilities retained or a continued involvement. The model is starting here. Derecognition of financial assets IFRS 9 Assume obligation to pay cash flow
If there is no transfer of contractual rights under IFRS 9 3.2.4(a), an entity should determine if there is an obligation to pass on the cash flows of the financial asset under a pass-through arrangement. [IFRS 9 3.2.4(b)] For example, a transferor that is a trust or SPE may issue beneficial interests in the underlying financial assets to investors but continue to own those financial assets.
All the following conditions have to be met to conclude that such pass-through arrangements meet the criteria for a transfer:
- 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. IFRS 9 Assume obligation to pay cash flow
- 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. IFRS 9 Assume obligation to pay cash flow
- The entity has an obligation to remit any cash flows that it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to reinvest such cash flows, except in cash or cash equivalents (as defined in IAS 7, ‘Cash flow statements’) during the short settlement period from the collection date to the date of required remittance to the eventual recipients, with any interest earned on such investments being passed to the eventual recipients [IFRS 9 3.2.5].
The financial assets remain on the balance sheet if any one of these conditions is not met. IFRS 9 Assume obligation to pay cash flow
If a transfer meets the pass-through requirements, the transferor is deemed to have transferred the asset. However, the transferor will still then need to assess whether it has transferred sufficient risks and rewards associated with the asset to achieve derecognition.
These pass-through conditions follow from the definitions of assets and liabilities in the Conceptual Framework.
The first condition ensures that the transferor is not obliged to transfer any cash flows to the transferee other than those it has collected from the transferred asset. This implies that the transferor has no liability arising from the transaction, as it has no obligation to pay cash.
The second condition regarding the transferor’s ability to sell or pledge the financial assets highlights that the transferor does not control access to the future economic benefits associated with the transferred cash flows and therefore may not have an asset.
The third condition ensures that the transferor does not have use of or benefit from the specific cash flows it collects on behalf of the transferee and is required to remit to them ‘without material delay’. Again, this condition helps ensure that the transferor does not have an asset. An immaterial delay is permitted for practical reasons. For example, in some pass-through arrangements, such as a securitisation of a portfolio of mortgages, it is not practical for the entity to transfer the relatively small amount of cash collected from many individual accounts as and when they arise. Instead, for administrative convenience, the contractual arrangement may provide for cash flows to be remitted in aggregate on a monthly or quarterly basis. IFRS 9 Assume obligation to pay cash flow IFRS 9 Assume obligation to pay cash flow
The third condition also restricts any investment made for the transferee’s benefit to cash or cash equivalents as defined in IAS 7. This means that the transferor is not allowed to invest the funds in other high-yielding medium-term investments, even for the benefit of the transferee. Furthermore, the transferor is not permitted to retain any interest from such short-term highly liquid investments. All such interest received is remitted to the transferee. In practice, the funds are often paid into a trustee bank account for the transferee’s benefit.
The effect of meeting all three pass-through conditions above is that the transferor does not have the rights to particular cash flows arising from the asset (second and third conditions) or a liability to pass on those particular cash flows (first condition), as defined in the Conceptual Framework. In these situations, the transferor may act more as an agent of the eventual recipient than the owner of the asset. Therefore, when those conditions are met, the arrangement is treated as a transfer of the contractual rights to the cash flows and considered for derecognition (ie, is subject to the risks and rewards and control tests – see step 5 and step 6). When the conditions are not met, the transferor acts more as an owner of the asset, with the result that the asset should continue to be recognised. In this case, the transferor still has the rights to the particular cash flows arising from the asset. IFRS 9 Assume obligation to pay cash flow
Continue using this decision tree to evaluate whether and to what extent a financial asset is derecognised…. Document the IFRS questions (including IFRS references) and your answers and your derecognition file is ready for review and authorisation. IFRS 9 Assume obligation to pay cash flow IFRS 9 Assume obligation to pay cash flow IFRS 9 Assume obligation to pay cash flow
Links for more on each IFRS referenced in the decision tree: IFRS 9 3.2.3(a) Rights to cash flows expired, IFRS 9 3.2.4(a) Transferred rights, IFRS 9 3.2.4(b) Assumed an obligation, IFRS 9 3.2.6(a) Transfer risk and rewards test, IFRS 9 3.2.6(b) Retained risks and rewards test, IFRS 9 3.2.6(c) Retained control, IFRS 9 B 3.2.13 Continuing involvement
See also: The IFRS Foundation