IFRS 9 Retain control of the asset IFRS 9 Retain control of the assetis 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 Retain control of the asset IFRS 9 Retain control of the asset
Step 6 Has the entity retained control of the asset? [IFRS 9 3.2.6(c)]
Under IFRS 9, control in this context is the power to govern so as to obtain benefits. 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. IFRS 9 Retain control of the asset
IFRS 9 explains that the transferee has the ‘practical ability’ to sell the transferred asset if:
- 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]. IFRS 9 Retain control of the asset
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 a 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 fulfil 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 fulfil 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. IFRS 9 Retain control of the 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. IFRS 9 Retain control of the asset IFRS 9 Retain control of the asset IFRS 9 Retain control of the asset
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. IFRS 9 Retain control of the asset IFRS 9 Retain control of the asset
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. IFRS 9 Retain control of the asset IFRS 9 Retain control of the asset IFRS 9 Retain control of the asset
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.
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.
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