IFRS 9 Transfer all risks and rewards

IFRS 9 Transfer all risks and rewards 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

Step 5 Has the entity transferred substantially all risks and rewards? [IFRS 9 3.2.6(a)]

Once an entity has established that it has transferred a financial asset either by transferring the contractual rights to receive the cash flows or under a qualifying pass-through arrangement as discussed above, it carries out the risks and rewards test. This requires the entity to evaluate whether it has: IFRS 9 Transfer all risks and rewards IFRS 9 Transfer all risks and rewards

  • transferred substantially all the risks and rewards of ownership of the financial asset; IFRS 9 Transfer all risks and rewards
  • retained substantially all such risks and rewards; or IFRS 9 Transfer all risks and rewards
  • has neither transferred nor retained substantially all such risks and rewards. In this case, the entity moves on to assess whether it has transferred control [IFRS 9 3.2.6]. IFRS 9 Transfer all risks and rewards

An entity derecognises an asset if it transfers substantially all the risks and rewards of ownership of the asset. Examples of when an entity has transferred substantially all the risks and rewards of ownership are: IFRS 9 Transfer all risks and rewards

  • An unconditional sale of a financial asset for a single fixed cash sum; IFRS 9 Transfer all risks and rewards
  • A sale of a financial asset together with an option to repurchase the financial asset at its fair value at the time of repurchase. In this situation, the entity is no longer exposed to any value risk (potential for gain or exposure to loss) on the transferred asset, which is borne by the buyer. The ability for the seller to buy the asset back at its fair value at the date of repurchase is, in terms of risks and rewards, no different from buying a new asset; and IFRS 9 Transfer all risks and rewards
  • A sale of a financial asset together with a put or call option that is deeply out of the money (that is, an option that is so far out of the money that it is highly unlikely to go into the money before expiry). In this situation, the seller has no substantial risks and rewards because there is no real possibility that the call or put option will be exercised. IFRS 9 Transfer all risks and rewards

Conversely, the entity continues to recognise the asset if it retains substantially all the risks and rewards of ownership of the asset. Derecognition requires the transferor’s exposure to the risks and rewards of ownership to change substantially. Examples of when an entity has retained substantially all the risks and rewards of ownership are: IFRS 9 Transfer all risks and rewards

  • A sale and repurchase transaction where the repurchase price is a fixed price or the sale price plus a lender’s return (for example, a repo or securities lending agreement); IFRS 9 Transfer all risks and rewards
  • A sale of a financial asset together with a total return swap that transfers the market risk exposure back to the entity; and
  • A sale of a financial asset together with a deep in-the-money put or call option (that is, an option that is so far in the money that it is highly unlikely to go out of the money before expiry). IFRS 9 Transfer all risks and rewards

The transfer of risks and rewards is evaluated based on the entity’s exposure, before and after the transfer, to the variability in amount and timing of the net cash flows. All reasonably possible variability in net cash flows (as to amounts and timing) should be considered, and greater weight should be given to those outcomes that are more likely to occur [IFRS 9 3.2.7]. The determination of whether the entity has transferred or retained substantially all the risks and rewards of ownership will often be apparent from the terms and conditions of the transfer. Where this is not obvious, the entity should undertake a quantitative evaluation. That evaluation requires the entity to compute and compare 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. If the entity’s exposure to such variability is no longer significant in relation to the total variability associated with the financial asset, the entity is regarded as having transferred substantially all the risks and rewards of ownership of the financial asset.

Example – Variability in the amounts and timing of cash flows

An entity sells a portfolio of short term 30-day receivables with a nominal value of C1 billion to a third party. The entity guarantees first losses on the portfolio up to 1.25% of the loan volume. The average loss on similar receivables over the last 10 years amounts to 2%.

The expected losses are C20m, and the entity has guaranteed C12.5m. It might therefore appear that, as the entity has guaranteed 62.5% of all the expected losses, it has retained substantially all the risks and rewards of ownership. This is not so, as the calculation cannot be done in this manner. The test looks to who absorbs variability in the asset’s cash flows, rather than who has most of the expected losses. By giving a guarantee, the entity has effectively retained a subordinated interest in the receivables. If the subordinated retained interest absorbs all of the likely variability in net cash flows, the entity retains the risks and rewards of ownership and continues to recognise the receivables in their entirety. However, this is not the case in this example. Therefore, in order to perform a risk and rewards analysis, it is necessary to determine the variability in the amounts and timing of the cash flows both before and after the transfer on a present value basis.

One way in which such a determination can be made is outlined below:

  • The first step is to model different scenarios of cash flows from the C1 billion receivables portfolio that reflects the variability in the amounts and timing of cash flows before the transfer.
  • For each scenario, the present value of the cash flows is calculated by using an appropriate current market interest rate.
  • Probabilities are then assigned to each scenario considering all reasonably possible variability in net cash flows, with greater probability weighting given to those outcomes that are more likely to occur.
  • An expected variance is then calculated that reflects the cash flows’ total variability in the amounts and timing.

The above steps are repeated for cash flows that remain after the transfer.

The expected variance after the transfer is compared with the variance before the transfer to determine whether there has been a significant change in the amounts and timing of cash flows as a result of the transfer. If the change is not significant, it can be concluded that there has been no substantial transfer of the risks and rewards of ownership. If the change is significant, it can be concluded that the risks and rewards of ownership have been substantially transferred.

An illustration of the above modelling is shown below. For illustrative purposes, only six scenarios are included in this example. More scenarios may be required in practice to adequately model the variability in net cash flows of the asset.IFRS 9 Transfer all risks and rewards

IFRS 9 Transfer all risks and rewards

The relative variability retained after the transfer = 638/6,472 = 9.86%. This implies that the entity has transferred substantially all of the risks and rewards of ownership of the receivables.

In the above example, the cash flows’ present value with their associated probabilities constitutes a discrete random variable, for which it is possible to derive an absolute value for the variability, as indicated above. A better measure would be to calculate the variance. However, in this example, that would also produce the same conclusion. Transfer all risks and rewards

Yes | No

 

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

IFRS 9 Transfer all risks and rewards

Leave a Reply

Your email address will not be published. Required fields are marked *