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Pass through testing

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Pass through testingPass through testing provides some examples to learn which types of financial instruments/transactions qualify for accounting for a pass-through arrangement. All the following conditions have to be met to conclude that such pass-through arrangements meet the criteria for a transfer: [IFRS 9 3.2.5]

  • 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. Pass-through arrangements
  • The entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to
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What is a Business Model?

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What is a Business Model? The business model test is about whether the asset is part of a group or portfolio that is being managed within a business model whose objective is to collect contractual cash flows from the non-equity financial asset (Amortised Cost), or to both collect contractual cash flows from the non-equity financial asset and sell the non-equity financial asset (FVOCI). Otherwise, the asset is measured at FVPL. What is a Business Model?

An entity’s business model for managing financial assets:

  • reflects how financial assets are managed to generate cash flows
  • is determined by the entity’s key management personnel
  • does not depend on management’s intentions for individual instruments but is
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IFRS 9 Reclassification of financial instruments

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IFRS 9 Reclassification of financial instruments

For financial assets, reclassification is required between FVTPL, FVTOCI and amortised cost, if and only if the entity’s business model objective for its financial assets changes so its previous model assessment would no longer apply. [IFRS 9, paragraph 4.4.1]

If reclassification is appropriate, it must be done prospectively from the reclassification date which is defined as the first day of the first reporting period following the change in business model. An entity does not restate any previously recognised gains, losses, or interest.

IFRS 9 does not allow reclassification: IFRS 9 Reclassification of financial instruments

  • for equity investments measured at FVTOCI, or
  • where the fair value option has been exercised in any
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IFRS 9 Financial Instruments Measurement

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IFRS 9 Financial Instruments Measurement uses the following criteria for determining the classification and measurement of financial assets at Amortized Cost, Fair Value through Other Comprehensive Income (FVOCI) or Fair Value through Profit or Loss (FVPL):

IFRS 9 Financial Instruments Measurement

The critical issues for classifying and measuring financial assets are whether:

  • The objective of the entity’s business model is to hold assets only to collect cash flows, or to collect cash flows and to sell (“the Business Model test”), and

  • The contractual cash flows of an asset give rise to payments on specified dates that are solely payments of principal and interest (“SPPI”) on the principal amount outstanding (“the SPPI test”). IFRS 9 Financial Instruments Measurement

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IFRS 9 The Business Model Test

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IFRS 9 The Business Model Test is a necessary condition (see IFRS 9 Classification and Measurement of Financial Instruments) for classifying a loan or receivable at Amortized Cost or FVOCI. The test is about whether the asset is part of a group or portfolio that is being managed within a business model whose objective is to collect contractual cash flows from the non-equity financial asset (Amortized Cost), or to both collect contractual cash flows from the non-equity financial asset and sell the non-equity financial asset (FVOCI). Otherwise, the asset is measured at FVPL. The key elements of this test are listed below.

Observe: IFRS 9 recommends applying the Business Model test before applying the SPPI

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The Risk and Rewards Test and the Control Test

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The Risk and Rewards Test and the Control Test are used to validate the accounting for a transfer of a financial asset under IFRS 9 Financial instruments.

Based on criteria in previous steps it has been concluded that an entity has transferred a financial asset (see IFRS 9 B3.2.1).

The central questions here are:

1) has the entity transferred or retained substantially all risks and rewards?

and The Risk and Rewards Test and the Control Test

2) has the entity retained control of the asset(s)? 

Which leads to 3 possible outcomes, or in a diagram:

The Risk and Rewards Test and the Control Test

The risk and rewards test and the Control Test

These steps are set out in paragraphs IFRS 9 3.2.6(a)-(b). The … Read more

Derecognise a transfer of a financial instrument or not?

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Derecognise a transfer of a financial instrument or not – to quickly grow comfortable and get a gut feeling for derecognising a financial instrument read this page. Small cases with different inputs with a analysing comment on the case provide a fruitful learning ground. Here are some examples regarding transfers of financial instruments and the question of whether or not these should be derecognised (and why)? Derecognise a transfer of a financial instrument or not

Transfer versus agency relationshipDerecognise a transfer of a financial instrument or not

Question Derecognise a transfer of a financial instrument or not

Is the transfer of securities to a custodian a transfer of the contractual rights under IFRS 9 3.2.4(a)?

Background Derecognise a transfer of a financial instrument or Read more

Derecognise a sale of a financial instrument or not?

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Derecognise a sale of a financial instrument or not – to quickly grow comfortable and get a gut feeling for derecognising a financial instrument read this page. Small cases with different inputs with a analysing comment on the case provide a fruitful learning ground. Here are some examples regarding sale transactions of financial instruments and whether or not these should be derecognised or not (and why)?

Sale of disproportionate interest

Question

Can the sale of the rights to the first of any cash collections from a group of similar financial assets be considered a part of those assets for derecognition purposes?

Background

Entity A originates a portfolio of similar five-year interest-bearing loans of 10,000. A then enters … Read more

Control and continuing involvement

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Control and continuing involvement – 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. Control and continuing involvement

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 Read more

Pass through arrangements

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Pass through arrangements – 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. 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. Pass through arrangements

All the following conditions have to be met to conclude that such pass-through arrangements meet the criteria for a transfer: [IFRS 9 3.2.5]

  • The entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original
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