The Risk And Rewards Test And The Control Test – FAQ | IFRS

The Risk and Rewards Test and the Control Test

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: The Risk and Rewards Test and the Control Test

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

and

2) has the entity retained control of the asset(s)? The Risk and Rewards Test and the Control Test

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

The risk and rewards 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 three potential outcomes of this evaluation are (see diagram above):

  1. transfer of substantially all risks and rewards of ownership (what normally would be called a (true) sale), derecognise the asset. If there are any rights and obligations created or retained in the transfer, they should be recognised separately as assets or liabilities (IFRS 9 3.2.6(a)],
  2. retain substantially all risks and rewards of ownership (what could be a lease or a rent contract), continue to recognise the asset [IFRS 9 3.2.6(b)], and
  3. the more difficult outcome in between of 1. and 2 – transferred some. [IFRS 9 3.2.6(c)]

1. + 2. Often it will be obvious whether the entity has transferred or retained substantially all risks and rewards of ownership and there will be no need to perform any computations.

3. In other cases, it will be necessary to compute and compare the entity’s exposure to the variability in the present value of the future net cash flows before and after the transfer. Computations and comparison are made using an appropriate current market interest rate as the discount rate. All reasonably possible variability in net cash flows is considered, with greater weight being given to those outcomes that are more likely to occur [IFRS 9 3.2.7-8].

IFRS 9 does not set any threshold that would represent ‘subst]ntially’ all risks and rewards.

Examples of when an entity has transferred substantially all the risks and rewards of ownership are given in paragraph IFRS 9 B3.2.4 and examples of when an entity has retained substantially all the risks and rewards of ownership are given in paragraph IFRS 9 B3.2.5. Finally, an example of when an entity has neither retained nor transferred substantially all the risks and rewards is given in paragraphs IFRS 9 B3.2.16(h)-(i) and IFRS 9 B3.2.17.

The control test The Risk and Rewards Test and the Control Test

This is the last test to be conducted in the derecognition decision tree (see  IFRS 9 B3.2.1). It should be answered when an entity transferred an asset, but has neither retained nor transferred substantially all risks and rewards. If the entity has not retained control, it should derecognise the financial asset and recognise separately as assets or liabilities any rights and obligations created or retained in the transfer. If the entity has retained control, it continues to recognise the financial asset to the extent of its continuing involvement in the financial asset (IFRS 9.3.2.6(c)).

Whether the entity has retained control of the transferred asset depends on the transferee’s (i.e. a party to whom the asset was transferred) ability to sell the asset. If the transferee has the practical ability to sell the asset in its entirety to an unrelated third party and is able to exercise that ability unilaterally and without needing to impose additional restrictions on the transfer, the entity has not retained control. In all other cases, the entity has retained control (IFRS 9 3.2.9).

Paragraphs IFRS 9 B3.2.7-9 elaborate on what is meant by practical ability to sell the asset. It starts with a sentence saying that ‘transferee has the practical ability to sell the transferred asset if it is traded in an active market because the transferee could repurchase the transferred asset in the market if it needs to return the asset to the entity’. Some tend to interpret this as a condition that an asset must be traded in an active market irrespective of the circumstances. In my opinion this is not the case, as the explanation goes on to say that an active market is needed when the transferee would need to repurchase the transferred asset in the market if it needs to return the asset to the entity. If the transferee would not be obliged to repurchase a transferred asset under no circumstances, there need not be an active market in order to conclude that the control has been transferred. In any case, accounting consequence will often be essentially the same, as retaining control means accounting for continuing involvement in the asset (see below), which will often be similar to recognition of any assets or liabilities resulting from rights and obligations created or retained in the transfer under paragraph IFRS 9 3.2.6(c).

The Risk and Rewards Test and the Control Test

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