Derecognition of a financial asset

The basic premise for the derecognition model in IAS 39 is to determine whether the asset under consideration for
derecognition is: [IAS 39.16]

 an asset in its entirety or

 specifically identified cash flows from an asset or

 a fully proportionate share of the cash flows from an asset or

 a fully proportionate share of specifically identified cash flows from a financial asset

Once the asset under consideration for derecognition has been determined, an assessment is made as to whether the
asset has been transferred, and if so, whether the transfer of that asset is subsequently eligible for derecognition.

An asset is transferred if either the entity has transferred the contractual rights to receive the cash flows, or the
entity has retained the contractual rights to receive the cash flows from the asset, but has assumed a contractual
obligation to pass those cash flows on under an arrangement that meets the following three conditions: [IAS 39.17-
19]

 the entity has no obligation to pay amounts to the eventual recipient unless it collects equivalent amounts
on the original asset

 the entity is prohibited from selling or pledging the original asset (other than as security to the eventual
recipient),

 the entity has an obligation to remit those cash flows without material delay

Once an entity has determined that the asset has been transferred, it then determines whether or not it has
transferred substantially all of the risks and rewards of ownership of the asset. If substantially all the risks and
rewards have been transferred, the asset is derecognised. If substantially all the risks and rewards have been
retained, derecognition of the asset is precluded. [IAS 39.20]

If the entity has neither retained nor transferred substantially all of the risks and rewards of the asset, then the entity
must assess whether it has relinquished control of the asset or not. If the entity does not control the asset then
derecognition is appropriate; however if the entity has retained control of the asset, then the entity continues to
recognise the asset to the extent to which it has a continuing involvement in the asset. [IAS 39.30]

These various derecognition steps are summarised in the decision tree in AG36.

Derecognition of a financial liability

A financial liability should be removed from the balance sheet when, and only when, it is extinguished,
that is, when the obligation specified in the contract is either discharged or cancelled or expires.
[IAS 39.39] Where there has been an exchange between an existing borrower and lender of debt
instruments with substantially different terms, or there has been a substantial modification of the terms of
an existing financial liability, this transaction is accounted for as an extinguishment of the original
financial liability and the recognition of a new financial liability. A gain or loss from extinguishment of
the original financial liability is recognised in profit or loss.

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 5. DERECOGNITION any unrealized holding gains or losses that previously have been included in equity
The term “derecognition” refers to when an entity should remove an asset or for that financial
liability from its balance asset.
sheet. The derecognition requirements in IAS 39 set out the conditions that must be
met in 5.1.8 If an entity transfers a financial asset but retains substantially all risks and
order to derecognize a financial asset or financial liability and the computation of rewards of ownership
any gain or loss of the financial asset—situation (1) above—IAS 39 requires the entity to continue to
on derecognition. There are separate derecognition requirements for financial assets recognize
and financial the financial asset in its entirety. No gain or loss is recognized as a result of the
liabilities. transfer. This
5.1 Derecognition of Financial Assets situation is sometimes referred to as a failed sale.
5.1.1 Under IAS 39, derecognition of a financial asset is appropriate if either one of Example
these two Examples of transactions where an entity retains substantially all risks and rewards
criteria is met: of ownership—
(1) The contractual rights to the cash flows of the financial asset have expired, or situation (1)—include
(2) The financial asset has been transferred (e.g., sold) and the transfer qualifies for • A sale of a financial asset where the asset will be returned to the transferor for a
derecognition fixed price
based on an evaluation of the extent of transfer of the risks and rewards of at a future date (e.g., a sale and repurchase [repo] transaction)
ownership • A securities lending transaction
of the financial asset. • A sale of a group of short-term accounts receivables where the transferor issues a
5.1.2 The first criterion for derecognition of a financial asset is usually easy to guarantee
apply. The contractual to compensate the buyer for any credit losses incurred in the group and there are no
rights to cash flows may expire, for instance, because a customer has paid off an other
obligation appropriate because the rights associated with the financial asset no substantive risks transferred
longer exist. • A sale of a financial asset where the transferor retains a call option to repurchase
5.1.3 The application of the second criterion for derecognition of financial assets is the transferred
often more asset, at the transferor’s option, where the option is deep-in-the-money (i.e., it is
complex. It relies on an assessment of the extent to which the entity has transferred highly probable that the option will be exercised)
the risks and • A sale of a financial asset where the transferor issues (writes) a put option that
rewards of ownership of the asset and, if that assessment is not conclusive, an obligates it to
assessment of repurchase the transferred asset, at the transferee’s option, where the option is
whether the entity has retained control of the transferred financial asset. deep-in-the
5.1.4 More specifically, when an entity sells or otherwise transfers a financial asset money
to another • A sale of a financial asset where the transferor enters into a total return swap with
party, the entity (transferor) must evaluate the extent to which it has transferred the the transferee
risks and rewards that returns all increases in fair value of the transferred asset to the transferor and
of ownership of the transferred financial asset to the other party (transferee). This provides
evaluation the transferee with compensation for all decreases in fair value
is based on a comparison of the exposure to the variability in the amounts and
timing of the net
cash flows of the asset before and after the transfer of the asset. 5.1.9 The evaluation of the extent to which derecognition of a financial asset is
5.1.5 IAS 39 distinguishes among three types of transfers: appropriate becomes
(1) The entity has retained substantially all risks and rewards of ownership of the more complex when the entity has retained some risks and rewards of ownership of
transferred a financial
asset. asset and transferred others. To do this evaluation, it may be necessary to perform a
(2) The entity has transferred substantially all risks and rewards of ownership of the quantitative
transferred comparison of the entity’s exposure before and after the transfer to the risks and
asset. rewards of the
(3) The entity has neither retained nor transferred substantially all risks and rewards transferred asset. If the evaluation results in the conclusion that the entity has neither
of ownership retained nor
of the transferred asset (i.e., cases that fall between situations (1) and (2) above). transferred substantially all risks and rewards of ownership—situation (3) above—
5.1.6 If an entity transfers substantially all risks and rewards of ownership of a derecognition
transferred financial depends on whether the entity has retained control of the transferred financial asset.
asset—situation (2) above—the entity derecognizes the financial asset in its entirety. An entity has
lost control if the other party (the transferee) has the practical ability to sell the asset
in its entirety
Example to a third party without attaching any restrictions to the transfer.
Examples of transactions where an entity has transferred substantially all risks and
rewards of
ownership—situation (1) above—include 5.1.10 If the transferor has lost control of the transferred asset, the financial asset is
• A sale of a financial asset where the seller (transferor) does not retain any rights derecognized
or obligations in its entirety. If there is a difference between the asset’s carrying amount (adjusted
(e.g., an option or guarantee) associated with the sold asset for any deferred
• A sale of a financial asset where the transferor retains a right to repurchase the unrealized holding gains and losses in equity) and the payment received, a gain or
financial loss is
asset, but the repurchase price is set as the current fair value of the asset on the recognized in the same way as in situation (1).
repurchase 5.1.11 If the transferor has retained control over the transferred asset, the entity
date continues to recognize
• A sale of a financial asset where the transferor retains a call option to repurchase the asset to the extent of its continuing involvement. The continuing involvement is
the transferred determined
asset, at the transferor’s option, but that option is deep-out-of-the-money (i.e., it is based on the extent to which the entity continues to be exposed to changes in
not amounts and
probable that the option will be exercised) timing of the net cash flows of the transferred asset (i.e., based on its nominal or
• A sale of a financial asset where the transferor writes a put option that obligates it maximum exposure
to repurchase to changes in net cash flows of the transferred asset).
the transferred asset, at the transferee’s option, but that option is deep-out-of-
themoney 5.1.10 If the transferor has lost control of the transferred asset, the financial asset is
5.1.7 On derecognition, if there is a difference between the consideration received derecognized
and the carrying in its entirety. If there is a difference between the asset’s carrying amount (adjusted
amount of the financial asset, the entity recognizes a gain or loss in profit or loss on for any deferred
the sale. unrealized holding gains and losses in equity) and the payment received, a gain or
For a derecognized financial asset classified as available for sale, the gain or loss is loss is
adjusted for recognized in the same way as in situation (1).

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 5.1.11 If the transferor has retained control over the transferred asset, the entity
continues to recognize
the asset to the extent of its continuing involvement. The continuing involvement is
determined
based on the extent to which the entity continues to be exposed to changes in
amounts and
timing of the net cash flows of the transferred asset (i.e., based

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