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Chapter
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Financial Instruments: Recognition and Measurement (lAS 39)
Case Study 4
249
This case illustrates the application of the principle fo r derecognition offi nancial assets
Facts
During the reporting period, Entity A has sold various financial assets:
(a) Entity A sells a financial asset for $10,000. There are no strings attached
to
the sale, and no
other rights or obligations are retained by Entity A.
(b) Entity A sells an investment in shares for $ 10,000 but retains a call option to repurchase the
shares at any time at a price equal to their current fair value on the repurchase date.
(c) Entity A sells a portfolio of short-term account receivables for $100,000 and promises to pay up
to $3,000 to compen sate the buyer if and when any defaults occur. Expected credit losses are
significantly less than $3,000, and there are no other significant risks.
(d) Entity A sells a portfolio of receivables for $10,000 but retains the right to service the receiv–
ables for a fixed fee (i.e., to collect payments on the receivables and pass them on to the buyer
of the receivabl es). The servicing arrangement meets the pass-through conditi ons.
(e) Entity A sells an investment in shares for $10,000 and simultaneously enters into a total return
swap with the buyer under which the buyer will return any increases in value to Entity A and
Entity A will pay the buyer interest plus compensation for any decreases in the value of the in–
vestment.
(f)
Entity A sells a portfolio of receivab les for $100,000 and promises to pay up to $3,000 to
compensate the buyer if and when any defaults occur. Expected credi t losses significantly ex–
ceed $3,000.
Required
Help Entity A by evaluating the extent to which derecognition is appropriate in each of the above cases.
Solution
(a) Entity A should derecognize the transferred financial asset, because it has transferred all risks
and rewards of ownership.
(b) Entity A should derecognize the transferred financial asset, because it has transferred substan–
tially all risks and rewards of ownership. While Entity A has retained a call option (i.e., a right
that often precludes derecognition), the exercise price of this call option is the current fair value
of the asset on the repurchase date. Therefore, the value of call option should be close to zero.
Accordingly, Entity A has not retained any significant risks and rewards of ownership.
(c) Entity A should continue to recognize the transferred receivables because it has retained sub–
stantially all risks and rewards of the receivables. It has kept all expected credit risk, and there
are no other substantive risks.
(d) Entity A should derecognize the receivables because it has transferred substantially all risks and
rewards. Depending on whether Entity A will obtain adequate compensation for the servicing
right, Entity A may have to recognize a servicing asset or servicing liability for the servicing
right.
(e) Entity A should continue to recognize the sold investment because it has retained substantially
all the risks and rewards of ownership. The total return swap results in Entity A still being ex–
posed to all increases and decreases in the value of the investment.
(f)
Entity A has neither retained nor transferred substantially all risks and rewards of the trans–
ferred assets. Therefore , Entity A needs to evaluate whether it has retained or transferred con–
trol. Assuming the receivables are not readily available in the market, Entity A would be con–
sidered to have retained control over the receivables. Therefore, it should continue to recogn ize
the continuing involvement it has in the receivables, that is, the lower of ( I) the amoun t of the
asset ($100,000) and (2) the maximum amount of the consideration received it could be re–
quired to repay ($3,000).
5.2 Derecognition of Financial Liabilities
5.2.1
The derecognition requirements for financial liabilities are d ifferent from those for financial
asset s. There is no requirement to asse ss the extent to which the entity has retained ri sks an d re–
ward s in order to derecognize a fin ancial liab ility. Instead, the derecognition requirements for fi–
nancial liabilities focus on whether the fina ncial liability ha s been extinguished. This means that
derecogn ition of a financial liabi lity is appropriate when the obligati on specifie d in the contract is
di scharged or is cancelled or expires. Ab sent legal release from an obligatio n, derecognition is not