Accounting for corporate finance: International Financial Reporting Standards: IAS 39: derecognition of financial asset
A company must go through a number of steps in deciding whether it should derecognise a financial asset.
First, it must decide whether it ought to be considering the asset in its entirety, or whether instead it should just be considering part of the asset, for example specifically identified cash flows from an asset.
Next, the company must consider whether the right to receive cash flows from the asset has expired (for example, a bond has matured, or an option held by the company has expired without being exercised); not surprisingly, this results in derecognition of the asset.
It must also consider whether it has transferred the right to receive such cash flows (for example by selling the asset outright or assigning it to someone else). In straightforward cases such as these, the asset will be derecognised. But transferring the right to receive cash flows is not necessarily the end of the story - IAS 39 imposes two further tests.
- Derecognition is only possible if the company has transferred substantially all the risks and rewards of ownership. For example, if a company sells shares under a repo arrangement where it will repurchase the shares for a fixed price, it retains its exposure to fluctuations in the share price. It would continue to recognise the shares on its balance sheet.
- Even where the company has not retained substantially all the risks and rewards of ownership, it cannot derecognise the asset if it retains control of it. It must continue to recognise it to the extent that it has a continuing involvement. The test of whether the transferor company retains control is whether the transferee has, in practice, the unfettered ability to sell the asset.
A company may, however, retain the right to receive cash flows from an asset, but assume a contractual obligation to pass those cash flows on to someone else. Such an arrangement is treated as a transfer of the asset provided that it meets certain conditions set out in IAS 39 - principally, the terms of the arrangement must prohibit the company from selling the financial asset. This covers, for example, a situation where a special purpose vehicle acquires an investment, but passes on the income from it to unrelated third party investors.