3.2.1 Importance of applying tests in sequence

The derecognition rules in IFRS 9 are based on several different accounting concepts, in particular a ‘risks and rewards’ model and a ‘control’ model, which may lead to opposite conclusions.

For example, an entity (A) might have a portfolio of listed shares for which there is a deep liquid market. It might enter into a contract with a third party counterparty (B) on the following terms. A sells the portfolio to B for €10 million, agreeing to repurchase it in two years' time for €10 million plus interest at market rates on €10 million less dividends on the shares.

The nature of the portfolio is such that B is able to sell it to third parties (since it will easily be able to reacquire the necessary shares to deliver back to A under the repurchase agreement). This indicates that B has control over the portfolio and therefore, since the same asset cannot be controlled by more than one party, that A does not. Thus, under a ‘control’ model of derecognition, A would derecognise the portfolio.

However, the nature of the repurchase agreement is also such that A is exposed to all the economic risks and rewards of the portfolio as if it had never been sold to B (since the repurchase price effectively returns to A all dividends paid on the portfolio, and all movements in its market value, during its period of ownership by B). Thus, under a ‘risks and rewards’ model of derecognition, A would continue to recognise the portfolio.

IFRS 9 seeks to avoid the potential conflict between those accounting models by the practically effective requirement to consider them in the strict sequence in the flowchart in 3.2 above – i.e. the ‘risks and rewards’ model first and the ‘control’ model second. Thus, as will be seen from the discussion below (particularly at 4 and 5 below) if an entity (A) transfers an asset to a third party (B) on terms that B is free to sell the asset:

• if A retains substantially all the risks and rewards of the asset (i.e. the answer to Box 7 in the flowchart is ‘Yes’), B's right to sell is irrelevant and the asset continues to be recognised by A; but
• if A has neither transferred nor retained substantially all the risks and rewards of the asset (i.e. the answer to Box 7 in the flowchart is ‘No’), B's right to sell is highly relevant, indicating a loss of control over the asset by A (i.e. the answer to Box 8 in the flowchart is ‘No’), such that A derecognises the asset.

In other words, depending on the reporting entity's position in the decision tree at 3.2 above, the fact that B has the right to sell the asset is either irrelevant or leads directly to derecognition of the asset by A. It is therefore crucial that the various asset derecognition tests in IFRS 9 are applied in the required order.

3.3.1 Credit enhancement through transferor's waiver of right to future cash flows

IFRS 9 gives an illustrative example, the substance of which is reproduced as Example 52.15 at 5.4.4 below, of the accounting treatment of a transaction in which 90% of the cash flows of a portfolio of loans are sold. All cash collections are allocated 90:10 to the transferee and transferor respectively, but subject to any losses on the loans being fully allocated to the transferor until its 10% retained interest in the portfolio is reduced to zero, and only then allocated to the transferee. IFRS 9 indicates that in this case it is appropriate to apply the derecognition criteria to the 90% sold, rather than the portfolio as whole.

At first sight, this seems inconsistent with the position in the scenario in the penultimate paragraph of 3.3 above, where application of the derecognition criteria to the 90% transferred is precluded by the transferor's having given a guarantee to the transferee. Is not the arrangement in Example 52.15 below (whereby the transferor may have to cede some of its right to receive future cash flows to the transferee) a guarantee in all but name?

Whilst IFRS 9 does not expand on this explicitly, a possible explanation could be that the two transactions can be distinguished as follows:

1. the transaction in Example 52.15 may result in the transferor losing the right to receive a future cash inflow, whereas a guarantee arrangement may give rise to an obligation to return a past cash inflow;
2. the transaction in Example 52.15 gives the transferee a greater chance of recovering its full 90% share, but does not guarantee that it will do so. For example, if only 85% of the portfolio is recovered, the transferor is under no obligation to make up the shortfall.

It must be remembered that, at this stage, we are addressing the issue of whether or not the derecognition criteria should be applied to all or part of an asset, not whether derecognition is actually achieved.

In many cases an asset transferred subject to a guarantee by the transferor would not satisfy the derecognition criteria, since the guarantee would mean that the transferor had not transferred substantially all the risks of the asset. For derecognition to be possible, the scope of the guarantee would need to be restricted so that some significant risks are passed to the transferee. However, if the guarantee has been acquired from a third party, there are additional issues to consider that may affect the derecognition of the asset and/or the guarantee (see 3.3.2 below).

3.3.2 Derecognition of groups of financial assets

As described above, the derecognition provisions of IFRS 9 apply to the whole, or a part only, of a financial asset or a group, or a part of a group, of similar financial assets (our emphasis). However, transfers of financial assets, such as debt factoring or securitisations (see 3.6 below), typically involve the transfer of a group of assets (and possibly liabilities) comprising:

• the non-derivative financial assets (i.e. the trade receivables or securitised assets) that are the main focus of the transaction;
• financial instruments taken out by the transferor in order to mitigate the risk of those financial assets. These arrangements may either have already been in place for some time, or they may have been entered into to facilitate the transfer; and
• non-derivative financial guarantee contracts that are transferred with the assets. These are not always recognised separately as financial assets, e.g. mortgage indemnity guarantees which compensate the lending bank if the borrower defaults and there is a deficit when the secured property is sold. Such guarantees may be transferred together with the mortgage assets to which they relate.

Financial instruments transferred with the ‘main’ assets typically include derivatives such as interest rate and currency swaps. The entity may have entered into such arrangements in order to swap floating rate mortgages to fixed rate, or to change the currency of cash flows receivable from financial assets to match the currency of the borrowings, e.g. sterling into euros.

Both the Interpretations Committee and the IASB have considered whether the reference to transfers of ‘similar’ assets in IFRS 9 is intended to require:

• a single derecognition test for the whole ‘package’ of transferred non-derivative assets, and any associated financial instruments, as a whole; or
• individual derecognition tests for each type of instrument (e.g. debtor, interest rate swap, guarantee or credit insurance) transferred.

The IASB and Interpretations Committee did not succeed in clarifying the meaning of ‘similar assets’. The Interpretations Committee came to a tentative decision but passed the matter to the IASB, together with some related derecognition issues, in particular, the types of transaction that are required to be treated as ‘pass through’ and the effect of conditions attached to the assets that have been transferred (discussed at 3.5 below). In November 2006 the Interpretations Committee issued a tentative decision not to provide formal guidance, based on the views publicly expressed by the IASB in the IASB Update for September 2006. The Interpretations Committee's decision not to proceed was withdrawn in January 2007 on the basis of comment letters received by the Interpretations Committee that demonstrated that the IASB's ‘clarification’ was, in fact, unworkable and further guidance was required after all. The Interpretations Committee announced this as follows:

‘In November 2006, the IFRIC published a tentative agenda decision not to provide guidance on a number of issues relating to the derecognition of financial assets. After considering the comment letters received on the tentative agenda decision, the IFRIC concluded that additional guidance is required in this area. The IFRIC therefore decided to withdraw the tentative agenda decision [not to provide further guidance] and add a project on derecognition to its agenda. The IFRIC noted that any Interpretation in this area must have a tightly defined and limited scope, and directed the staff to carry out additional research to establish the questions that such an Interpretation should address.’¹

The next section describes the Interpretations Committee's and IASB's attempts to establish the meaning of ‘similar’, which demonstrated the absence of a clear principle. There is bound to be diversity in practice in the light of the failure to provide an interpretation, so it is most important that entities establish an accounting policy that they apply consistently to the derecognition of groups of financial assets.

3.3.2.A The IASB's view and the Interpretations Committee's tentative conclusions

Although the Interpretations Committee initially tended to the view that the IASB intended a single test to be undertaken,² the IASB itself indicated that derivatives transferred together with non-derivative financial assets were not ‘similar’ to non-derivative financial assets for the purposes of what is now paragraph 3.2.2 of IFRS 9. Therefore, an entity would apply the derecognition tests in IFRS 9 to non-derivative financial assets (or groups of similar non-derivative financial assets) and derivative financial assets (or groups of similar derivative financial assets) separately, even if they were transferred at the same time.³ The IASB also indicated that, in order to qualify for derecognition, transferred derivatives that could be assets or liabilities (such as interest rate swaps) would have to meet both the financial asset and the financial liability derecognition tests⁴ – see the further discussion of this issue at 6.4 below. Whilst the IASB's published decision referred only to derivatives transferred with the main non-derivative assets, observers of the relevant meeting reported that the IASB also took the view that the derecognition tests must also be applied separately to other financial assets, such as guarantees and credit insurance, transferred with the main assets.

This could have had practical effects on many securitisations as currently structured (see 3.6 below). The interpretation could have made it easier to derecognise certain items (particularly non-derivative assets) than at present. Many derivatives themselves might not meet the appropriate derecognition criteria at all and would continue to be recognised. By contrast, a transaction might achieve a transfer of substantially all the risks and rewards (see Box 6 in Figure 52.1 at 3.2 above, and 3.8 below) of a transferred asset considered separately from any associated derivatives or guarantees, but not if the asset and the associated derivatives or guarantees are considered as a whole. However, the interpretation could well have resulted in far more arrangements falling into the category of ‘continuing involvement’, where the entity has neither retained nor disposed of substantially all of the risks and rewards of ownership.

Suppose that an entity transfers a fixed rate loan subject to prepayment risk and a credit guarantee, but retains prepayment risk through an amortising interest rate swap, linked to the principal amount of the transferred loan, with the transferee. On the view that the loan and guarantee should be considered for derecognition as a whole, there was no real credit risk prior to the transfer because of the guarantee. The entity was exposed to prepayment risk and the risk of failure by the counterparty to the guarantee. On the assumption that the latter risk could be considered negligible, the only real risk was prepayment risk. Thus, on the view that the loan and guarantee should be considered for derecognition as a whole, they would probably not be derecognised because the entity would retain the only substantial risk (prepayment risk) to which it was exposed before the transfer – i.e. the transaction would fail the test of transferring substantially all risks and rewards in Box 6 in Figure 52.1.

Following the IASB's decision, the implication is that the derecognition criteria would be applied separately to the loan and the guarantee. Considered individually, the loan gives rise to prepayment risk and credit risk. On this analysis, the transfer would leave the entity with only one of the two substantial risks (i.e. prepayment risk, but not credit risk) that it bore previously. This could lead to the conclusion that the entity had neither transferred nor retained substantially all the risks of the loan, and that the loan would therefore be recognised only to the extent of the entity's continuing involvement (in this example, the interest rate swap) – see Box 9 in Figure 52.1 at 3.2 above, and 5.3 below. (This assumes the transferor had retained control of the asset, which would normally be the case in a transaction such as this.)

3.3.3 Transfer of asset (or part of asset) for only part of its life

The examples given in IFRS 9 implicitly appear to have in mind the transfer of a tranche of cash flows from the date of transfer for the remainder of the life of an instrument. This raises the question of the appropriate accounting treatment where (for example) an entity with a loan receivable repayable in 10 years' time enters into a transaction whereby all the interest flows for the next 5 years only (or those for years 6 to 10) are transferred to a third party. There is no reason why such a transaction could not be considered for partial derecognition.

3.3.4 ‘Financial asset’ includes whole or part of a financial asset

In the derecognition provisions in IFRS 9, as well as the discussion at 3 to 5 of this chapter, the term ‘financial asset’ is used to refer to either the whole, or a part, of a financial asset (or the whole or a part of a group of similar financial assets). [IFRS 9.3.2.2]. It is therefore important to remember throughout the following discussion that a reference to an asset being derecognised ‘in its entirety’ does not necessarily mean that 100% of the asset is derecognised. It may mean, for example, that there has been full derecognition of, say, 80% of the asset to which the derecognition rules have applied separately (in accordance with the criteria above).

3.4.1 Renegotiation of the terms of an asset

It is common for an entity, particularly but not necessarily when in financial difficulties, to approach its major creditors for a restructuring of its debt commitments. The restructuring may involve a modification to the terms of a loan or an exchange of one debt instrument issued by the borrower for another. In these circumstances, IFRS 9 contains accounting requirements for the borrower to apply which address whether the restructured debt should be regarded as:

• the continuation of the original liability, albeit with recognition of a modification gain or loss in profit or loss (see 6.2 and particularly 6.2.3 below); or
• a new financial liability which replaces the original liability that is hence derecognised. In this case the borrower would recognise a gain or loss based on the difference between the fair value of the restructured debt and the carrying amount of the original liability (see 6.2 below).

However, IFRS 9 does not contain substantive guidance on when a modification of a financial asset should result in derecognition from a lender's perspective. Rather, the basis for conclusions simply states that some modifications of contractual cash flows result in derecognition of a financial instrument and the recognition of a new instrument, but frequently they do not. [IFRS 9.BC5.216, BC5.227].

The Interpretations Committee has acknowledged that determining when a modification of an asset should result in its derecognition is an issue that arises in practice and considered undertaking a narrow-scope project to clarify the requirements of IFRS 9. However, in May 2016 the committee concluded that the broad nature of the issue meant it could not be resolved in an efficient manner and decided not to further consider such a project.⁵ Consequently, given the limited guidance as to which modifications of financial assets should lead to derecognition, there will be diversity in practice in this area.

Derecognition is more likely to be considered appropriate when, for instance, there is a change in currency or a basis of interest calculation (such as moving from fixed to floating) so that the original effective interest rate (EIR) would no longer provide an appropriate measure of interest income. Derecognition is also more likely to be considered appropriate when significant new features are introduced into the instrument, such as adding a profit participation to a loan agreement, particularly where the characteristics of the asset would no longer satisfy the criteria of IFRS 9 to be recorded at amortised cost (see Chapter 48 at 6.4.5).

IFRS 9 contains requirements on accounting for the modification of a financial asset when its contractual cash flows are renegotiated or otherwise modified and the asset is not derecognised. In those cases the entity should recalculate the gross carrying amount of the financial asset and recognise a modification gain or loss in profit or loss. The gross carrying amount is recalculated as the present value of the renegotiated or modified contractual cash flows, discounted at the financial asset's original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets) or, when applicable, the revised effective interest rate calculated in accordance with paragraph 6.5.10 of IFRS 9. Any costs or fees incurred adjust the carrying amount of the modified financial asset and are amortised over the remaining term of the modified financial asset. [IFRS 9.5.4.3]. These requirements are considered in more detail in Chapter 50 at 3.8.

3.4.2 Interpretations Committee discussions on asset restructuring in the context of Greek government debt

In February 2012, the Greek government announced the terms of a restructuring of certain of its issued bonds. One aspect involved the exchange of 31.5% of the principal amount of the bonds for twenty new bonds with different maturities and interest rates. The remaining portions of the bonds were either forgiven or exchanged for other securities issued by the European Financial Stability Facility, a special purpose entity established by Eurozone states.

Soon afterwards, the Interpretations Committee was asked to address the appropriate accounting treatment for certain aspects of the restructuring, which they did initially in May 2012. One question the Committee considered was whether the exchange of 31.5% of the principal amount of the original bonds for new bonds could be regarded as a continuation of that portion of the original asset or whether that portion should also be derecognised (it being widely accepted that the remaining portions of the bonds should be derecognised).

The committee first addressed whether the exchange should be regarded as a transfer. They noted that the bonds were transferred back to the issuer rather than to a third party and, as a consequence, concluded this particular restructuring should not be regarded as a transfer (see 3.5.1 below). Instead, it should be evaluated to determine whether it amounted to an actual or in-substance expiry or extinguishment of the original cash flows.

The staff analysis was clear that a modification of terms can result in expiry of the asset's original rights to cash flows, although it would not always do so. This is because it is implicit within the requirements for measuring impairment losses that a modification would sometimes be regarded as a continuation of the original, albeit impaired, asset. Therefore an entity would assess the modifications made against the notion of ‘expiry’ of the rights to the cash flows.⁶

The staff analysis indicated that the ‘hierarchy’ in IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors – would be applied in developing an appropriate accounting policy. Whilst this requires the application of judgement, it is not an absolute discretion. Consequently, it would be appropriate to analogise, at least to some extent, to those requirements in IFRS 9 applying to modifications and exchanges of financial liabilities, particularly the notion of ‘substantial modification’ and the fact that modifications and exchanges between an existing lender and borrower are seen as equivalent (see 6.2 below). However, applying the ‘10% test’ to determine whether a modification is substantial would not always be appropriate.

The committee did not explicitly conclude on this part of the staff analysis, particularly the question of when it would be appropriate to regard a modification or exchange as the expiry or in-substance extinguishment of the original asset. Instead they simply noted that, in their view, derecognition of the original Greek government bonds would be the appropriate accounting treatment however this particular transaction was assessed, i.e. whether it was viewed as (a) an actual expiry of the rights of the original asset or (b) as a substantial modification that should be accounted for as an extinguishment of the original asset (because of the extensive changes in the assets' terms). An agenda decision setting out the committee's conclusions was published in September 2012.⁷

Whilst that discussion resolved most of the issues associated with the restructuring of Greek government bonds, the wider topic continues to require the application of judgement and, as a result, potentially leads to inconsistent approaches being applied by different entities.

3.4.3 Novation of contracts to intermediary counterparties

A change in the terms of a contract may take the legal form of a ‘novation’. In this context novation means that the parties to a contract agree to change that contract so that an original counterparty is replaced by a new counterparty.

For example, a derivative between a reporting entity and a bank may be novated to a central counterparty (CCP) as a result of the introduction of new laws or regulations. In these circumstances, the IASB explains that through novation to a CCP the contractual rights to cash flows from the original derivative have expired and as a consequence the novation meets the derecognition criteria for a financial asset. [IFRS 9.BC6.332‑337].

Whilst the IASB reached the above conclusion in relation to novations of over-the-counter derivatives, it is our view that the principle is applicable to all novations of contracts underlying a financial instrument. Accordingly, when a counterparty changes as a result of a novation, the financial instrument should be derecognised and a new financial instrument should be recognised. Although such a change may not be expected to give rise to a significant gain or loss when the financial instrument derecognised and the new financial instrument recognised are both measured at fair value through profit or loss, the bid/ask spread and the effect of change in counterparty on credit risk may cause some value differences. Furthermore, a novation may result in discontinuation of hedge accounting if the original financial instrument was a derivative designated in a hedging relationship (see Chapter 53 at 8.3 for further details).

3.4.4 Write-offs

An entity is required to directly reduce the gross carrying amount of a financial asset when it has no reasonable expectations of recovery. Such a write-off is regarded as the asset being derecognised – effectively it is seen as an in-substance expiry of the associated rights. Write-offs can also relate to a portion of an asset. For example, consider an entity that plans to enforce the collateral on a financial asset and expects to recover no more than 30% of the financial asset from the collateral. If the entity has no reasonable prospects of recovering any further cash flows from the financial asset, it should write off the remaining 70%. [IFRS 9.5.4.4, B3.2.16(r), B5.4.9].

3.5.1 Transfers of contractual rights to receive cash flows

The discussion in this section refers to Box 4 in the flowchart at 3.2 above.

IFRS 9 does not define what is meant by the phrase ‘transfers the contractual rights to receive the cash flows of the financial asset’ in (a) in 3.5 above, possibly on the assumption that this is self-evident. However, this is far from the case, since the phrase raises a number of questions of interpretation.

There are two key uncertainties about the meaning of ‘transferring the contractual rights’ (which in turn determines whether a transaction falls within (a) or (b) in 3.5 above):

• whether it is restricted to transfers of legal title only or also encompasses transfers of equitable title or an equitable interest (see 3.5.1.A below); and
• the effect of conditions attached to the transfers (see 3.5.1.B below).

While both of these are of great significance to securitisations (see 3.6 below), they also have implications for other transactions. These issues were discussed in 2006 by both the Interpretations Committee and the IASB. However, as described at 3.3.2 above, the Interpretations Committee's tentative decision not to issue further guidance and the interpretation of the issues that had so far been published were both withdrawn in January 2007. There is no clear evidence that practice has changed as a result of the views that had been expressed by the IASB and the Interpretations Committee but, as this has demonstrated a lack of clear underlying principles, it would be no surprise to find that entities have different interpretations of the requirements.

In the context of the restructuring of Greek government bonds (see 3.4.2 above), the Interpretations Committee considered whether an exchange of debt instruments between a borrower and a lender should be regarded as a transfer. It was noted that the bonds were transferred back to the issuer rather than to a third party and, as a consequence, it was agreed that this particular restructuring should not be regarded as a transfer.⁸ However, it was noted during the committee's discussion and in the comment process that applying such a conclusion more widely might not always be appropriate, e.g. in the case of a short-term sale and repurchase agreement over a bond with the bond issuer or the simple repurchase of a bond by the issuer for cash.

3.5.2 Retention of rights to receive cash flows subject to obligation to pay over to others (pass-through arrangement)

The discussion in this section refers to Box 5 in the flowchart at 3.2 above.

It is common in certain securitisation and debt sub-participation transactions (see 3.6 below) for an entity to enter into an arrangement whereby it continues to collect cash receipts from a financial asset (or more typically a pool of financial assets), but is obliged to pass on those receipts to a third party that has provided finance in connection with the financial asset. Whilst the term ‘pass-through’ for these arrangements does not actually appear in IFRS 9 it has become part of the language of the financial markets.

Under IFRS 9, an arrangement whereby the reporting entity retains the contractual rights to receive the cash flows of a financial asset (the ‘original asset’), but assumes a contractual obligation to pay the cash flows to one or more recipients (the ‘eventual recipients’) is regarded as a transfer of the original asset if, and only if, all of the following three conditions are met:

1. 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 (see 3.6.1 and 3.6.2 below);
2. the entity is prohibited by the terms of the transfer contract from selling or pledging the original asset other than as security to the eventual recipients for the obligation to pay them cash flows; and
3. the entity has an obligation to remit any cash flows it collects on behalf of the eventual recipients without material delay. In addition, the entity is not entitled to reinvest such cash flows, except in cash or cash equivalents as defined in IAS 7 – Statement of Cash Flows (see Chapter 40 at 3) during the short settlement period from the collection date to the date of required remittance to the eventual recipients, with any interest earned on such investments being passed to the eventual recipients. [IFRS 9.3.2.5].

These conditions are discussed further at 3.6.4 below.

IFRS 9 notes that an entity that is required to consider the impact of these conditions on a transaction is likely to be either:

• the originator of the financial asset in a securitisation transaction (see 3.6 below); or
• a group that includes a consolidated special purpose entity that has acquired the financial asset and passes on cash flows to unrelated third party investors. [IFRS 9.B3.2.3].

IFRS 9 does not address whether it is necessary for a pass-through arrangement to be able to survive the bankruptcy of the transferor in order to be considered a transfer. Consequently, there is no explicit requirement in the standard to consider the likelihood of the transferor's bankruptcy when assessing pass-through arrangements. This issue was discussed by the IASB in its April 2009 Exposure Draft – Derecognition – where it was proposed that bankruptcy remoteness would not form part of the derecognition model. This was seen at the time as an intentional divergence from US GAAP, which requires transferred financial assets to be legally isolated from the transferor, its consolidated affiliates and its creditors, even in bankruptcy. In practice, if the transferred assets are held in a ring-fenced structured entity this may protect cash flows to the transferee in the event of the transferor's bankruptcy.

3.6.1 Recourse to originator

The conditions in 3.5.2 above clearly have the effect that an arrangement that does not transfer the contractual rights to receive the cash flows but provides for direct recourse to the originator does not meet the definition of a ‘transfer’ for the purposes of pass-through and therefore does not qualify to be considered for derecognition. Direct recourse would include an arrangement whereby part of the consideration for the financial asset transferred was deferred depending on the performance of the asset.

In our view, however, certain techniques for providing indirect recourse do not breach the conditions for transfer. These include, for example, the provision of certain types of insurance (see 3.6.3 below).

3.6.2 Short-term loan facilities

Enhancing a securitised asset with the provision of loan facilities to meet temporary shortfalls as a result of slow payments from the asset would not preclude an arrangement being regarded as a pass-through (see 3.5.2 above), but only where the loans:

• are made on a ‘short-term’ basis;
• are repayable irrespective of whether the slow payments are eventually received; and
• bear interest at market rates.

The purpose of these restrictions is to ensure that IFRS 9 allows derecognition of assets subject to such facilities only where the facilities are providing a short-term cash flow benefit to the investor, and not when they effectively transfer slow payment risk back to the originator (as would be the case if the originator made significant interest-free loans to the investor). Clearly, therefore, the circumstances in which such funds can be advanced must be very tightly defined if pass-through is to be achieved.

3.6.3 Insurance protection

The conditions for ‘transfer’ are not, in our view, breached by the originator purchasing an insurance contract for the benefit of investors in the event of a shortfall in cash collections from the securitised assets, provided that the investors' only recourse is to the insurance policy. In other words, the originator cannot give a guarantee to investors to make good any shortfalls should the insurer become insolvent, nor can the originator provide any support to the insurer through a guarantee arrangement or a reinsurance contract.

The implications of the derecognition and pass-through requirements of IFRS 9 for transfers of groups of financial assets including insurance contracts have been reconsidered by the Interpretations Committee and the IASB but their tentative conclusions were withdrawn. For a discussion of the issues and the alternative interpretations of ‘similar’ assets, see 3.3.2 above.

3.6.4 Treatment of collection proceeds

Securitisation contracts rarely require any amount received on the securitised assets to be immediately transferred to investors. This is for the obvious practical reason that it would be administratively inefficient, in the case of a securitisation of credit card receivables for example, to transfer the relevant portion of each individual, and relatively small, cash flow received from the hundreds, if not thousands, of cards in the portfolio. Instead, it is usual for transfers to be made in bulk on a periodic basis (e.g. weekly or monthly). This raises the question of what happens to the cash in the period between receipt by the issuer and onward transfer to the investors.

IFRS 9 requires cash flows from transferred financial assets for which derecognition is sought to be:

• passed to the eventual recipients ‘without material delay’; and
• invested only in cash or cash equivalents as defined in IAS 7 entirely for the benefit of the investors (see condition (c) in 3.5.2 above).

These requirements mean that many securitisation arrangements may well fail to satisfy the pass-through test in 3.5.2 above, as explained below.

Suppose that a credit card issuer wishes to raise five year finance secured on its portfolio of credit card receivables. The assets concerned are essentially short term (being in most cases settled in full within four to eight weeks), whereas the term of the borrowings secured on them is longer. In practice, what generally happens is that, at the start of the securitisation, a ‘pool’ of balances is transferred to the issuer. The cash receipts from that ‘pool’ are used to pay interest on the borrowings, and to fund new advances on cards in the ‘pool’ or to purchase other balances. Such an arrangement, commonly referred to as a ‘revolving’ structure, appears to breach the requirement of the pass-through tests to:

• pass on cash receipts without material delay (since only the amount of cash receipts necessary to pay the interest on the borrowings is passed on, with the balance being reinvested until the principal of the borrowings falls due); and
• only invest in cash or cash equivalents as defined in IAS 7 in the period prior to passing them onto the investor. This is because the cash not required to pay interest on the borrowings is invested in further credit card receivables, which are not cash or cash equivalents as defined in IAS 7.

The Interpretations Committee confirmed in November 2005 that ‘revolving’ structures do not meet the requirements of the pass-through test for funds to be passed on without material delay and to be invested only in cash and cash equivalents.¹⁵

In practice, we have observed the pass-through tests are applied very strictly such that any arrangement that provides for even a small tranche of the interest from such short-term deposits to be retained by or for the benefit of the originator will not satisfy the criteria for transfer under IFRS 9. Moreover, IFRS 9 requires that the reporting entity ‘is not entitled’ to invest the cash other than in cash or cash equivalents as described above. Thus, it appears that the criteria for transfer are not satisfied merely where the entity does not in fact invest the cash in any other way – it must be contractually prohibited from doing so. In practice, this is often achieved by having the funds paid into a trustee bank account that can be used only for the benefit of the providers of finance.

The IASB does not expand further on the term ‘without material delay’. It is not, in our view, intended to require settlement to noteholders on an unrealistically frequent basis such as daily, although we would normally expect payments to be made by the next quarterly coupon payment date to meet this condition.

The strict requirements of IFRS 9 in respect of cash received from assets subject to a pass-through arrangement raise the related, but broader, issue of the appropriate treatment of client money which is discussed at 3.7 below.

3.6.5 Transfers of non-optional derivatives along with a group of financial assets

As discussed at 3.3.2 above, interest rate swaps that are transferred along with a group of non-derivative financial assets may be derecognised only when any associated obligation is discharged, cancelled or expires (see 6 below). This, however, does not occur in most securitisations.

In a securitisation transaction involving the equitable transfer of an interest rate swap to an SPE, the swap would continue to be recognised by the transferor. The ongoing accounting consequences of this are less clear. The swap must clearly continue to be measured at fair value through profit or loss in accordance with the general requirement of IFRS 9 for the measurement of derivatives not in a hedging relationship (see Chapter 46). However, this would have the effect that the reporting entity reflected gains and losses in the income statement for a derivative in which it no longer has a beneficial interest. In such a case, the entity should presumably recognise the notional back-to-back swap which it has effectively entered into with the transferee, so as to offset the income statement effect of the original swap.

3.6.6 ‘Empty’ subsidiaries or SPEs

If an entity enters into a transaction whereby:

• the entity transfers an asset to a subsidiary or SPE; and
• the subsidiary or SPE transfers the asset to noteholders on terms that satisfy the pass-through derecognition criteria in IFRS 9 discussed at 3.5.2 and 3.6 above,

the overall effect will be that the individual financial statements of the subsidiary or SPE will include neither the transferred asset nor the finance raised from noteholders. This may well mean that the financial statements show nothing apart from the relatively small amount of equity of the entity and any related assets. This analysis is likely to be applicable only for relatively simple transfers, and not, for example, when derivatives are transferred along with the non-derivative assets.

3.8.1 Transfers resulting in transfer of substantially all risks and rewards

An entity has transferred substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the amounts and timing of the net cash flows of the transferred asset is no longer significant in relation to the total such variability. IFRS 9 gives the following examples of transactions that transfer substantially all the risks and rewards of ownership:

• an unconditional sale of a financial asset;
• a sale of a financial asset together with an option to repurchase the financial asset at its fair value at the time of repurchase (since this does not expose the entity to any risk of loss or give any opportunity for profit);
• a sale of a financial asset together with a put or call option that is deeply out of the money (i.e. an option that is so far out of the money it is highly unlikely to go into the money before expiry); or
• the sale of a fully proportionate share of the cash flows from a larger financial asset in an arrangement, such as a loan sub-participation, that satisfies the criteria for a ‘transfer’ in 3.5.2 above. [IFRS 9.3.2.7, B3.2.4].

Such transactions are discussed in more detail at 4 below.

It is important to note that, in order for derecognition to be achieved, it is necessary that the entity's exposure to the variability in the amounts and timing of the net cash flows of the transferred asset is considered not in isolation, but ‘in relation to the total such variability’ (see above). Thus derecognition is not achieved simply because the entity's remaining exposure to the risks or rewards of an asset is small in absolute terms. It has also become clear, from the Interpretations Committee and IASB's discussions described at 3.3.2 above, that derecognition also depends on the interpretation of ‘asset’ and of groups of similar assets that is applied by the entity.

3.8.2 Transfers resulting in retention of substantially all risks and rewards

An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer. IFRS 9 gives the following examples of transactions in which an entity has retained substantially all the risks and rewards of ownership:

• a sale and repurchase transaction where the repurchase price is a fixed price or the sale price plus a lender's return;
• a securities lending agreement;
• a sale of a financial asset together with a total return swap that transfers the market risk exposure back to the entity;
• a sale of a financial asset together with a deeply in the money put or call option (i.e. an option that is so far in the money that it is highly unlikely to go out of the money before expiry). It will be in the holder's interest to exercise such an option, so that the asset will almost certainly revert to the transferor; and
• a sale of short-term receivables in which the entity guarantees to compensate the transferee for credit losses that are likely to occur. [IFRS 9.3.2.7, B3.2.5].

Such transactions are discussed in more detail at 4.1 below.

3.8.3 Transfers resulting in neither transfer nor retention of substantially all risks and rewards

IFRS 9 gives the following examples of transactions in which an entity has neither transferred nor retained substantially all the risks and rewards of ownership:

• a sale of a financial asset together with a put or call option that is neither deeply in the money nor deeply out of the money. [IFRS 9.B3.2.16(h)‑(i)]. The effect of such an option is that the transferor will have either (in the case of purchased call option) capped its exposure to a loss in value of the asset but have potentially unlimited access to increases in value or (in the case of a written put option) capped its potential access to increases in value in the asset but assumed potential exposure to a total loss in value of the asset; and
• a sale of 90% of a loan portfolio with significant transfer of prepayment risk, but retention of a 10% interest, with losses allocated first to that 10% retained interest. [IFRS 9.B3.2.17].

Such transactions are discussed in more detail at 4 below.

3.8.4 Evaluating the extent to which risks and rewards are transferred – practical example

The following example illustrates one approach to evaluating the extent to which risks and rewards associated with a portfolio of assets have been transferred.

3.9.1 Transferee's ‘practical ability’ to sell the asset

IFRS 9 provides further guidance in two scenarios. Firstly, when a transferred asset is subject to a repurchase option, second, when a transfer imposes additional restrictions on selling the transferred assets. If a transferred asset is sold subject to an option that allows the entity to repurchase it, the transferee may (subject to the further considerations discussed below) have the practical ability to sell the asset if it can readily obtain the transferred asset in the market if the option is exercised. [IFRS 9.B3.2.7]. For this purpose there has to be an active market for the asset.

The transferee has the practical ability to sell the transferred asset only if the transferee can sell the transferred asset in its entirety to an unrelated third party and is able to exercise that ability unilaterally and without imposing additional restrictions on the transfer. IFRS 9 requires that practical ability to sell the transferred asset be determined by considering what the transferee is able to do in practice, rather than solely by reference to any contractual rights or prohibitions. The standard notes that a contractual right to dispose of the transferred asset has little practical effect if there is no market for the transferred asset. [IFRS 9.B3.2.8(a)].

An ability to dispose of the transferred asset also has little practical effect if it cannot be exercised freely. Accordingly, the transferee's ability to dispose of the transferred asset must be a unilateral ability independent of the actions of others. In other words, the transferee must be able to dispose of the transferred asset without needing to attach conditions to the transfer (e.g. conditions about how a loan asset is serviced, or an option giving the transferee the right to repurchase the asset). [IFRS 9.B3.2.8(b)].

For example, the entity might sell a financial asset to a transferee but the transferee has an option to put the asset back to the entity or has a performance guarantee from the entity. IFRS 9 argues that such an option or guarantee might be so valuable to the transferee that it would not, in practice, sell the transferred asset to a third party without attaching a similar option or other restrictive conditions. Instead, the transferee would hold the transferred asset so as to obtain payments under the guarantee or put option. Under these circumstances IFRS 9 regards the transferor as having retained control of the transferred asset. [IFRS 9.B3.2.9].

However, the fact that the transferee is simply unlikely to sell the transferred asset does not, of itself, mean that the transferor has retained control of the transferred asset. [IFRS 9.B3.2.9].

4.1.1 Agreements to return the same asset

If a financial asset is:

• sold under an agreement to repurchase it at a fixed price or at the sale price plus a lender's return; or
• loaned under an agreement to return it to the transferor,

the asset is not derecognised, because the transferor retains substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(a)], (Figure 52.1, Box 7, Yes). The accounting treatment of such transactions is discussed at 5.2 below.

4.1.2 Agreements with right to return the same or substantially the same asset

If a financial asset is:

• sold under an agreement to repurchase the same or substantially the same asset at a fixed price or at the sale price plus a lender's return; or
• loaned under an agreement to return the same or substantially the same asset to the transferor,

the asset is not derecognised because the transferor retains substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(b)], (Figure 52.1, Box 7, Yes). The accounting treatment of such transactions is discussed at 5.2 below.

4.1.3 Agreements with right of substitution

If a financial asset is the subject of:

• a repurchase agreement at a fixed repurchase price or a price equal to the sale price plus a lender's return; or
• a similar securities lending transaction,

that provides the transferee with a right to substitute assets that are similar and of equal fair value to the transferred asset at the repurchase date, the asset sold or lent is not derecognised because the transferor retains substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(c)], (Figure 52.1, Box 7, Yes). The accounting treatment of such transactions is discussed at 5.2 below.

4.1.4 Net cash-settled forward repurchase

IFRS 9 gives some guidance on the treatment of net cash-settled options over transferred assets (see 4.2.5 below), which in passing refers to net cash-settled forward contracts. This guidance indicates that the key factor for determining whether derecognition is appropriate remains whether or not the entity has transferred substantially all the risks and rewards of the transferred asset. [IFRS 9.B3.2.16(k)]. This suggests that an asset sold subject to a fixed price net-settled forward contract to reacquire it should not be derecognised (see 4.1.1 to 4.1.3 above) until the forward contract is settled (Figure 52.1, Box 7, Yes).

The accounting treatment of such transactions is discussed at 5.2 below.

4.1.5 Agreement to repurchase at fair value

A transfer of a financial asset subject only to a forward repurchase agreement with a repurchase price equal to the fair value of the financial asset at the time of repurchase results in derecognition because of the transfer of substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(j)], (Figure 52.1, Box 6, Yes). The accounting treatment of such transactions is discussed at 5.1 below.

4.1.6 Right of first refusal to repurchase at fair value

If an entity sells a financial asset and retains only a right of first refusal to repurchase the transferred asset at fair value if the transferee subsequently sells it, the entity derecognises the asset because it has transferred substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(d)], (Figure 52.1, Box 6, Yes).

IFRS 9 does not address the treatment of a financial asset sold with a right of first refusal to repurchase the transferred asset at a predetermined value that might well be lower or higher than fair value (e.g. an amount estimated, at the time at which the original transaction was entered into, as the future market value of the asset). One analysis might be that, since the transferee is under no obligation to put the asset up for sale, derecognition is still appropriate. Another analysis might be that, if the asset can ultimately only be realised by onward sale, the arrangement is nearer in substance to a transferor's call option (see 4.2 below).

4.1.7 Wash sale

A ‘wash sale’ is the repurchase of a financial asset shortly after it has been sold. Such a repurchase does not preclude derecognition provided that the original transaction met the derecognition requirements. However, if an agreement to sell a financial asset is entered into concurrently with an agreement to repurchase the same asset at a fixed price or the sale price plus a lender's return, then the asset is not derecognised. [IFRS 9.B3.2.16(e)]. Such a transaction would be equivalent to those in 4.1.1 to 4.1.4 above.

4.2.1 Deeply in the money put and call options

If a transferred financial asset can be called back by the transferor, and the call option is deeply in the money, the transfer does not qualify for derecognition because the transferor has retained substantially all the risks and rewards of ownership (Figure 52.1, Box 7, Yes).

Similarly, if the financial asset can be put back by the transferee, and the put option is deeply in the money, the transfer does not qualify for derecognition because the transferor has retained substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(f)], (Figure 52.1, Box 7, Yes).

The accounting treatment for such transactions would be similar to that for ‘repos’ as set out in Example 52.9 at 5.2 below.

If a transferred asset continues to be recognised because of a transferor's call option or transferee's put option, but the option subsequently lapses unexercised, the asset and any associated liability would then be derecognised.

4.2.2 Deeply out of the money put and call options

A financial asset that is transferred subject only to a transferee's deeply out of the money put option, or a transferor's deeply out of the money call option, is derecognised. This is because the transferor has transferred substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(g)], (Figure 52.1, Box 6, Yes).

4.2.3 Options that are neither deeply out of the money nor deeply in the money

Where a financial asset is transferred subject to an option (whether a transferor's call option or a transferee's put option) that is neither deeply in the money nor deeply out of the money, the result is that the entity neither transfers nor retains substantially all the risks and rewards associated with the asset, [IFRS 9.B3.2.16(h)-(i)], (Figure 52.1, Box 7, No). It is therefore necessary to determine whether or not the transferor has retained control of the asset under the criteria summarised in 3.9 above.

If a transferred asset continues to be recognised because of a transferor's call option or transferee's put option, but the option subsequently lapses unexercised, the asset and any associated liability would then be derecognised.

4.2.4 Option to put or call at fair value

A transfer of a financial asset subject only to a put or call option with an exercise price equal to the fair value of the financial asset at the time of repurchase results in derecognition because of the transfer of substantially all the risks and rewards of ownership, [IFRS 9.B3.2.16(j)], (Figure 52.1, Box 6, Yes).

4.2.5 Net cash-settled options

Where a transfer of a financial asset is subject to a put or call option that will be settled net in cash, IFRS 9 requires the entity to evaluate the transfer so as to determine whether it has retained or transferred substantially all the risks and rewards of ownership. [IFRS 9.B3.2.16(k)]. IFRS 9 comments that ‘if the entity has not retained substantially all the risks and rewards of ownership of the transferred asset, it determines whether it has retained control of the transferred asset’ – a repetition of the basic principles of the standard adding no clarification specific to this type of transaction.

4.2.6 Removal of accounts provision

A ‘removal of accounts provision’ is an unconditional repurchase (i.e. call) option that gives an entity the right to reclaim transferred assets subject to some restrictions. Provided that such an option results in the entity neither retaining nor transferring substantially all the risks and rewards of ownership, IFRS 9 allows derecognition, except to the extent of the amount subject to repurchase (assuming that the transferee cannot sell the assets).

For example, if an entity transfers loan receivables with a carrying amount of €100,000 for proceeds of €100,000, subject only to the right to call back any individual loan(s) up to a maximum of €10,000, €90,000 of the loans would qualify for derecognition. [IFRS 9.B3.2.16(l)].

4.2.7 Clean-up call options

A ‘clean-up call’ option is an option held by an entity that services transferred assets (and may be the transferor of those assets) to purchase remaining transferred assets when the cost of servicing the assets exceeds the entity's participation in their benefits. If such a clean-up call results in the entity neither retaining nor transferring substantially all the risks and rewards of ownership, and the transferee cannot sell the assets, IFRS 9 precludes derecognition only to the extent of the amount of assets subject to the call option. [IFRS 9.B3.2.16(m)].

4.2.8 Same (or nearly the same) price put and call options

IFRS 9 does not specifically address the transfer of an asset subject to both a transferee's option to put, and a transferor's option to call, the asset at a fixed price rather than at fair value (as discussed in 4.2.4 above). Assuming that:

• both options can be exercised simultaneously; and
• both the transferor and transferee behave rationally,

it will clearly be in the interest of either the transferor or the transferee to exercise its option, so that the asset will be reacquired by the transferor. This indicates that the transferor has retained substantially all the risks and rewards of ownership.

However, if the two options were exercisable on different dates or at different prices the effects of each option would need to be considered carefully.

4.2.9 Changes in probability of exercise of options after initial transfer of asset

As noted at 4.2.3.B above, IFRS 9 is not explicit as to the accounting consequences (if any) of an option that was considered at the time of the original transfer to be deeply out of the money subsequently becoming neither deeply in the money nor deeply out of the money, or even deeply in the money, (or any other of the possible permutations). This is explored further in Examples 52.2 to 52.4 below.

There are no accounting consequences since, as noted at 3.8 above, IFRS 9 paragraph B3.2.6 specifies that an asset previously derecognised because substantially all the risks and rewards associated with the asset have been transferred (as would be the analysis for an asset transferred subject only to a deeply out of the money call – see 4.2.2 above) is not re-recognised in a future period unless it is reacquired. Instead the increase in the fair value of the option would be captured in the financial statements as a gain under the normal requirement of IFRS 9 to account for derivatives at fair value with changes in value reflected in profit or loss (see Chapter 46).

However, if the market changes were not demonstrably beyond any reasonable expectation as at 1 January 2017 there might be an argument (given the definition of a deeply out of the money option as an option that is ‘highly unlikely’ to become in the money before expiry – see 4.2 above) that the fact that the option is now not merely in the money, but deeply in the money, indicates that the original assessment that that option was deeply out of the money was in fact an accounting error requiring correction under IAS 8 (see Chapter 3 at 4.6).

This is the mirror image of the fact pattern in Example 52.2. However, whereas IFRS 9 makes it clear that an asset previously derecognised is not re-recognised, there is no comparable provision that an asset that previously did not qualify for derecognition on the origination of a particular transaction may not later be derecognised as a result of a subsequent change in the assessed likely impact of the transaction. Because the standard does not explain the consequences, it is not clear when the asset is derecognised or whether there is any basis for derecognising the asset before the expiry of the option.

Assuming the asset in Example 52.3 above is not derecognised, the fall in the value of the option indicates an impairment of the asset which is likely to be required to be reflected in the financial statements under the normal requirements of IFRS 9 (see Chapter 51 at 5). This would in turn appear to require a corresponding adjustment to the liability recognised for the sale proceeds, so as to avoid recognising a net loss in the income statement that has not actually been suffered.

Again, matters are not entirely clear. The rule in paragraph B3.2.6 of IFRS 9 that a previously derecognised asset should not be re-recognised (other than on reacquisition of the asset) applies, as drafted, only where derecognition results from a transfer of substantially all the risks and rewards associated with the asset. In this case, derecognition has resulted from a loss of control over, not a transfer of substantially all the risks and rewards associated with, the asset. There is therefore some ambiguity as to whether B3.2.6 is to be read:

• generally as prohibiting any re-recognition of a derecognised asset; or
• specifically as referring only to circumstances where derecognition results from transfer of substantially all the risks and rewards (i.e. it applies only to ‘Box 6, Yes’ transactions, and not to ‘Box 8, No’ transactions).

Again, however, we take the view that the original decision to derecognise the asset should not be revisited, unless (in exceptional circumstances) the original assessment was an accounting error within the scope of IAS 8. The fact that the asset was transferred on terms that the transferee could freely dispose of it means that the transferor did indeed lose control.

4.4.1 Total return swaps

An entity may sell a financial asset to a transferee and enter into a total return swap with the transferee, whereby the transferor pays an amount equivalent to fixed or floating rate interest on the consideration for the transfer and receives an amount equivalent to the cash flows from, together with any increases or decreases in the fair value of, the underlying asset. In such a case, derecognition of all of the asset is prohibited, [IFRS 9.B3.2.16(o)], since the transaction has the effect that substantially all the risks and rewards associated with the asset are retained by the transferor (Figure 52.1, Box 7, Yes).

4.4.2 Interest rate swaps

An entity may transfer a fixed rate financial asset and enter into an interest rate swap with the transferee to receive a fixed interest rate and pay a variable interest rate based on a notional amount equal to the principal amount of the transferred financial asset. IFRS 9 states that the interest rate swap does not preclude derecognition of the transferred asset, provided that the payments on the swap are not conditional on payments being made on the transferred asset. [IFRS 9.B3.2.16(p)]. It is interesting that this is included as guidance as it does not follow from the principles. There are situations in which the entity retains substantially all of the risks by retaining interest rate risk.

If, however, the transferor were to transfer an asset subject to prepayment risk (e.g. a domestic mortgage), and the transferor and transferee were to enter into an amortising interest rate swap (i.e. one whose notional amount amortises so that it equals the principal amount of the transferred financial asset outstanding at any point in time), the transferor would generally retain substantial prepayment risk through the swap. In this case, the transferor would (depending on the other facts of the transaction, such as the transfer or retention of credit risk) continue to recognise the transferred asset either in its entirety (Figure 52.1, Box 7, Yes) or to the extent of the transferor's continuing involvement (Figure 52.1, Box 9). [IFRS 9.B3.2.16(q)].

Conversely, if the transferor and the transferee were to enter into an amortising interest rate swap, the amortisation of the notional amount of which is not linked to the principal amount outstanding on the transferred asset, the transferor would no longer retain prepayment risk. Therefore such a swap would not preclude derecognition of the transferred asset, provided the payments on the swap were not conditional on interest payments being made on the transferred asset and the swap did not result in the entity retaining any other significant risks and rewards of ownership on the transferred asset. [IFRS 9.B3.2.16(q)].

5.1.1 Transferred asset part of larger asset

If the transferred asset is part of a larger financial asset, for example when an entity transfers interest cash flows that are part of a debt instrument (see 3.3 above), and the part transferred qualifies for derecognition in its entirety, IFRS 9 requires the previous carrying amount of the larger financial asset to be allocated between the part that continues to be recognised and the part that is derecognised. The allocation is based on the relative fair values of those parts on the date of the transfer. For this purpose, a retained servicing asset (see 5.1.2 below) is to be treated as a part that continues to be recognised.

IFRS 9 requires the difference between:

1. the carrying amount allocated to the part derecognised; and
2. the sum of:
   1. the consideration received for the part derecognised (including any new asset obtained less any new liability assumed); and
   2. any cumulative gain or loss allocated to it previously recognised directly in equity,

to be recognised in profit or loss. Any cumulative gain or loss that had been recognised in equity is allocated between the part that continues to be recognised and the part that is derecognised, based on the relative fair values of those parts. [IFRS 9.3.2.13].

The requirement in (b)(ii) above for ‘recycling’ of any cumulative gain or loss previously recognised directly in equity applies to debt instruments accounted for at fair value through other comprehensive income under IFRS 9.

IFRS 9 notes that the accounting treatment prescribed for the derecognition of a part (or parts) of a financial asset requires an entity to determine the fair value of the part(s) that continue to be recognised. Where the entity has a history of selling parts similar to the part that continues to be recognised, or other market transactions exist for such parts, IFRS 9 requires recent prices of actual transactions to be used to provide the best estimate of its fair value. When there are no price quotations or recent market transactions to support the fair value of the part that continues to be recognised, the best estimate of the fair value is the difference between:

• the fair value of the larger financial asset as a whole; and
• the consideration received from the transferee for the part that is derecognised. [IFRS 9.3.2.14].

The requirements of IFRS 13 that deal with the determination of fair value should also be used [IFRS 9.B3.2.11] – see Chapter 14.

Example 52.6 illustrates the requirements for full derecognition of a part of an asset.

5.1.2 Servicing assets and liabilities

It is common for an entity to transfer a financial asset (or part of a financial asset) in its entirety, but to retain the right or obligation to service the asset, i.e. to collect payments as they fall due and undertake other administrative tasks, in return for a fee.

When an entity transfers a financial asset in a transfer that qualifies for derecognition in its entirety and retains the right to service the financial asset for a fee, IFRS 9 requires the entity to recognise either a servicing asset or a servicing liability for that servicing contract, as follows:

• If the fee to be received is not expected to compensate the entity adequately for performing the servicing, the entity should recognise a servicing liability for the servicing obligation at its fair value.
• If the fee to be received is expected to be more than adequate compensation for the servicing, the entity should recognise a servicing asset for the servicing right. This should be recognised at an amount determined on the basis of an allocation of the carrying amount of the larger financial asset (as described in 5.1.1 above). [IFRS 9.3.2.10].

It is not immediately clear what is meant by this requirement. The application guidance expands on the point, as follows.

An entity may retain the right to a part of the interest payments on transferred assets as compensation for servicing those assets. The part of the interest payments that the entity would give up upon termination or transfer of the servicing contract is allocated to the servicing asset or servicing liability. The part of the interest payments that the entity would not give up is an interest-only strip receivable.

For example, if the entity would not give up any interest upon termination or transfer of the servicing contract, the entire interest spread is an interest-only strip receivable. Presumably, as the entity will still have a liability to service the portfolio, it will have to account for this if it allocates none of the interest spread to a servicing asset. For the purposes of applying the requirements for disposals of part of an asset discussed in 5.1.1 above, the fair values of the servicing asset and interest-only strip receivable are used to allocate the carrying amount of the receivable between the part of the asset that is derecognised and the part that continues to be recognised. If there is no servicing fee specified, or the fee to be received is not expected to compensate the entity adequately for performing the servicing, a liability for the servicing obligation is recognised at fair value. [IFRS 9.B3.2.10].

Unfortunately, IFRS 9 does not provide examples of what exactly is meant here, but we believe that something along the lines of Example 52.7 below was intended.

A servicing asset is a non-financial asset representing a right to receive a higher than normal amount for performing future services. Accordingly it would normally be accounted for in accordance with IAS 38 – Intangible Assets. Similarly, a servicing liability represents consideration received in advance for services to be performed in the future and would normally be accounted for as deferred revenue in accordance with IFRS 15 – Revenue from Contracts with Customers.

5.3.1 Guarantees

When the entity's continuing involvement takes the form of guaranteeing the transferred asset, the extent of the entity's continuing involvement is the lower of:

• the carrying amount of the asset; and
• the maximum amount of the consideration received that the entity could be required to repay (‘the guarantee amount’). [IFRS 9.3.2.16(a)].

An example of this treatment is given at 5.4.1 below.

It follows that if the transferor guarantees the entire amount of the transferred asset, no derecognition would be achieved, even though it may have passed other significant risks to the transferee.

5.3.2 Options

When the entity's continuing involvement takes the form of a written and/or purchased option (including a cash-settled option or similar provision) on the transferred asset, the extent of the entity's continuing involvement is the amount of the transferred asset that the entity may repurchase. However, in case of a written put option (including a cash-settled option or similar provision) on an asset measured at fair value, the extent of the entity's continuing involvement is limited to the lower of the fair value of the transferred asset and the option exercise price. [IFRS 9.3.2.16(b)‑(c)].

Examples of this treatment are given at 5.4.2 and 5.4.3 below.

5.3.3 Associated liability

When an entity continues to recognise an asset to the extent of its continuing involvement, IFRS 9 requires the entity to recognise an associated liability. [IFRS 9.3.2.17]. IFRS 9 provides that ‘despite the other measurement requirements in this Standard’, the transferred asset and the associated liability are to be measured on a basis that reflects the rights and obligations that the entity has retained. The associated liability is measured in such a way that the net carrying amount of the transferred asset and the associated liability is equal to:

• if the transferred asset is measured at amortised cost, the amortised cost of the rights and obligations retained by the entity; or
• if the transferred asset is measured at fair value, the fair value of the rights and obligations retained by the entity when measured on a stand-alone basis. [IFRS 9.3.2.17].

This has the effect that the ‘liability’ is often calculated as a balancing figure that will not necessarily represent the proceeds received as the result of the transfer (see Examples 52.10 to 52.13 at 5.4 below). This does not fit very comfortably with the normal rules in IFRS 9 for the initial measurement of financial liabilities (see Chapter 49 at 3) – hence the comment that this treatment applies ‘despite the other measurement requirements in this Standard’.

5.3.4 Subsequent measurement of assets and liabilities

IFRS 9 requires an entity to continue to recognise any income arising on the transferred asset to the extent of its continuing involvement and to recognise any expense incurred on the associated liability. [IFRS 9.3.2.18]. This is comparable to the requirements in respect of assets not derecognised through retention of substantially all risks and rewards (see 5.2 above).

When the transferred asset and associated liability are subsequently measured, IFRS 9 requires recognised changes in the fair value of the transferred asset and the associated liability to be accounted for consistently with each other in accordance with the general provisions of IFRS 9 for measuring gains and losses (see Chapter 50 at 2) and not offset. [IFRS 9.3.2.19]. Moreover, if the transferred asset is measured at amortised cost, the option in IFRS 9 to designate a financial liability as at fair value through profit or loss (see Chapter 48 at 7) is not applicable to the associated liability. [IFRS 9.3.2.21].

5.3.5 Continuing involvement in part only of a larger asset

An entity may have continuing involvement in a part only of a financial asset, for example where the entity retains an option to repurchase part of a transferred asset, or retains a residual interest in part of an asset, such that the entity does not retain substantially all the risks and rewards of ownership, but does retain control.

In such a case, IFRS 9 requires the entity to allocate the previous carrying amount of the financial asset between the part that it continues to recognise under continuing involvement, and the part that it no longer recognises on the basis of the relative fair values of those parts on the date of the transfer. The allocation is to be made on the same basis as applies on derecognition of part only of a larger financial asset – see 5.1.1 and 5.1.2 above.

The difference between:

1. the carrying amount allocated to the part that is no longer recognised; and
2. the sum of:
   1. the consideration received for the part no longer recognised; and
   2. any cumulative gain or loss allocated to it that had been recognised directly in equity,

is recognised in profit or loss. A cumulative gain or loss that had been recognised in equity is allocated between the part that continues to be recognised and the part that is no longer recognised on the basis of the relative fair values of those parts. [IFRS 9.3.2.13].

The ‘recycling’ of any cumulative gain or loss previously recognised directly in equity in (b)(ii) above would apply to debt instruments accounted for at fair value through other comprehensive income under IFRS 9. This was previously an explicit requirement of IAS 39, but has not been carried over to IFRS 9, something we suspect is nothing but an oversight.

This topic is discussed further at 5.4.4 below.

5.4.1 Transfers with guarantees

If a guarantee provided by an entity to pay for default losses on a transferred asset prevents the transferred asset from being derecognised to the extent of the continuing involvement, IFRS 9 requires:

1. the transferred asset at the date of the transfer to be measured at the lower of:
   1. the carrying amount of the asset; and
   2. the maximum amount of the consideration received in the transfer that the entity could be required to repay (‘the guarantee amount’); and
2. the associated liability to be initially measured at the guarantee amount plus the fair value of the guarantee (which is normally the consideration received for the guarantee).

Subsequently, the initial fair value of the guarantee is recognised in profit or loss on a time proportion basis in accordance with IFRS 15 and the carrying value of the asset is reduced by any impairment losses. [IFRS 9.B3.2.13(a)].

This is illustrated in Example 52.10 below (which is based on the circumstances in Example 52.15 below).

5.4.2 Transfers of assets measured at amortised cost

If a put or call option prevents derecognition (see 3.8.3 and 4 above) of a transferred asset measured at amortised cost, IFRS 9 requires the associated liability to be measured at cost (i.e. the consideration received) and subsequently adjusted for the amortisation of any difference between that cost and the amortised cost of the transferred asset at the expiration date of the option, as illustrated by Example 52.11 below. [IFRS 9.B3.2.13(b)].

5.4.3 Transfers of assets measured at fair value

IFRS 9 discusses the application of continuing involvement accounting to transferred assets measured at fair value in terms of transferred assets subject to:

• a transferor's call option (see 5.4.3.A below);
• a transferee's put option (see 5.4.3.B below); and
• a ‘collar’ – i.e. a transferor's call option combined with a transferee's put option (see 5.4.3.C below).

The way in which the rules are articulated in IFRS 9 is somewhat confusing, but in general the effect is that the transferred asset is recognised at:

• in the case of an asset subject to a transferor call option, its fair value (on the basis that the call option gives the transferor access to any increase in the fair value of the asset); and
• in the case of an asset subject to a transferee put option, the lower of fair value and the option exercise price (on the basis that the put option denies the transferor access to any increase in the fair value of the asset above the option price).

This methodology summarised below is applied both on the date on which the option is written and subsequently.

5.4.4 Continuing involvement in part only of a financial asset

IFRS 9 gives the following example of the application of the continuing involvement approach to continuing involvement in part only of a financial asset. [IFRS 9.B3.2.17].

It is crucial to an understanding of this example that, as a result of the transaction, the original asset (the portfolio of prepayable loans) is being accounted for as two separate assets. Because the cash flows from the portfolio are split in fully proportionate (pro rata) shares (see 3.3 above), each of these assets must be considered separately.

The first of these assets, the right to cash flows of €9 million, continues to be recognised only to the extent of the entity's continuing involvement, which in this case is via the credit enhancement. The approach is very similar to continuing involvement through guarantee (see Example 52.10 at 5.4.1 above), except that the liability for subordination includes the maximum cash flow that the entity might not receive from its retained share (i.e. €1 million) rather than, as in Example 52.10, a potential cash outflow (the guarantee amount, which is the maximum amount that the entity could be required to repay). This is aggregated with the fair value of the amount received in respect of the credit enhancement, in order to calculate the full liability for subordination. This is similar to the way in which the fair value of the guarantee is added to the guarantee amount in order to calculate the associated liability. [IFRS 9.B3.2.13(a)].

The second asset is the entity's proportionate retained share of €1 million. It is, seemingly, irrelevant to the accounting analysis in IFRS 9 that this has already been taken into account in calculating the entity's continuing involvement in the remaining €9 million of the portfolio.

The effect is to gross up the statement of financial position with a subordination asset and liability. As IFRS 9 notes, immediately following the transaction, the carrying amount of the asset is €2.04 million (i.e. €1 million part retained plus €1 million subordination asset plus €40,000 excess spread) – in respect of an asset whose fair value is only €1.01 million!

We have some reservations concerning the example above. First, we challenge whether, as a point of principle, it is appropriate to apply the derecognition criteria to part of an asset where the part that is retained provides credit enhancement for the transferee. As discussed more fully at 3.3.1 above, it is possible that IFRS 9 is implicitly drawing a distinction between:

• a guarantee that could result in an outflow of the total resources of the transferor, or a return of consideration for the transfer already received (which would not allow partial derecognition); and
• a guarantee that could result in the transferor losing the right to receive a specific future cash inflow, but not being obliged to make any other payment should that specific future cash inflow not materialise.

Moreover, even in the context of the analysis presented by IFRS 9, we do not understand the basis of the treatment of the excess spread. The example simply asserts that this forms part of the consideration for providing the subordination, although it is not clear that it forms any more or any less of the consideration for the subordination than the interest and principal on the 10% of the portfolio retained.

In our view, a more logical analysis would have been that:

• the entity has disposed of not 90% of the whole portfolio, but 90% of the principal balances and 9.5% interest on that 90%; and
• the consideration for the subordination is still €65,000, on the basis that if:
  • the fair value of the consideration for a fully proportionate share of 90% (i.e. including 10% interest) is €9,090,000; and
  • the fair value of the excess spread of 0.5% interest is €40,000, then

    the fair value of consideration for a fully proportionate share less the excess spread is €9,050,000 (i.e. €9,090,000 less €40,000). This in turn means that the balance of the total consideration of €9,115,000 (i.e. €65,000) relates to the subordination.

In addition, of course, Example 52.15 ignores the possibility that the excess spread is retained by the transferor because it continues to service the portfolio, although this may be an attempt to avoid overcomplicating matters even further.

A further issue is that, if the excess spread is regarded as part of the asset retained, rather than the consideration received, it would seem more appropriate to recognise it on a basis consistent with the accounting treatment of the original transferred asset (typically, amortised cost) rather than at fair value.

5.5.1 Offset

IFRS 9 provides that, if a transferred asset continues to be recognised, the entity must not offset:

• the asset with the associated liability; or
• any income arising from the transferred asset with any expense incurred on the associated liability. [IFRS 9.3.2.22].

Whilst IFRS 9 does not say so specifically, this is clearly intended to apply both to assets that continue to be recognised in full and to those that continue to be recognised to the extent of their continuing involvement.

This requirement apparently overrides the offset criteria in IAS 32, [IAS 32.42], as illustrated, for example, by the various situations highlighted in the discussion at 4 and 5.1 to 5.4 above where a transaction required to be net-settled (which would normally be required to be accounted for as such under IAS 32) is accounted for as if it were to be gross-settled.

5.5.2 Collateral

If a transferor provides non-cash collateral (such as debt or equity instruments) to the transferee, the accounting treatment for the collateral by both the transferor and the transferee depends on:

• whether the transferee has the right to sell or repledge the collateral; and
• whether the transferor has defaulted.

If the transferee has the right by contract or custom to sell or repledge a collateral asset, the transferor should reclassify that asset in its statement of financial position (e.g. as a loaned asset, pledged equity instruments or repurchase receivable) separately from other assets.

If the transferee sells collateral pledged to it, it recognises the proceeds from the sale and a liability measured at fair value for its obligation to return the collateral.

If the transferor defaults under the terms of the contract and is no longer entitled to redeem the collateral, it derecognises the collateral, and the transferee either:

• recognises the collateral as its asset initially measured at fair value; or
• if it has already sold the collateral, derecognises its obligation to return the collateral.

In no other circumstances should the transferor derecognise, or the transferee recognise, the collateral as an asset. [IFRS 9.3.2.23].

5.5.3 Rights or obligations over transferred assets that continue to be recognised

Where a transfer of a financial asset does not qualify for derecognition, the transferor may well have contractual rights or obligations related to the transfer, such as options or forward repurchase contracts that are derivatives of a type that would normally be required to be recognised under IFRS 9.

IFRS 9 prohibits separate recognition of such derivatives, if recognition of the derivative together with either the transferred asset or the liability arising from the transfer would result in recognising the same rights or obligations twice.

For example, IFRS 9 notes that a call option retained by the transferor may prevent a transfer of financial assets from being accounted for as a sale (see 4 above). In that case, the call option must not be separately recognised as a derivative asset. [IFRS 9.B3.2.14].

5.6.1 Reassessment of consolidation of subsidiaries and SPEs

The effect of IFRS 10, combined with the derecognition provisions of IFRS 9 is that a transaction (commonly, but not exclusively, in a securitisation) may result in derecognition of the financial asset concerned in the seller's own financial statements, but the ‘buyer’ may be a consolidated SPE, so that the asset is immediately re-recognised in the consolidated financial statements in which the seller is included. However, an entity may derecognise assets if they are transferred to an SPE that is not consolidated because, having considered all of the facts and circumstances, the entity concludes that it does not control the SPE. The assessment as to whether a particular SPE is controlled by the reporting entity is discussed in Chapter 6.

IFRS 10 requires an investor to reassess whether it controls an investee if facts and circumstances indicate that there are changes to any elements of control, including the investor's exposure, or rights, to variable returns from its involvement with the investee (see Chapter 6). [IFRS 10.8].

6.1.1 What constitutes ‘part’ of a liability?

The requirements of IFRS 9 for the derecognition of liabilities apply to all or ‘part’ of a financial liability. It is not entirely clear what is meant by ‘part’ of a liability in this context. The rules, and the examples, in IFRS 9 seem to be drafted in the context of transactions that settle all remaining cash flows (i.e. interest and principal) of a proportion of a liability, such as the repayment of £25 million of a £100 million loan, together with any related interest payments.

However, these provisions are presumably also intended to apply in situations where an entity prepays the interest only (or a proportion of future interest payments) or the principal only (or a proportion of future principal payments) on a loan.

6.1.2 Legal release by creditor

A liability can be derecognised by a debtor if the creditor legally releases the debtor from the liability. It is clear that IFRS 9 regards legal release as crucial, with the effect that very similar (if not identical) situations may lead to different results purely because of the legal form.

For example, IFRS 9 provides that:

• where a debtor is legally released from a liability, derecognition is not precluded by the fact that the debtor has given a guarantee in respect of the liability; [IFRS 9.B3.3.1(b)] but
• if a debtor pays a third party to assume an obligation and notifies its creditor that the third party has assumed the debt obligation, the debtor derecognises the debt obligation if, and only if, the creditor legally releases the debtor from its obligations. [IFRS 9.B3.3.4].

The effect of these requirements is shown by Example 52.16.

It is clear, in our view, that in either scenario above the bondholders are in the same economic and legal position – they will receive payments from B and, if B defaults, they will have recourse to A.

However, IFRS 9 gives rise to the, in our view, anomalous result that:

• Scenario 1 is accounted for by the continuing recognition of the debt because no legal release has been obtained; but
• Scenario 2 is accounted for by derecognition of the debt, and recognition of the guarantee, notwithstanding that the effect of the guarantee is to put A back in the same position as if it had not been released from its obligations under the original bond.

IFRS 9 also clarifies that, if a debtor:

• transfers its obligations under a debt to a third party and obtains legal release from its obligations by the creditor; but
• undertakes to make payments to the third party so as to enable it to meet its obligations to the creditor,

it should derecognise the original debt, but recognise a new debt obligation to the third party. [IFRS 9.B3.3.4].

Legal release may also be achieved through the novation of a contract to an intermediary counterparty. For example, a derivative between a reporting entity and a bank may be novated to a central counterparty (CCP). In these circumstances, the IASB explains that the novation to the CCP releases the bank from the responsibility to make payments to the reporting entity. Consequently, the original derivative meets the derecognition criteria for a financial liability and a new derivative with the CCP is recognised. [IFRS 9.BC6.335]. However, for hedge accounting purposes only, it is sometimes possible in these circumstances to treat the new derivative as a continuation of the original (see Chapter 53 at 8.3).

6.1.3 ‘In-substance defeasance’ arrangements

Entities sometimes enter into so-called ‘in-substance defeasance’ arrangements in respect of financial liabilities. These typically involve a lump sum payment to a third party (other than the creditor) such as a trust, which then invests the funds in (typically) very low-risk assets to which the entity has no, or very limited, rights of access. These assets are then applied to discharge all the remaining interest and principal payments on the financial liabilities that are purported to have been defeased. It is sometimes argued that the risk-free nature of the assets, and the entity's lack of access to them, means that the entity is in substance in no different position than if it had actually repaid the original financial liability.

IFRS 9 regards such arrangements as not giving rise to derecognition of the original liability in the absence of legal release by the creditor. [IFRS 9.B3.3.3].

6.1.4 Extinguishment in exchange for transfer of assets not meeting the derecognition criteria

IFRS 9 notes that in some cases legal release may be achieved by transferring assets to the creditor which do not meet the criteria for derecognition (see 3 above). In such a case, the debtor will derecognise the liability from which it has been released, but recognise a new liability relating to the transferred assets that may be equal to the derecognised liability. [IFRS 9.B3.3.5]. It is not entirely clear what is envisaged here, but it may be some such scenario as the following.

6.2.1 Loan syndications

Large borrowing arrangements for a single borrower are often funded by multiple lenders in a process referred to as ‘loan syndication’. In such circumstances the borrower must determine whether this arrangement represents a single loan with a single lender (often referred to as the ‘lead lender’) who enters into a sub-participation arrangement with the other lenders, or whether the arrangement represents multiple loans with multiple lenders. This determination will affect how changes to the arrangement should be considered by the borrower to determine whether they represent a modification of the borrower's financial liability or an extinguishment of the original financial liability and the recognition of a new financial liability.

Where the borrower determines that it has a single loan agreement with a single lead lender, changes to this agreement must be considered by the borrower on an aggregate basis to determine whether the changes represent a modification or an extinguishment. Meanwhile, changes in the composition of the syndicate may not be relevant to the borrower, as long as the lead lender stays the same.

Where the borrower determines that it has multiple loans with multiple lenders, the borrower would consider changes to the borrowing arrangements with each lender separately. If one lender is replaced by a different lender, then the borrower must consider whether the replacement represents an extinguishment of the original loan and its replacement by another.

The assessment will require an analysis of the legal terms of the contract. Factors that need to be considered, individually or in combination, in assessing whether there is a single loan or multiple loans include the following:

• the borrower negotiates loan terms only with the lead lender or with individual lenders within the syndicate;
• the loan terms are identical or differ, depending on the lender;
• loan repayments are automatically allocated among lenders on a pro-rata basis, or the borrower may be able to selectively repay amounts to specific lenders within the syndicate;
• the borrower can only renegotiate with the lead lender or may selectively renegotiate loans with individual lenders or subsets of lenders within the syndicate; and
• members of the syndicate may change without the permission of the borrower or such a change may require an amendment to the loan agreement.

6.2.2 Costs and fees

An entity will almost always be required to pay fees to the lender and incur costs (such as legal expenses) on an exchange or modification of a financial liability.

If an exchange of debt instruments or modification of terms is accounted for as an extinguishment of the original debt, IFRS 9 requires any costs or fees incurred to be recognised as part of the gain or loss on the extinguishment (see 6.3 below). [IFRS 9.B3.3.6].

Where the exchange or modification is not accounted for as an extinguishment, any costs or fees incurred adjust the carrying amount of the liability and are amortised over the remaining term of the modified liability. [IFRS 9.B3.3.6]. IFRS 9 does not specify a particular method for amortising such costs and fees. In our view, applying the effective interest method or another approach that approximates this such as a straight-line method would be appropriate. This is illustrated in the following example.

6.2.3 Modification gains and losses

In Example 52.18 above, the remaining cash flows on the loan remained the same after the modification, but in practice they will often change. For example, in the situation set out in Example 52.18, the lender might have agreed to charge additional interest of, say, $170,000 per year for the remaining three year term of the loan instead of the $450,000 fee at the time of the modification. Detailed calculations show an almost identical outcome when applying the 10% test to these revised facts, with the net present value of the cash flows under revised terms being $97.89 million excluding the $50,000 of costs, a difference of $0.45 million or 0.46%. Again it would be concluded that the modification does not result in derecognition of the liability.

IFRS 9 requires modifications of financial liabilities that do not result in derecognition to be accounted for similarly to modifications of financial assets (see Chapter 50 at 3.8.1). The amortised cost of the financial liability should be recalculated by computing the present value of estimated future contractual cash flows that are discounted at the financial instrument's original EIR. Any consequent adjustment should be recognised immediately in profit or loss. [IFRS 9.BC4.252, BC4.253].

In the situation discussed above, this would result in the entity recognising a modification loss of $0.45 million, being the net present value of the additional interest payable of $170,000 per annum, discounted at the original effective interest rate of 6.975%. This might seem counter-intuitive to some when compared to the original facts in Example 52.18. The only difference between the two scenarios is that in the first the borrower makes an immediate cash payment to the lender of $0.45 million in the form of a fee, whereas in the second it makes payments to the lender over the next three years (in the form of additional interest) which have a net present value of $0.45 million.

This example highlights that the accounting treatment for costs and fees paid to the lender is different from that for changes to future cash flows paid to the lender. The former are amortised over the remaining term of the modified liability, the effects of the latter being recognised immediately in profit or loss. Therefore, in some situations, it will be necessary to consider whether the substance of a payment is different from its form, e.g. it may be more appropriate to account for a payment that is described as a fee as if it were a modification to the contractual cash flows.

6.2.4 Illustrative examples

Examples 52.19 and 52.20 below illustrate some more complex modifications of debt.

6.2.5 Settlement of financial liability with issue of new equity instrument

A related area is the accounting treatment to be adopted where an entity issues non-convertible debt, but subsequently enters into an agreement with the debt-holder to discharge the liability under the debt in full or in part for an issue of equity instruments. This most often occurs when the entity is in financial difficulties. This topic is now dealt with in IFRIC 19 – Extinguishing Financial Liabilities with Equity Instruments – which is discussed in Chapter 47 at 7.