Saturday, November 2, 2013

Recognition and de-recognition of financial assets under IFRS 9 – The cow and its milk

To understand how to recognize and de-recognize financial assets on your balance sheet, imagine you have a cow




Recognition of financial assets

When is the cow yours? Under IFRS, it is yours, when you have the right to keep the milk it produces.

Turning back to financial assets, you recognize a financial asset on your balance sheet when you are entitled to receive its cash flows. IFRS accountants talk about “becoming party to the contractual provisions of the instrument”.


De-recognition of financial assets

When is the cow no more yours? Two scenarios are possible here – either the cow dies or your neighbor takes care of it.


1. The cow dies.

Under IFRS, you de-recognize a financial asset if “the contractual rights to the cash flows from the financial asset expire”.


2. Your neighbor takes care of the cow.

When you talk to your neighbor about your cow, you can take two approaches:

You can suggest selling the cow so that your neighbor takes care of it in his own hutch. Under IFRS, accountants talk about a “transfer of contractual rights to receive cash flows”.

Another possibility is to let the cow in your hutch and to continue feeding it. Your neighbor will nevertheless pay the price for the cow and, in return, receive the milk it produces, if any. Simply, you have to promise that you will not give your cow to someone else. After all, you cannot get paid twice for the same cow!

Substituting the cow for a financial asset, you will de-recognize a financial asset under five cumulative conditions:

  • You “retain the contractual rights to receive cash flows but assume a contractual obligation to pay those cash flows to one or more entities.” (You will milk the cow in the first place and then pass the milk to your neighbor.)
  • You are obliged to transfer cash flows only after their collection. (If there is no milk, your neighbor gets nothing.)
  • You commit not to “sell or pledge the original asset (other than a pledge for security purposes to the eventual recipient of the cash flows).” (Your neighbor can come and see his cow, nobody else.)
  • You engage to “remit received cash flows without material delay” and to “reinvest cash flows in cash or cash equivalents only.” (You have to give you neighbor the milk on the same day.)
  • You “transfer substantially all the risks and rewards of ownership of the financial asset” (In other words, you’re are no more exposed to a variability of the present value of future cash flows of the financial asset. You don’t care whether the cow produces milk or not. You were paid for it anyway.) or you transfer the control over the financial asset (In other words, you cannot sell the financial asset any more. As I wrote above, you cannot get paid twice for the same cow.).


Resource:

  • IFRS 9, Chapter 3