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IFRS 9 Financial Instruments: Derecognition
Terms
Autopilot:
Structured entities ("SEs") frequently operate in a predetermined way so that no entity had explicit decision-making authority over the SE’s ongoing activities after its formation. In this situation, the SE is said to operate on autopilot.
Continuing involvement:
An entity’s continued exposure to the risks and rewards of a transferred financial asset.
Control:
For consolidation purposes: An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.
For derecognition purposes: The transferor has control if the transferee does not have the practical ability to sell the transferred asset.
Credit risk:
The risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.
Derecognition:
The removal of a previously recognized financial asset or financial liability from an entity’s statement of financial position.
Derivative:
A derivative is a financial instrument or other contract within the scope of IFRS 9 with all three of the following characteristics: (a) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the "underlying"); (b) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and (c) it is settled at a future date.
Financial liability at fair value through profit or loss:
A financial liability at fair value through profit or loss is either a financial liability that is held for trading or one that is designated upon initial recognition by the entity as at fair value through profit or loss as it meets the designation criteria within IFRS 9.
In substance defeasance:
Where one party pays another party to assume an obligation.
Interest rate risk:
The risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates.
Legal release:
Where an entity has been released of its legal obligations.
Options in/out of the money:
If an option is in the money then it is likely the holder will exercise the option, as there is economic benefit in doing so. If an option is out of the money then it is likely the holder will not exercise the option, as there is no economic benefit in doing so. Example: if the holder of a call option had the right to buy a share for $100, and the share was trading at $80, then the call option is said to be out of the money because it would be disadvantageous for the holder to exercise the option. If the market value was $120, then the call option would be considered to be in the money because it would be advantageous for the holder to exercise the option.
Originator:
The person who initially creates an instrument. For example, a loan note will be originated by the lender who extends a loan to the borrower.
Partial derecognition:
When only a specific percentage or part of an asset or liability is derecognized.
Pass-through:
When an entity retains the contractual rights to receive the cash flows of a financial asset but assumes a contractual obligation to one or more entities to pay them on. Note: the IASB decided not to use the term pass-through in IFRS 9 as many arrangements termed pass-through often fail derecognition. However, in this module, the term is used to describe transactions where the tests in the Standard are met to achieve successful pass-through of the assets for derecognition purposes.
Put options/call options:
A put option gives the holder the right but not the obligation to sell an asset at a given price at some point in the future at their discretion. A call option gives the holder the right but not the obligation to buy an asset at a given price at some point in the future at their discretion.
Retained interest:
Where an entity is said to keep an interest in a transferred financial asset, they are said to keep a retained interest.
Sale and repurchase agreements:
When an entity sells an asset to another party but agrees to buy it back at a later date in the future.
Securitization:
A securitization is a form of debt financing. It often consists of an entity selling financial assets to a structured entity that in turn issues beneficial interests in those assets in the form of securities to new investors.
Servicing:
The act of 'servicing' the assets, for example cash collection or performance of certain other duties in a securitization transaction.
Structured entity:
An entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements.
Subordination:
A transferor may purchase a subordinated interest in a Structured Entity (SE) in order to make notes issued out of the SE more marketable to third party investors. Such a subordinated interest or 'subordination' is equivalent to retention of a part of the risk of the transferred assets. If the transferred assets fail to perform as expected, the transferor will be the first to lose out as his investment is subordinated in rank to the other investors in the vehicle, i.e. subordination is a form of credit enhancement.
Substantially different:
A modification is substantially different if the discounted present value of the cash flows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is at least 10% different from the discounted present value of the remaining cash flows of the original financial liability.
Transferee:
The entity which is taking receipt or delivery of the asset or the liability as a result of a transfer.
Transferor:
The entity which transfers assets or liabilities in a transaction.
Accounting entries for Airline Ltd
Dale's memo
Derecognition decision tree
Measurement basis
Basic securitization stucture
New securitization structure
Notes on technology investments
Possible further financing