Derecognition of Financial Assets and Financial Liabilities

Derecognition refers to the removal of an asset or liability (or a portion thereof) from an entity’s balance sheet. Derecognition questions can arise with respect to all types of assets and liabilities. This project focuses on financial instruments. Questions regarding derecognition of assets and liabilities often arise in the context of certain special purpose entities and whether those entities should be included in a set of consolidated financial statements.

Derecognition is the removal of a previously recognized financial asset or financial liability from an entity’s balance sheet. A financial asset should be derecognized if either the entity’s contractual rights to the asset’s cash flows have expired or the asset has been transferred to a third party (along with the risks and rewards of ownership). If the risks and rewards of ownership have not passed to the buyer, then the selling entity must still recognize the entire financial asset and treat any consideration received as a liability.

The IASB agreed to consider both a comprehensive project on derecognition or all types of assets and liabilities and also a separate, narrower scope project that would explore the need to revise guidance in IAS 39 Financial Instruments: Recognition and Measurement in the area of derecognition of financial instruments. This limited scope project would address questions that have arisen with regard to the application of conflicting aspects of IAS 39’s guidance on derecognition. The project would result in an amendment to IAS 39 possibly through issuance of a separate standard on derecognition that supersedes that section of IAS 39.

Standard IAS 39 provides extensive guidance on derecognition of a financial asset. Before deciding on derecognition, an entity must determine whether derecognition is related to:

1. A financial asset (or a group of similar financial assets) in its entirety, or
2. A part of a financial asset (or a part of a group of similar financial assets). The part must fulfil the following conditions (if not, then asset is derecognized in its entirety):

• The part comprises only specifically defined cash flows from a financial asset (or group)
• the part comprises only a fully proportionate (pro rata) share of the cash flows from a financial asset (or group)
• the part comprises only a fully proportionate (pro rata) share of specifically identified cash flows from a financial asset (or group)

An entity shall derecognize the financial asset when:

• The contractual rights to the cash flows from the financial asset expire, or
• an entity transfers the financial asset and the transfer qualifies for the derecognition

Transfers of financial assets are discussed in more details. First of all, an entity must decide whether the asset was transferred or not. Then, if the financial asset was transferred, the entity must determine whether also risks and rewards from the financial asset were transferred.

Derecognition of a financial liability

A financial liability should be removed from the balance sheet when, and only when, it is extinguished, that is, when the obligation specified in the contract is either discharged or cancelled or expires. [IAS 39.39] Where there has been an exchange between an existing borrower and lender of debt instruments with substantially different terms, or there has been a substantial modification of the terms of an existing financial liability, this transaction is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. A gain or loss from extinguishment of the original financial liability is recognised in profit or loss. [IAS 39.40-41]