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Derecognition of Financial Instruments

Date recorded:

Bankruptcy remoteness concept

The Board analysed the legal isolation test with reference to the derecognition model. The Board discussed the issues that were connected with the application of the legal isolation test in US GAAP (a transfer must be bankruptcy-remote for an asset or component of an asset to be eligible for derecognition as a result of the transfer.

The Board decided not to include the legal isolation criteria in its derecognition approach as it believed that derecognition criteria should be driven by accounting principles and not specific legal rules. In the view of one Board member, determining what was and what was not a sale in financial statements should be based on accounting principles and not determined with reference to law. The Board was also concerned that introduction of the legal isolation test would be inconsistent with the Framework.

On the other hand, the Board stressed that bankruptcy remoteness concept should be reflected in measurement of the instruments and clarified by appropriate disclosures.

Accounting for repurchase agreements and similar transactions

The Board considered accounting for repo transactions in response to a very strong opposition among constituents to the proposals in the ED (which proposed to treat these transactions as sale transactions). The Board was told that these transactions were almost universally perceived as financing and that their treatment as sale transactions would increase volatility in profit or loss that had no economic substance. Moreover, several Board members noted that proposed treatment would be inconsistent with treatment of sale and leaseback transactions and might be contrary to substance over form principle embodied in the Framework.

On the other hand, other Board members preferred more conceptual arguments in favour of the proposed treatment (for example, differences to collateralised loans, existence of two sources of credit risk).

After an extended debate the Board acknowledged that some of the transactions, generally referred as repos, might have economic substance of a loan and some might have the economic substance of a sale. Consequently, the Board asked the staff to propose a criterion that would try to capture this distinction. In addition, the Board decided to discuss this question with the FASB in an attempt to coordinate views on this matter.

Accounting for retained interests

After a short discussion, the Board agreed to treat retained interests representing a proportionate interest in the asset previously recognised as part of the asset previously recognised. In all other cases, the Board decided to treat retained interest as a new asset and measure it at fair value on initial recognition. Subsequently retained interest should be accounted for on the basis of classification and measurement guidance on financial instruments.

The derecognition approach

The Board discussed two possible derecognition approaches, the amended IAS 39 approach and a modified alternative approach (modified by the accounting for repos and retained interests). The Board tentatively agreed with the alternative approach. Nonetheless, the Board agreed to discuss this approach with the FASB with the aim to achieve convergence. The Chairman noted that in light of this decision, re-exposure of the derecognition ED was probable.

Related Topics

Correction list for hyphenation

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