Derecognition is the removal of an asset or liability (or a portion thereof) from an entity’s balance sheet. It occurs when an entity no longer controls the asset or is no longer obligated for the liability. Derecognition can occur for various reasons, such as a sale, exchange, or settlement of the asset or liability.
Key Facts
- Definition: Derecognition is the removal of an asset or liability (or a portion thereof) from an entity’s balance sheet.
- Types of assets and liabilities: Derecognition questions can arise with respect to all types of assets and liabilities.
- Transfer of risks and rewards: Under International Financial Reporting Standards (IFRS) 9, full derecognition of a financial asset is appropriate when both of the following conditions have been met:
- The financial asset has been transferred outside the consolidated group.
- The entity has transferred substantially all of the risks and rewards of ownership of the financial asset.
- Qualifying transfer: An entity must determine whether a qualifying transfer has taken place, whether risks and rewards have been transferred, and, in some cases, whether control over the asset in question has been transferred.
- Pass-through arrangement: Derecognition can occur when an entity transfers the contractual rights to receive the cash flows of the financial asset or when an entity retains the contractual rights to the cash flows but assumes a contractual obligation to pass the cash flows on to one or more recipients (referred to as a pass-through arrangement).
- Retained risks and rewards: If an entity retains substantial risks and rewards, derecognition may be precluded, and a liability equal to the consideration received would be recorded instead.
Types of Assets and Liabilities Subject to Derecognition
Derecognition questions can arise with respect to all types of assets and liabilities. However, certain types of assets and liabilities are more likely to be subject to derecognition than others. These include:
- Financial assets, such as cash, accounts receivable, and investments
- Non-financial assets, such as property, plant, and equipment
- Liabilities, such as accounts payable, notes payable, and bonds
Derecognition Under International Financial Reporting Standards (IFRS) 9
Under IFRS 9, full derecognition of a financial asset is appropriate when both of the following conditions have been met:
- The financial asset has been transferred outside the consolidated group.
- The entity has transferred substantially all of the risks and rewards of ownership of the financial asset.
Qualifying Transfer
To determine whether derecognition is appropriate, an entity must first determine whether a qualifying transfer has taken place. A qualifying transfer is a transfer of a financial asset in which the transferor transfers control of the asset to the transferee. Control is defined as the ability to obtain the economic benefits from the asset and to direct the use of the asset.
Pass-Through Arrangement
Derecognition can also occur when an entity transfers the contractual rights to receive the cash flows of the financial asset or when an entity retains the contractual rights to the cash flows but assumes a contractual obligation to pass the cash flows on to one or more recipients (referred to as a pass-through arrangement).
Retained Risks and Rewards
If an entity retains substantial risks and rewards of ownership of the transferred asset, derecognition may be precluded. In such cases, a liability equal to the consideration received would be recorded instead.
Conclusion
Derecognition is a complex accounting topic with various implications for financial statements. Entities must carefully consider the applicable accounting standards and guidance to ensure that derecognition is appropriate in each specific situation.
References
FAQs
What is derecognition in accounting?
Derecognition is the removal of an asset or liability (or a portion thereof) from an entity’s balance sheet. It occurs when an entity no longer controls the asset or is no longer obligated for the liability.
What are some examples of transactions that can trigger derecognition?
Examples of transactions that can trigger derecognition include the sale, exchange, or settlement of an asset or liability, as well as the extinguishment of a liability.
What are the criteria for derecognition under IFRS 9?
Under IFRS 9, full derecognition of a financial asset is appropriate when both of the following conditions have been met:
- The financial asset has been transferred outside the consolidated group.
- The entity has transferred substantially all of the risks and rewards of ownership of the financial asset.
What is a qualifying transfer?
A qualifying transfer is a transfer of a financial asset in which the transferor transfers control of the asset to the transferee. Control is defined as the ability to obtain the economic benefits from the asset and to direct the use of the asset.
What is a pass-through arrangement?
A pass-through arrangement is a type of transfer in which the transferor retains the contractual rights to the cash flows of the financial asset but assumes a contractual obligation to pass the cash flows on to one or more recipients.
When is derecognition precluded?
Derecognition may be precluded if the transferor retains substantial risks and rewards of ownership of the transferred asset. In such cases, a liability equal to the consideration received would be recorded instead.
What are the implications of derecognition?
Derecognition can have various implications for financial statements, including the removal of the asset or liability from the balance sheet, the recognition of a gain or loss on the transaction, and the potential impact on key financial ratios.
What are some of the challenges associated with derecognition?
Some of the challenges associated with derecognition include determining whether a qualifying transfer has taken place, assessing whether risks and rewards have been transferred, and evaluating whether control over the asset in question has been transferred.