COLLEGE OF BUSINESS AND ACCOUNTANCY

Topic: Derecognition of Receivable

Learning Objectives:
 Identify the instances where derecognition of receivable is appropriate.
 Account for the derecognition of receivables.
Core Value/Biblical Principles:
Deuteronomy 31:6
Be strong and of a good courage, fear not, nor be afraid of them: for the LORD your God, he it is that does go with
you; he will not fail you, nor forsake you.

Learning Activity:
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.

Introduction:
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.

Body:

DERECOGNITION OF RECEIVABLES

A financial asset is derecognized when:

 contractual rights to the cash flows from the financial asset expire; or
 financial asset is transferred, and the transfer qualifies for derecognition

Derecognition is the opposite of recognition. Derecognition refers to the removal of a previously recognized
asset or liability from the entity's statement of financial position.

Expiration of contractual rights to cash flows

Contractual rights to cash flows from a financial asset expire when the cash flows are collected, cancelled, or
whenthey become uncollectible because of loss events.

Transfer
A financial asset is transferred if the entity either
a. transfers the contractual rights to receive the cash flows of the financial asset, but assumes an obligation
to remit the collections to a recipient in an arrangement that meets all the conditions listed below:
b. retains the contractual rights to receive the cash flows of the financial asset, but assumes an obligation to
remit the collections to a recipient in an arrangement that meets all the conditions listed below:
i. The entity is not obligated to pay the recipient unless it collects an equivalent amount from the
original asset.
ii. The entity is prohibited from selling or pledging the original asset except as security in favor of the
recipient.
iii. The entity is obligated to remit collections to the eventual recipients without material delay. In
addition, the entity is prohibited from reinvesting the collections, except in cash of cash equivalents
during the short period from the collection date to the required remittance date, and any interest
earned on the investment is also remitted to the recipient.

Example for (a) above: Transfer of contractual right

ABC Co. has a P10,000 receivable from Alpha Co. and a payable of P8,000 to Beta Co. In settlement of the
P8,000 payable to Beta, ABC Co. transfers its receivable from Alpha to Beta. Beta will in turn be the one to
collect from Alpha.
In here, the contractual right of ABC Co. over the receivable from Alpha is transferred to Beta. ABC Co. will then
derecognize the receivable.

Example for (b) above: Retention of contractual right

ABC Co. is an insurance broker acting as agent in selling insurance for XYZ Insurance Corporation. ABC Co. is
entitled to a 10% commission on insurance sold and also acts as collector for XYZ. ABC sells insurance to Mr.
Letters at P10,000. How should ABC Co. record the sale? (Entry #1 or Entry #2 below?)

Entry #1 Entry #2
Accounts Receivable – Mr. Letters 10,000
Accounts Receivable – XYZ 1,000
Commission Income (10k x 10%) 1,000
Commission Income 1,000
Accounts Payable – XYZ 9,000

EVALUATION OF TRANSFERS
If the entity transfers substantially all the risks and rewards of ownership of the financial asset, the
entity derecognizes the financial asset and recognizes separately as assets or liabilities any rights and
obligations created or retained in the transfer.
If the entity retains substantially all the risks and rewards of ownership of the financial asset, the
entity continues to recognize the financial asset.
If the entity neither transfers nor retains substantially all the risks and rewards (e.g., when there is
partial transfer and partial retention), the entity determines whether it has retained control of the financial
asset:
a. If the entity has not retained control, it derecognizes the financial asset and recognizes separately
as assets or liabilities any rights and obligations created or retained in the transfer.
b. If the entity has retained control, it continues to recognize the financial asset to the extent of its
continuing involvement in the financial asset.

ILLUSTRATION 1: Evaluation of transfers

ABC Co. transferred loans receivable with carrying amount and fair value of P100,000 to XYZ, Inc. in exchange
for cash of P100,000.

Scenario 1: ABC Co. transfers substantially all the risks and rewards of ownership of the loans receivable.

Analysis: The transfer qualifies for derecognition. ABC Co. derecognizes the receivable as follows:
J/E: Cash 100,000
Loans Receivable 100,000

Scenario 2: ABC Co. is obligated to repurchase the transferred loans at a future date at fair value plus 10%
interest.

Analysis: The transfer does not qualify for derecognition because ABC Co. is obligated to repurchase
the transferred loans and therefore, retains substantially all the risks and rewards of ownership of
the financial asset. Accordingly, ABC Co. continues to recognize the receivable but recognizes a
liability for the cash received.
J/E: Cash 100,000
Liability on Repurchase Agreement 100,000

Scenario 3: ABC Co. is obligated under the terms of the transfer to repurchase any individual loan but the
aggregate amount of loans that could be repurchased could not exceed P10,000.

Analysis: ABC Co. neither transfers nor retains substantially all the risks and rewards of
ownership of the financial asset. Accordingly, ABC Co. continues to recognize the receivable to the
extent of its continuing involvement in the financial asset, i.e., the minimum amount ABC Co. is
obligated to repurchase.
J/E: Cash 100,000
Loans Receivable 90,000
Liability on Repurchase Agreement 10,000
Scenario 4: ABC Co. has only an option to repurchase the transferred asset at its fair value at the time of
repurchase.

Analysis: The transfer qualifies for derecognition because the repurchase is only optional.
J/E: Cash 100,000
Loans Receivable 100,000

TRANSFERS THAT QUALIFY FOR DERECOGNITION

If a financial asset is transferred in its entirety but the transferring entity retains the right to service
the financial asset for a fee, a financial asset or financial liability is recognized for the servicing contract.
 If the fee is considered inadequate to compensate for the services, a servicing liability is recognized
at fair value.
 If the fee is considered more than adequate, a servicing asset is recognized. The amount of asset
recognized is determined by allocating the previous carrying amount of the financial asset to the part
that is derecognized and the part that continues to be recognized based on the relative fair values of
those parts on the date of the transfer.
 If the transfer results to obtaining a new financial asset or assuming a new financial liability, such
item is recognized at fair value.

On derecognition of a financial asset in its entirety, the difference between (a) and (b) below is recognized as
gain or loss in profit or loss:
a. the consideration received (including any new asset obtained less any new liability assumed); and
b. the carrying amount (measured at the date of derecognition).
ILLUSTRATION 2: Transfer of financial asset

ABC Co. transfers loans receivable with a fair value of P300,000 and carrying amount of P280,000. ABC Co.
obtains an option to purchase similar loans and assumes a recourse obligation to repurchase such loans. ABC
Co. also agrees to provide a floating rate of interest to the transferee company. The assets and liabilities
received as consideration for the transfer are listed below:

Assets received & liabilities assumed Fair values

Cash proceeds 200,000
Interest rate swap 150,000
Call option 50,000
Recourse obligation 100,000

Requirement: Compute for the gain or loss on the derecognition of the financial asset.

The entry to record the transfer is as follows:

Cash 200,000
Interest rate swap 150,000
Call option 50,000
Recourse Obligation 100,000
Loans Receivable (at CA) 280,000
Gain on transfer of loans 20,000
 
The gain or loss on derecognition may also be computed as follows:
Cash proceeds 200,000
Interest rate swap 150,000
Call option 50,000
Less: Recourse obligation (100,000)
Fair value of net assets received 300,000
Less: Carrying amount of loans transferred (280,000)
Gain on transfer of loans 20,000

Notes:
 The new financial assets and financial liability obtained from the transfer are recorded at fair values.
The interest rate swap and call option are debited because these are assets received (derivative
assets).
 The difference between (a) the net consideration received (assets less liability) and (b) the carrying
amount of the loans transferred is recognized as gain on the transfer.
 The fair value of the transferred receivables of P300,000 is ignored.

ILLUSTRATION 3: Servicing of a financial asset

Use the information in Illustration 2, except that ABC Co. agreed to service the loans without explicitly stating
the compensation. The fair value of the service is P15,000.

Requirement: Compute for the gain or loss on the derecognition of the financial asset.

The servicing fee is considered inadequate because it is not explicitly stated. Accordingly, a servicing
liability is recognized at fair value. The entry to record the transfer is as follows:
Cash 200,000
Interest rate swap 150,000
Call option 50,000
Recourse Obligation 100,000
Loans Receivable (at CA) 280,000
Liability on service obligation 15,000
Gain on transfer of loans 5,000
TRANSFERS THAT DO NOT QUALIFY FOR DERECOGNITION
If a transfer does not result in derecognition because the entity has retained substantially all the risks
and rewards of ownership of the transferred asset, the entity continues to recognize the transferred asset but
recognizes a financial liability for the consideration received. The entity presents the transferred asset and the
financial liability separately and does not offset them.
In subsequent periods, the entity recognizes any income on the transferred asset and any expense on
the financial liability. The entity also does not offset the income and expense.

OFFSETTING A FINANCIAL ASSET AND A FINANCIAL LIABILITY

A financial asset and a financial liability are offset and only the net amount is presented in the
statement of financial position when the entity has both:
a. A legal right of setoff; and
b. An intention to settle the amounts on a net basis or simultaneously

SALE OR SECURED BORROWING

Under traditional US GAAP, transfers of receivables are treated as either sale or secured borrowing.

SALE
A transfer is considered a sale if all of the following conditions are met:
a. The transferred asset has been isolated from the transferor (put beyond reach of the
transferor and its creditors),
b. The transferee has obtained the right to pledge or exchange either the transferred asset or
beneficial interest in the transferred asset; and
c. The transferor does not maintain effective control over the transferred asset through an
agreement to repurchase or redeem them before their maturity.

In a transfer that is considered a sale, the transferred receivable is derecognized in its entirety and
the difference between the consideration received and the receivable's carrying amount is recognized as
gain or loss.

Secured borrowing
A transfer is considered a secured borrowing if one of the conditions above is not met. The
transferred receivable is not derecognized, and the consideration received on the transfer is recognized as a
liability. No gain or loss is recognized.

If a partial transfer occurs, only the portion transferred is derecognized; the portion retained is continued to
be recognized.

ILLUSTRATION 4: Evaluation of transfers of financial assets (page 360)

On Nov. 14, 20x1, Athena Co. sold its P30,000 loan receivable from Zevrek Co. to Devin Bank for P28,000. The
sale agreement requires Athena Co. to repurchase the loan at a future date for P28,000 plus interest based on
the current market rate on repurchase date.

Requirement: Provide the journal entry on Nov. 14, 20x1. Offsetting of financial assets and financial
liabilities

Nov. 14, 20x1 Cash 28,000

Liability on repurchase agreement 28,000

The transfer does not qualify for derecognition because Athena Co. is required to repurchase the transferred
loan. The cash received on the transfer is recorded as liability.

ILLUSTRATION 5: Offsetting of financial assets and financial liabilities (page 360)

On December 31, 20x1, Twinkle Co. has accounts receivable from, and accounts payable to, Star, Inc.
amounting to P200,000 and P180,000, respectively. Both accounts are due currently. Twinkle Co. has the
legal right of offset. However, because the credit term for the accounts payable is one month longer than the
accounts receivable, Twinkle Co. intends to collect first the accounts receivable and pay the accounts payable
at the end of the credit term.
Requirement: How much accounts receivable shall be presented in Twinkle's December 31, 20x1 statement
of financial position?

₱200,000 – the gross amount.

Offsetting is not applicable because ABC Co. does not intend to settle the accounts receivable and accounts
payable simultaneously. A financial asset and a financial liability are offset and only the net amount is
presented in the statement of financial position if the entity has both:
a. a legal right of setoff; and
b. an intention to settle the amounts on a net basis or simultaneously

Life Application:
A useful discussion is contained in May 2012 and September 2012 IFRIC updates in the context of the
restructuring of Greek government bonds in the aftermath of 2007/2008 financial crisis. IFRIC concluded
that, in determining whether a debt restructuring results in the derecognition of the financial asset, the best
approach is to make an analogy (based on IAS 8 hierarchy) to derecognition criteria for financial liabilities
referring to an exchange between an existing borrower and lender of debt instruments with substantially
different terms.

Summary:
Evaluation of transfers of receivables
If control over the receivable is:
 Substantially transferred, the receivable is derecognized.
 Substantially retained, the receivable is not derecognized but continued to be recognized. Any cash
received from the transfer is recognized as liability.
 Partially transferred and partially retained, the portion transferred is derecognized while the portion
retained is continued to be recognized.

Offsetting of financial assets and financial liabilities

 A financial asset and a financial liability shall be offset, and the net amount presented in the
statement of financial position only when both of the following conditions are met:
 The entity currently has a legally enforceable right to set off the recognized amounts; and
 The entity intends either to settle on a net basis, or to realize the asset and settle the liability
simultaneously.