Mention IAS 39 and most people think of fair value and hedge accounting. However, the standard also deals with another fundamentally important area—accounting for various types of complex financing arrangements. UK companies need to keep abreast of developments in this area if they are not to encounter problems with their balance sheet ratios from 2005.

The existing IAS 39 requirements are difficult to apply because different paragraphs point towards different accounting treatments. The IASB proposed in its 2002 exposure draft to delete those requirements and adopt a ‘continuing involvement’ approach instead. That proposal has since been abandoned. What the IASB now intends is to impose a structure on the existing requirements. That structure is summarised in the chart and paragraphs below.

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• The derecognition requirements to be applied depend on whether there has been a transfer of contractual rights to cash flows (Box A). If there has not been, rights will be derecognised (ie treated as sold) if the so-called ‘pass-through provisions’ are met. Under those provisions, a right to cash flows will be derecognised if the reporting entity has taken on an obligation to pay out cash (Box B), if that obligation exactly offsets either all or a proportion of a right it has to receive cash (Box C), and if certain other criteria are met. Traditional UK loan sub-participations will generally be sales under these provisions.

• Boxes D-G summarise the approach to be adopted if (a) a contractual right to cash flows has been transferred or (b) no actual transfer has taken place, but obligations have been taken on that do not meet the pass-through test. The first tests to be applied are based on the principle that also underlies FRS 5: if the transferor has given up substantially all the exposure to cash flow variability (Box D), the transferred asset has been sold and should be derecognised; and if the transferor has retained substantially all the exposure to cash flow variability (Box E), the transaction should be treated as a borrowing. So, for example, receivables factored with full recourse will remain on the originator’s balance sheet, as will receivables factored with partial recourse when the effect of the recourse arrangement is that substantially all the risk remains with the originator. Most repos and stocklending transactions will also be treated as borrowings under these requirements.

• Boxes F and G apply to transactions that fall between these two extremes; in other words, to transfers that divide up the underlying risk between the parties. Under FRS 5, such transactions are not generally treated as sales (unless what is transferred is a right to a specific cash flow stream, such as an income-only strip, or to a proportionate share of the cash flows), although a linked presentation is sometimes used and results in a display which is similar to treating the transaction as a partial sale. It seems likely that the revised IAS 39 will apply a very different analysis, although the result may often be the same.

• The transferor will derecognise the transferred rights if the transferee has the practical ability to sell the rights to a third party (Box F).

• If the transferee does not have the ability to sell the transferred rights, the transferor will still derecognise the rights unless it is possible that they could be reacquired under the terms of the transfer (Box G). For example, if loan receivables are transferred and the risks underlying those receivables are shared between the parties, the originator will typically be required to recognise only the residual interest (if any) retained and the maximum amount of any portfolio performance guarantees given.