transfer of financial assets, diversity continues to exist. Two of the more commonly
used models for derecognition of financial assets are the risk-and-rewards model and
the financial components model.
Under the risk-and-rewards model, assets are derecognized when risks and re-
wards related to the asset are surrendered to the transferee. Variations on that ap-
proach attempt to choose which risks and rewards are most critical and whether all
or some major portion of those risks and rewards must be surrendered to allow dere-
cognition. The risk-and-rewards approach may allow for more management judg-
ment, as the concept of risk and rewards is subjective in nature. Such an approach fo-
cuses on the substance of a transaction rather than its legal form. The asset is
derecognized where the transaction transfers to others the significant rights or other
access to benefits relating to that asset, and the significant exposure to the risks in-
herent in those benefits. The risk-and-rewards approach could sometimes result in an
entity continuing to recognize assets even though it had surrendered control over the
assets to a successor entity.
The United Kingdom adopted a variation of the risk and rewards model with FRS
5, “Reporting the Substance of Transactions.” FRS 5 requires the surrender of sub-
stantially all risks and rewards for derecognition of financial assets but permits, in
limited circumstances, the use of a linked presentation. Use of the linked presenta-
tion is restricted to circumstances in which an entity borrows funds to be repaid from
the proceeds of pledged financial assets, any excess proceeds go to the borrower, and
the lender has no recourse to other assets of the borrower. In those circumstances, the
pledged assets remain on the borrower’s statement of financial position, but the un-
paid borrowing is reported as a deduction from the pledged assets rather than as a li-
ability; no gain or loss is recognized. The question of whether it is appropriate for an
entity to offset restricted assets against a liability or to derecognize a liability merely
because assets are dedicated to its repayment remains a point of further debate.
The IASB originally issued an exposure draft based on the risk and rewards
model. After consideration of the comments received and FASB’s issuance of SFAS
No. 140, the IASB determined that a financial components approach based on con-
trol is more consistent with its accounting framework. Accordingly, a financial com-
ponents approach was adopted in IAS 39. This approach analyzes a transfer of a fi-
nancial asset by examining the different components of assets (controlled economic
benefits) and liabilities (present obligations for probable future sacrifices of eco-
nomic benefits) that exist after the transfer. According to the FASB in the United
States, the financial components approach is designed to:
1.Be consistent with the way participants in the financial markets deal with fi-
nancial assets, including the combination and separation of components of
those assets
2.Reflect the economic consequences of contractual provisions underlying finan-
cial assets and liabilities
3.Conform to the FASB conceptual frameworkUnder the financial component approach, the economic benefits provided by a fi-
nancial asset (generally, the right to future cash flows) are derived from the contrac-
tual provisions that underlie that asset, and the entity that controls those benefits
should recognize them as its asset. The concept of control led to the following crite-
ria to be established in SFAS No. 140 (similar conditions required under IAS 39):
12 • 26 SUMMARY OF ACCOUNTING PRINCIPLE DIFFERENCES