Chapter 3 — Recognition and Measurement of Freestanding Derivatives

3.4 Derecognition

ASC 815-10

40-1 Extinguishments of derivative instruments that are liabilities are addressed by paragraph 405-20-40-1. Transfers of derivative instruments that are financial assets are addressed by Section 860-10-40.

40-2 Transfers of assets that are derivative instruments and subject to the requirements of this Subtopic but that are not financial assets shall be accounted for by analogy to Subtopic 860-10. This guidance is limited to transfers of nonfinancial assets that are derivative instruments that are or will be subject to the requirements of this Subtopic. An example would be a transfer to another entity of a derivative instrument, such as a forward contract to purchase gold that requires physical settlement and is or will be subject to the requirements of this Subtopic.

40-3 If a derivative instrument has the potential to be both a nonfinancial asset and a nonfinancial liability (such as a commodity forward contract that is a nonfinancial derivative instrument), then, as described in paragraph 860-10-40-40, the criteria of both Sections 405-20-40 and 860-10-40 shall be met to qualify for derecognition.

ASC 860-10

Application of the Sale Criteria for Financial Instruments That Have the Potential to Be Assets or Liabilities

40-40 Certain recognized financial instruments, such as forward contracts and swaps, have the potential to be financial assets or financial liabilities. Accordingly, transfers of those financial instruments must meet the conditions of both paragraphs 405-20-40-1 and 860-10-40-5 to be derecognized. Paragraph 815-10-40-2 states that transfers of assets that are derivative instruments and subject to the requirements of Subtopic 815-10 but that are not financial assets shall be accounted for by analogy to this Subtopic. The same criteria shall be applied to transfers of nonfinancial derivative instruments that have the potential to become either assets or liabilities (for example, forward contracts and swaps).

The accounting model for evaluating whether to derecognize a derivative depends on whether the instrument is an asset or a liability. Derivative instruments that are liabilities would be evaluated for extinguishment on the basis of the guidance in ASC 405-20, while derivative instruments that are assets would be evaluated for derecognition on the basis of the guidance in ASC 860-10. Although the guidance in ASC 860-10 only explicitly applies to the transfers and sales of derivative instruments that meet the definition of a financial asset, it is appropriate for an entity to analogize to such guidance when evaluating the transfer or sale of a nonfinancial derivative asset.

Instruments that would have been accounted for as derivative instruments if it were not for an applicable scope exception (see Chapter 2) would not be considered derivatives in the application of this derecognition guidance.

Importantly, some derivative contracts have the potential to result in the recognition of either a derivative asset or a derivative liability.3 ASC 860-10-40-40 specifies that to be derecognized, transfers of recognized financial instruments that have the potential to be assets or liabilities, such as certain derivatives, must meet the conditions for (1) sale accounting of financial assets in ASC 860-10-40-5 and (2) extinguishment of liabilities in ASC 405-20-40-1. This guidance also applies to transfers of nonderivative instruments that may be assets or liabilities (e.g., forwards to acquire a commodity).

ASC 405-20

40-1 Unless addressed by other guidance (for example, paragraphs 405-20-40-3 through 40-4 or paragraphs 606-10-55-46 through 55-49), a debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met:

The debtor pays the creditor and is relieved of its obligation for the liability. Paying the creditor includes the following:
1. Delivery of cash
2. Delivery of other financial assets
3. Delivery of goods or services
4. Reacquisition by the debtor of its outstanding debt securities whether the securities are cancelled or held as so-called treasury bonds.
The debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor. For purposes of applying this Subtopic, a sale and related assumption effectively accomplish a legal release if nonrecourse debt (such as certain mortgage loans) is assumed by a third party in conjunction with the sale of an asset that serves as sole collateral for that debt.

As indicated above, ASC 405-20-40-1 identifies the two circumstances in which a liability should be considered extinguished:

“The debtor pays the creditor and is relieved of its obligation.” For instance, an entity may settle all or a portion of a derivative liability by delivering cash, other financial assets, its own equity shares, goods, or services to the counterparty.
“The debtor is legally released [as] the primary obligor . . . either judicially or by the creditor.” For instance, a derivative liability may be extinguished through a court order, the counterparty forgiving the obligation, or the assumption of the obligation by a third party.

See Deloitte’s Roadmap Transfers and Servicing of Financial Assets for further discussion of the application of ASC 860.

Footnotes

For example, a fixed-price forward contract to purchase the underlying would be recorded as a liability if the forward price is expected to be greater than the fair value of the underlying; however, the same forward could instead be recorded as an asset if the forward price is expected to be less than the fair value of the underlying.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.