It is common to provide some kind of guarantee/ pledge/ collateral to a lender from whom a loan is being taken/ received. Ind-As specifies the rules and situations to record such transactions according to the agreement between a Lender & a Borrower.
The article deals mainly with the COLLATRERAL which is non-cash in nature and an agreement or custom (common business practices) exists which defines the rights and obligation attached to the collateral for transferee (who receives such collateral) and for transferor (who provides such collateral).
Let’s have a look at the relevant provision as per the Accounting Standards and then we would try to understand the concept by taking some examples-
Para -3.2.23 –If a transferor provides non-cash collateral (such as debt or equity instruments) to the transferee, the accounting for the collateral by the transferor and the transferee depends on whether the transferee has the right to sell or repledge the collateral and on whether the transferor has defaulted. The transferor and transferee shall account for the collateral as follows:
(a) If the transferee has the right by contract or custom to sell or repledge the collateral, then the transferor shall reclassify that asset in its balance sheet (eg as a loaned asset, pledged equity instruments or repurchase receivable) separately from other assets.
(b) If the transferee sells collateral pledged to it, it shall recognise the proceeds from the sale and a liability measured at fair value for its obligation to return the collateral.
(c) If the transferor defaults under the terms of the contract and is no longer entitled to redeem the collateral, it shall derecognise the collateral, and the transferee shall recognize the collateral as its asset initially measured at fair value or, if it has already sold the collateral, derecognise its obligation to return the collateral.
(d) Except as provided in (c), the transferor shall continue to carry the collateral as its asset, and the transferee shall not recognise the collateral as an asset.
Let’s take some SCENARIOS to understand the concept pertaining to such collateral related accounting from the perspective of Transferee and Transferor.
For the sake of simplicity and to avoid any confusion, let’s name the transferor as GIVER and transferee as TAKER –
GIVER borrows some funds from TAKER and hence GIVER provides a non-cash collateral as required by the agreement between these two parties. The collateral provided by GIVER has following scenarios-
a. GIVER has given rights to the TAKER to sell the non-cash collateral ,
b. On an event of default , TAKER has sold the collateral to ensure some portion of its payment but not entitled to have sale amount of such collateral,
c. TAKER has sold such collateral as GIVER was unable to pay off its loan and hence it was considered (as per the agreement) to recover payment from the sale amount,
Suggested approach –
Such transferred assets which has control & risk/ rewards with the transferee would still be shown in the financial statements of the transferee unless such right has been extinguished.
a. When an agreement states that the TAKER has right to sell the asset in case of default then below guidance will follow by each parties-
GIVER – It classifies such non-cash collateral separately from other asset and to be shown as e.g. loaned assets, collateral given etc,
|Non-cash collateral given||Dr.|
|Assets/ Equity Instruments/ other assets given||Cr.|
|(being risk & rewards still with the company)|
TAKER – It will not recognize any assets in its books since there is no risk and rewards associated with the collateral has been transferred to TAKER.
b. In the event of default when TAKER sells the collateral but do not have right to use the proceed against the final settlement for the loans which has been given to GIVER –
GIVER – Since the right was given to the TAKER to sell the collateral on certain events on account of securing recovery from the loan hence it would not derecognize its claim and create a receivable from TAKER –
|Receivable from TAKER||Dr.|
|Non-cash collateral given||Cr.|
|(being sale of collateral to recover from TAKER)|
TAKER – Since the sale of such collateral does not entitled TAKER to keep all proceed with it and it has an obligation to return the same to GIVER-
|Payable to GIVER||Cr.|
|(being sale of collateral to pay to GIVER)|
c. Now, since the GIVER was not able to pay off its liability against loan taken and as per the agreement it was considered to compensate the sale amount against such settlement hence the below procedure would follow-
GIVER- Receivable was not able to pay off its liability against the loan/ borrowed fund hence it will reverse its receivable against TAKER and close its liability as borrowed funds-
|Borrowed funds/ Loan||Dr.|
|Receivable from TAKER||Cr.|
|(being settlement of loan by netting with sale proceeds of collateral earlier made)|
TAKER- Now the taker would recognize the sale proceed it received earlier and make a settlement entry for the loan given to GIVER –
|Payable to GIVER||Dr.|
|Loan given to GIVER||Cr.|
|(being settlement of loan given to GIVER)|
One thing to remember that to transfer an amount that may arise by difference between amortized cost of the loan at the date of such settlement and an amount of sale proceed which eventually now used for final settlement.
Readers will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
(Author of this article is an experienced chartered accountant who has specialization on various GAAP conversions assignments covering different industries around different part of the world including acting as an Independent IFRS Advisor & Corporate Trainer. He can be reached via email at [email protected] or Whatsapp +91-9634706933)