there is a catch up adjustment to profit or loss for the change in expected cash flows
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discounted at the original EIR. [IFRS 9.B5.4.6]. This is equivalent to the accounting
previously required by paragraph AG8 of IAS 39.
The standard is not so clear on how to account for modifications or exchanges of
financial liabilities measured at amortised cost that do not result in derecognition of the
financial liability. The IFRIC received a request which asked whether, when applying
IFRS 9, an entity recognises any adjustment to the amortised cost of the financial
liability arising from such a modification or exchange in profit or loss at the date of the
modification or exchange. The Committee decided to refer the matter to the Board.11 In
October 2017, the Board rather than making an amendment to the standard, chose to
add some words to the Basis for Conclusions of IFRS 9 as part of the amendment for
prepayment features with negative compensation (see Chapter 44 at 6.4.4.A). This
addition states that the requirements in IFRS 9 provide an adequate basis for an entity
to account for modifications and exchanges of financial liabilities that do not result in
derecognition and that further standard-setting is not required. The Board highlighted
that the requirements in IFRS 9 for adjusting the amortised cost of a financial liability
when a modification (or exchange) does not result in the derecognition of the financial
liability are consistent with the requirements for adjusting the gross carrying amount of
a financial asset when a modification does not result in the derecognition of the financial
asset (see Chapter 48 at 6.2.2 and 5.1.1 below on the transition requirements).
[IFRS 9.BC4.252-253].
This treatment of modifications represents a change in practice for many entities
compared to under IAS 39 and such entities have had to apply this change
retrospectively on first time application of IFRS 9.
When the terms of a financial instrument are amended, application of the standard’s
guidance on modifications raises questions as to what the ‘original effective interest rate’
actually means, in particular when the original contractual terms introduce some form
of variability in the rate. This has led to more general questions about when it may be
appropriate to apply a prospective change to the effective interest rate in accordance
with paragraph B5.4.5, assuming the effective interest rate is partially or totally variable,
rather than applying a fixed effective interest rate. The following examples illustrate
when the changes in terms constitute a modification or when it may be appropriate to
apply paragraph B5.4.5. These examples address the accounting from the lender’s
perspective, but are applicable to both financial assets and financial liabilities, since the
same modification requirements apply to both, as discussed above.
Example 46.14: Changes in credit spread
Fact Pattern 1: A ratchet loan with a rate reset
Bank A issues a ratchet loan whereby the credit spread is increased in accordance with a scale of
predetermined rates, on the occurrence of one or more predetermined events that are linked to the borrower’s
financial covenants (e.g. debt and equity or interest coverage ratios). These clauses are included to avoid the
need to renegotiate the loan when the credit risk of the borrower changes and are considered to meet the
standard’s requirements for the loan to be recorded at amortised cost for the holder.
Fact Pattern 2: Renegotiation of loan covenant in return for a higher credit spread
Company B has a term loan which pays interest at LIBOR plus 2%. Company B is close to breaching a covenant
and renegotiates the loan to adjust the covenant in return for increasing the credit spread applied to the loan to
3%. The revised credit spread reflects the amended terms of the loan and Company B’s current credit risk.
Financial instruments: Subsequent measurement 3711
Analysis:
Fact Pattern 1: A ratchet loan with a rate reset
The credit spread is reset to reflect changes in credit risk and credit spreads are a component of a market
interest rate as indicated by the January 2016 IFRIC agenda decision (see 3.1 above). For a vanilla floating
rate loan (e.g. at LIBOR plus 2%), it is widely accepted that resetting only the benchmark component of the
rate would be regarded as a change in EIR in accordance with paragraph B5.4.5 of IFRS 9. Similarly, resetting
only the credit spread component when the reset is predetermined at inception can be regarded as a change
in EIR as it is considered as a component of the market interest rate. Although the amount of the reset is
specified at inception rather than being the market credit spread at the reset date, this may be accounted for
as a reset of the EIR provided that the predetermined rate changes reasonably approximate the market rates
for the different credit qualities as observed at inception.
Fact Pattern 2: Renegotiation of loan covenant in return for a higher credit spread
The change in rate results solely from a renegotiation of the terms and this change was not specified in the
contract at inception. Unless it was specified in the original terms that the credit spread would be reset to
predetermined rates based on specific events, the change should be treated as a modification in accordance with
paragraph 5.4.3 of IFRS 9. This would mean retaining the original fixed EIR of LIBOR plus 2%, which requires
the computation and recognition of a gain or loss based on the change of spread discounted at this rate.
Example 46.15: Modification – troubled debt restructuring
Company B enters into a fixed rate term loan. A few years later, the company is in financial difficulty and
renegotiates with the lender to reduce or defer some of the payments due under the loan. The changes in the terms
of the loan are not considered to result in a substantial modification and therefore it is not appropriate to derecognise the entire loan. This renegotiation is also not treated as a partial derecognition (see Chapter 48 at 3.4.1).
As the changes in payment are not a result of movements in market interest rates and this change was not
specified in the contract at inception, it should be treated as a modification in accordance with paragraph 5.4.3
of IFRS 9. This would mean retaining the original fixed rate EIR, which requires the computation and
recognition of a gain or loss based on the change in contractual payments discounted at this rate.
Example 46.16: Modification – renegotiation of a fixed rate loan
Fact pattern 1: Renegotiation of a non-prepayable fixed rate loan with a partial rate reset
Company C has had a fixed-rate loan for several years, during which time the market interest rate has fallen.
The terms of the loan do not include any ability for the company to prepay. Company C renegotiates the loan
with the bank, to reduce the future interest payments to reflect a partial reset of the benchmark rate component
of the rate. There has been no change in the credit risk or credit spread applicable to the loan and there are no
other changes to the terms.
Fact pattern 2: Renegotiation of fixed rate loan that is prepayable at par to a current market rate
Company D has a fixed rate loan that is prepayable at par, i.e. for unpaid principal and interest, at any time
with no penalty. Company D renegotiates the terms of the loan with the l
ender to a new fixed market rate of
interest. The renegotiation is assumed not to be considered a substantial modification.
Fact pattern 3: Renegotiation of a fixed rate loan that is prepayable with compensation for the change in
benchmark interest rate
Company E has a prepayable fixed-rate loan whereby the prepayment amount includes reasonable additional
compensation to compensate for the change in benchmark interest rates. The prepayment clause is considered
to meet the standard’s requirements for the loan to be recorded at amortised cost. Company E renegotiates
the terms of the loan with the lender to a new fixed market rate of interest. The revision is assumed not to be
considered as a substantial modification.
Analysis
Fact pattern 1: Renegotiation of a non-prepayable fixed rate loan with a partial rate reset
The change in rate results solely from a renegotiation of the terms and there was no existing prepayment
option that would allow Company C to prepay and re-enter into a new loan with the revised rate.
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Consequently, the change should be treated as a modification in accordance with paragraph 5.4.3 of IFRS 9.
This would mean retaining the original fixed rate EIR, which requires the computation and recognition of a
gain or loss based on the change in rate discounted at the original fixed EIR.
Fact pattern 2: Renegotiation of a fixed rate loan that is prepayable at par to a current market rate
The standard is unclear on how to treat this fact pattern. In such circumstances, the lender may apply its
judgement and select an appropriate accounting policy as follows:
• Derecognition: The revision of the rate is in substance a settlement of the existing loan through the
exercise of the prepayment option and commencement of a new loan at the market rate of interest. The
cash flows of the original loan is deemed to have expired and should be derecognised with a
corresponding new loan recognised.
• Modification – keeping the original EIR: The revision does not represent an expiry of the contractual
cash flows and there was no actual prepayment of the loan. Since the rate reset is not specifically detailed
in the contract at inception, the prepayment option is not viewed as a reset option. Accordingly, the
revision is treated as a modification in accordance with paragraph 5.4.3 of IFRS 9. This would mean
retaining the original fixed rate EIR, which requires the computation and recognition of a gain or loss
based on the change of rate discounted at the original fixed EIR.
• Modification – prospective change in EIR: The loan with a prepayment option at par with no penalty is
considered analogous to a loan with an option to reset the interest rate to the then prevailing market rate.
With such a prepayment option, Company B may prepay the fixed rate loan when interest rates decrease
and refinance at a market rate of interest with the same or different lender, or force the same lender to
renegotiate the existing interest rate to a market rate of interest. In both cases, the current lender is not
entitled to receive the original fixed-rate over the full maturity of the loan. Accordingly, although the
renegotiation is treated as a modification, the EIR is adjusted to reflect the new fixed market rate.
Fact pattern 3: Renegotiation of a fixed rate loan that is prepayable with compensation for the change in
benchmark interest rate
In such circumstances, the lender may apply its judgement and select an appropriate accounting policy as follows:
• Derecognition: The revision of the rate is in substance a settlement of the existing loan through the
exercise of the prepayment option to prepay at fair value and commencement of a new loan at the market
rate of interest. The cash flows of the original loan is deemed to have expired and should be derecognised
with a corresponding new loan recognised.
• Modification – keeping the original EIR: The revision does not represent an expiry of the contractual
cash flows and there was no actual prepayment of the loan. In addition, the rate reset is not specifically
detailed in the contract at inception and the prepayment amount requires compensation for the change
in rates which differs from Fact pattern 2 above whereby it prepays at par with no penalty. Consequently,
the loan cannot be analogous to a loan with an option to reset the interest rate to the then prevailing
market rate. The revision should therefore be treated as a modification in accordance with
paragraph 5.4.3. This would mean retaining the original fixed rate EIR, which requires the computation
and recognition of a gain or loss based on the change of rate discounted at the original fixed EIR. Note
that if the maturity of the renegotiated loan is at the same time extended compared to the original loan
(for example from 10 years to 15 years), the penalty paid to compensate the lender for the movements
in market rate over the residual maturity of the original 10 year loan should be amortised over this
remaining period only and not over the extended maturity from years 11 to 15.
3.8.2
Treatment of modification fees
Assuming that the modification does not result in the derecognition of the financial
asset, IFRS 9 requires that changes in the contractual cash flows of the asset are
recognised in profit or loss and any costs or fees incurred adjust the carrying amount of
the modified financial asset and are amortised over the remaining term of the modified
financial asset. [IFRS 9.5.4.3]. Therefore, the original EIR determined at initial recognition
will be revised on modification to reflect any costs or fees incurred.
Financial instruments: Subsequent measurement 3713
Example 46.17: Accounting treatment of modification fees
The terms of a loan are modified and the revised contractual cash flows discounted at the original EIR,
determined at initial recognition, are £5,000 (£6,050 receivable in two years discounted at 10% per annum).
If the bank incurs external costs related to the modification of £50, e.g. for valuation of collateral and legal
services, the original EIR of 10% will be revised to approximately 9%, i.e. the discount rate that discounts
£6050 receivable in two years to a present value of £5,050.
The standard is not as clear as to the appropriate treatment by the lender when
modification fees are charged to the borrower. One view could be that they should be
included in the modification gain or loss as they are part of the modified contractual
cash flows and do not represent ‘fees incurred’. Alternatively, one might argue that the
fees charged to the borrower would adjust the carrying amount of the loan. As a
variation to the above example, assume £60 of fees are charged to the customer. The
effect of this approach would be to revise the carrying amount of the loan to £4,940 and
the EIR to 11%. This would be consistent with the treatment of fees paid by the borrower
and also with the principle in paragraph B5.4.2 of IFRS 9, which explains that origination
and commitment fees are an integral part of the EIR and, therefore, amortised over the
term of the financial asset in accordance with the effective interest method.
4 FOREIGN
CURRENCIES
4.1
Foreign currency instruments
The provisions of IAS 21 – The Effects of Changes in Foreign Exchange Rates – apply
to transactions
involving financial instruments in just the same way as they do for other
transactions, although the manner in which certain hedges are accounted for can over-
ride its general requirements.
Consequently, the statement of financial position measurement of a foreign currency
financial instrument is determined as follows:
• First, it is recorded and measured in the foreign currency in which it is
denominated, whether it is carried at fair value, cost, or amortised cost.
• Second, that amount is retranslated to the entity’s functional currency using the
closing rate. [IAS 21.23].
Profit and loss items associated with financial instruments, e.g. dividends receivable,
interest payable or receivable and impairments, are recorded at the spot rate ruling
when they arise (although average rates may be used when they represent an
appropriate approximation to spot rates throughout the period).
The reporting of exchange differences in profit or loss or in other comprehensive
income depends on whether the instrument is a monetary item (e.g. debt instruments)
or a non-monetary item (e.g. an equity investment), and whether it is designated as part
of a foreign currency cash flow hedge. (This excludes the translation of foreign entities
which is addressed at 4.2 below).
Foreign exchange differences arising on retranslating monetary items, including debt
instruments measured at fair value through other comprehensive income, are generally
recognised in profit or loss. However, those exchange differences may be recognised in
other comprehensive income for instruments designated as a hedging instrument in a
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cash flow hedge, a hedge of a net investment in a foreign operation (except to the extent
that there is hedge ineffectiveness). Exchange differences may also be recorded in other
comprehensive income for a fair value hedge of an equity instrument for which an entity
has elected to present changes in fair value in other comprehensive income (see 2.5
above and Chapter 49). [IFRS 9.B5.7.2, B5.7.2A].
Any changes in the carrying amount of a non-monetary item are recognised in profit or
loss or in other comprehensive income in accordance with IFRS 9. For example, for an
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 734
