5.6 Reassessing
derecognition
IFRS 9 states that if an entity determines that, as a result of the transfer, it has transferred
substantially all the risks and rewards of ownership of the transferred asset, it does not
recognise the transferred asset again in a future period, unless it reacquires the transferred
asset in a new transaction. [IFRS 9.B3.2.6]. We have noted earlier that there is some ambiguity
as to whether this rule in paragraph B3.2.6 is to be read generally as prohibiting any re-
recognition of a derecognised asset or specifically as referring only to circumstances
where derecognition results from transfer of substantially all the risks and rewards (i.e. it
applies only to ‘Box 6, Yes’ transactions, and not to ‘Box 8, No’ transactions). Our view, as
expressed at 4.2 above, is that the broader interpretation should be applied and the
requirement still applies if derecognition occurs for another reason, e.g. loss of control.
The risks and rewards of ownership retained by the entity may change as a result of
market changes in such a way that, had the revised conditions existed at inception, they
would have prevented derecognition of the asset. However, the original decision to
derecognise the asset should not be revisited, unless (in exceptional circumstances) the
original assessment was an accounting error within the scope of IAS 8.
5.6.1
Reassessment of consolidation of subsidiaries and SPEs
The effect of IFRS 10, combined with the derecognition provisions of IFRS 9 is that a
transaction (commonly, but not exclusively, in a securitisation) may result in
derecognition of the financial asset concerned in the seller’s own financial statements,
but the ‘buyer’ may be a consolidated SPE, so that the asset is immediately re-recognised
in the consolidated financial statements in which the seller is included. However, an
entity may derecognise assets if they are transferred to an SPE that is not consolidated
because, having considered all of the facts and circumstances, the entity concludes that
it does not control the SPE. The assessment as to whether a particular SPE is controlled
by the reporting entity is discussed in Chapter 6.
IFRS 10 requires an investor to reassess whether it controls an investee if facts and
circumstances indicate that there are changes to any elements of control, including the
investor’s exposure, or rights, to variable returns from its involvement with the investee
(see Chapter 6). [IFRS 10.8].
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6 DERECOGNITION
–
FINANCIAL LIABILITIES
The provisions of IFRS 9 with respect to the derecognition of financial liabilities are
generally more straightforward and less subjective than those for the derecognition
of financial assets. However, they are also very different from the asset derecognition
rules which focus primarily on the economic substance of the transaction. By
contrast, the rules for derecognition of liabilities, like the provisions of IAS 32 for the
identification of instruments as financial liabilities (see Chapter 43), focus more on
legal obligations than on economic substance – or, as the IASB would doubtless
argue, they are based on the view that the economic substance of whether an entity
has a liability to a third party is ultimately dictated by the legal rights and obligations
that exist between them.
IFRS 9 contains provisions relating to:
• the extinguishment of debt (see 6.1 below);
• the substitution or modification of debt by the original lender (see 6.2 below); and
• the calculation of any profit or loss arising on the derecognition of debt (see 6.3 below).
6.1
Extinguishment of debt
IFRS 9 requires an entity to derecognise (i.e. remove from its statement of financial
position) a financial liability (or a part of a financial liability – see 6.1.1 below) when, and
only when, it is ‘extinguished’, that is, when the obligation specified in the contract is
discharged, cancelled, or expires. [IFRS 9.3.3.1]. This will be achieved when the debtor either:
• discharges the liability (or part of it) by paying the creditor, normally with cash,
other financial assets, goods or services; or
• is legally released from primary responsibility for the liability (or part of it) either
by process of law or by the creditor. [IFRS 9.B3.3.1]. Extinguishment of liabilities by
legal release is discussed further at 6.1.2 below.
If the issuer of a debt instrument repurchases the instrument, the debt is extinguished
even if the issuer is a market maker in that instrument, or otherwise intends to resell
or reissue it in the near term. [IFRS 9.B3.3.2]. IFRS 9 focuses only on whether the entity
has a legal obligation to reissue the debt, not on whether there is a commercial
imperative for it to do so.
6.1.1
What constitutes ‘part’ of a liability?
The requirements of IFRS 9 for the derecognition of liabilities apply to all or ‘part’ of a
financial liability. It is not entirely clear what is meant by ‘part’ of a liability in this
context. The rules, and the examples, in IFRS 9 seem to be drafted in the context of
transactions that settle all remaining cash flows (i.e. interest and principal) of a
proportion of a liability, such as the repayment of £25 million of a £100 million loan,
together with any related interest payments.
However, these provisions are presumably also intended to apply in situations where
an entity prepays the interest only (or a proportion of future interest payments) or the
principal only (or a proportion of future principal payments) on a loan.
3948 Chapter 48
6.1.2
Legal release by creditor
A liability can be derecognised by a debtor if the creditor legally releases the debtor from the
liability. It is clear that IFRS 9 regards legal release as crucial, with the effect that very similar
(if not identical) situations may lead to different results purely because of the legal form.
For example, IFRS 9 provides that:
• where a debtor is legally released from a liability, derecognition is not precluded
by the fact that the debtor has given a guarantee in respect of the liability;
[IFRS 9.B3.3.1(b)] but
• if a debtor pays a third party to assume an obligation and notifies its creditor that
the third party has assumed the debt obligation, the debtor derecognises the debt
obligation if, and only if, the creditor legally releases the debtor from its obligations.
[IFRS 9.B3.3.4].
The effect of these requirements is shown by Example 48.16.
Example 48.16: Transfer of debt obligations with and without legal release
Scenario 1
Entity A issues bonds that have a carrying amount and fair value of $1,000,000. A pays $1,000,000 to Entity B
for B to assume responsibility for paying interest and principal on the bonds to the bondholders. The
bondholders are informed that B has assumed responsibility for the debt. However, A is not legally released
from the obligation to pay interest and principal by the bondholders. Accordingly, if B does not make
payments when due, the bondholders may seek payment from A.
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Scenario 2
Entity A issues bonds that have a carrying amount and fair value of $1,000,000. A pays $1,000,000 to Entity B
for B to assume responsibility for paying interest and principal on the bonds to the bondholders. The
bondholders are informed that B has assumed responsibility for the debt and legally release A from any
further obligation under the debt. However, A enters into a guarantee arrangement whereby, if B does not
make payments when due, the bondholders may seek payment from A.
It is clear, in our view, that in either scenario above the bondholders are in the same
economic and legal position – they will receive payments from B and, if B defaults, they
will have recourse to A.
However, IFRS 9 gives rise to the, in our view, anomalous result that:
• Scenario 1 is accounted for by the continuing recognition of the debt because no
legal release has been obtained; but
• Scenario 2 is accounted for by derecognition of the debt, and recognition of the
guarantee, notwithstanding that the effect of the guarantee is to put A back in the same
position as if it had not been released from its obligations under the original bond.
IFRS 9 also clarifies that, if a debtor:
• transfers its obligations under a debt to a third party and obtains legal release from
its obligations by the creditor; but
• undertakes to make payments to the third party so as to enable it to meet its
obligations to the creditor,
it should derecognise the original debt, but recognise a new debt obligation to the third
party. [IFRS 9.B3.3.4].
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Legal release may also be achieved through the novation of a contract to an
intermediary counterparty. For example, a derivative between a reporting entity and a
bank may be novated to a central counterparty (CCP). In these circumstances, the IASB
explains that the novation to the CCP releases the bank from the responsibility to make
payments to the reporting entity. Consequently, the original derivative meets the
derecognition criteria for a financial liability and a new derivative with the CCP is
recognised. [IFRS 9.BC6.335]. However, for hedge accounting purposes only, it is
sometimes possible in these circumstances to treat the new derivative as a continuation
of the original (see Chapter 49 at 8.3).
6.1.3
‘In-substance defeasance’ arrangements
Entities sometimes enter into so-called ‘in-substance defeasance’ arrangements in
respect of financial liabilities. These typically involve a lump sum payment to a third
party (other than the creditor) such as a trust, which then invests the funds in (typically)
very low-risk assets to which the entity has no, or very limited, rights of access.
These assets are then applied to discharge all the remaining interest and principal
payments on the financial liabilities that are purported to have been defeased. It is
sometimes argued that the risk-free nature of the assets, and the entity’s lack of access
to them, means that the entity is in substance in no different position than if it had
actually repaid the original financial liability.
IFRS 9 regards such arrangements as not giving rise to derecognition of the original
liability in the absence of legal release by the creditor. [IFRS 9.B3.3.3].
6.1.4
Extinguishment in exchange for transfer of assets not meeting the
derecognition criteria
IFRS 9 notes that in some cases legal release may be achieved by transferring assets to
the creditor which do not meet the criteria for derecognition (see 3 above). In such a
case, the debtor will derecognise the liability from which it has been released, but
recognise a new liability relating to the transferred assets that may be equal to the
derecognised liability. [IFRS 9.B3.3.5]. It is not entirely clear what is envisaged here, but it
may be some such scenario as the following.
Example 48.17: Extinguishment of debt in exchange for transfer of assets not
meeting derecognition criteria
An entity has a bank loan of €1 million. The bank agrees to accept in full payment of the loan the transfer to
it by the entity of a portfolio of corporate bonds with a market value of €1 million. The entity and the bank
then enter into a put and call option over the bonds, the effect of which will be that the entity will repurchase
the bonds in three years’ time at a price that gives the bank a lender’s return on €1 million. As discussed
further at 4.2.8 above, this would have the effect that the entity is unable to derecognise the bonds.
Under the provisions of IFRS 9, the entity would be able to derecognise the original bank loan, as it has been
legally released from it. The provisions under discussion here have the overall result that a loan effectively
continues to be recognised. Strictly, however, the analysis is that the original loan has been derecognised and
a new one recognised. In effect the accounting is representing that the entity has repaid the original loan and
replaced it with a new one secured on a bond portfolio.
However, as the new loan is required to be initially recognised at fair value whereas the old loan may well
have been recognised at amortised cost (see Chapter 46 at 3), there may well be a gain or loss to record as the
result of the different measurement bases being used – see 6.2 and 6.3 below.
3950 Chapter 48
6.2
Exchange or modification of debt by original lender
It is common for an entity, particularly but not necessarily when in financial difficulties,
to approach its major creditors for a restructuring of its debt commitments – for
example, an agreement to postpone the repayment of principal in exchange for higher
interest payments in the meantime, or to roll up interest into a single ‘bullet’ payment of
interest and principal at the end of the term. Such changes to the terms of debt can be
effected in a number of ways, in particular:
• a notional repayment of the original loan followed by an immediate re-lending of
all or part of the proceeds of the notional repayment as a new loan (‘exchange’); or
• legal amendment of the original loan agreement (‘modification’).
The accounting issue raised by such transactions is essentially whether there is, in fact,
anything to account for. For example, if an entity owes £100 million at floating rate
interest and negotiates with its bankers to change the interest to a fixed coupon of 7%,
should the accounting treatment reflect the fact that:
(a) the entity still owes £100 million to the same lender, and so is in the same position
as before; or
(b) the modification of the interest profile has altered the net present value of the total
obligations under the loan?
IFRS 9 requires an exchange between an existing borrower and lender of debt
instruments with ‘substantially different’ terms to be accounted for as an extinguishment
of the original financial liability and the recognition of a new financial liability. Similarly,
a substantial modification of the terms of an existing financial liability, or a part of it,
(whether or not due to the financial difficulty of the debtor) should be accounted for as
an extinguishment of the
original financial liability and the recognition of a new financial
liability. [IFRS 9.3.3.2].
The accounting consequences for an exchange or a modification that results in
extinguishment and one that does not lead to extinguishment are discussed in further
detail at 6.2.1 to 6.2.3 below.
IFRS 9 regards the terms of exchanged or modified debt as ‘substantially different’ if the
net present value of the cash flows under the new terms (including any fees paid net of
any fees received) discounted at the original effective interest rate is at least 10%
different from the discounted present value of the remaining cash flows of the original
debt instrument. [IFRS 9.B3.3.6]. This comparison is commonly referred to as ‘the 10% test’.
Whilst IFRS 9 does not say so explicitly, it seems clear that the discounted present value
of the remaining cash flows of the original debt instrument used in the 10% test must
also be determined using the original effective interest rate, so that there is a ‘like for
like’ comparison. This amount should also represent the amortised cost of the liability
prior to modification.
Also, it is not clear from the standard whether the cash flows under the new terms
should include only fees payable to the lender or whether they should also include other
fees and costs that would be considered transaction costs, such as amounts payable to
the entity’s legal advisers. Read literally the standard suggest only fees should be
included, but as the accounting treatment for fees and costs incurred on a modification
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3951
are identical, some would argue that both should be included in the test. The
Interpretations Committee considered this matter and concluded only fees payable to
the lender should be considered when applying the 10% test.18 Consequently, the IASB
has decided to clarify IFRS 9 to this effect with the clarifications having prospective
effect,19 although at the time of writing no proposals had been published.
IFRS 9 does not explicitly prohibit extinguishment accounting for an exchange or
modification of a liability where the net present value of the cash flows under the new
terms is less than 10% different from the discounted present value of the remaining cash
flows of the original debt instrument. Indeed, there may be situations where the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 781
