modification of the debt is so fundamental that immediate derecognition is appropriate
whether or not the 10% test is satisfied. The following are examples of situations where
derecognition of the original instrument could be required:
• An entity has issued a ‘plain vanilla’ debt instrument and restructures the debt to
include an embedded equity instrument.
• An entity has issued a 5% euro-denominated debt instrument and restructures the
instrument to an 18% Turkish lire-denominated debt instrument.
The present value of the cash flows of the restructured debts, discounted at the original
effective interest rate, may not be significantly different from the discounted present value
of the remaining cash flows of the original financial liability. However, even if the 10% test
is not satisfied, the introduction of the equity-linked feature or a change in currency could
significantly alter the future economic risk exposure of the instrument. In these
circumstances the modification of terms should, in our view, be regarded as representing
a substantial change which would lead to derecognition of the original liability.
6.2.1
Costs and fees
An entity will almost always be required to pay fees to the lender and incur costs (such
as legal expenses) on an exchange or modification of a financial liability.
If an exchange of debt instruments or modification of terms is accounted for as an
extinguishment of the original debt, IFRS 9 requires any costs or fees incurred to be
recognised as part of the gain or loss on the extinguishment (see 6.3 below). [IFRS 9.B3.3.6].
Where the exchange or modification is not accounted for as an extinguishment, any
costs or fees incurred adjust the carrying amount of the liability and are amortised over
the remaining term of the modified liability. [IFRS 9.B3.3.6]. IFRS 9 does not specify a
particular method for amortising such costs and fees. In our view, applying the effective
interest method or another approach that approximates this such as a straight-line
method would be appropriate. This is illustrated in the following example.
Example 48.18: Fees and costs incurred on modification of debt not treated as
extinguishment
On 1 January 2016 an entity borrowed $100 million on, at that time, arm’s length market terms, so that interest
of 6% was to be paid annually in arrears and the loan repaid in full on 31 December 2020. Transaction costs
of $4 million were incurred. Assuming that the loan had run to term, the entity would have recorded the
following amounts using the effective interest method. The loan is originally recorded at the issue proceeds
of $100 million less transaction costs of $4 million, and the effective interest rate of 6.975% is derived by a
computer program or trial and error. For a more detailed discussion of the effective interest method, see
Chapter 46 at 3.
3952 Chapter 48
Interest
Year Liability
b/f
at 6.975%
Cash paid
Liability c/f
$m
$m
$m
$m
1.1.2016 96.00
96.00
2016 96.00
6.70
(6.00)
96.70
2017 96.70
6.74
(6.00)
97.44
2018 97.44
6.80
(6.00)
98.24
2019 98.24
6.85
(6.00)
99.09
2020 99.09
6.91
(106.00)
–
During the latter part of 2017 the entity considers expanding its business in a way that would crystallise
the lender’s right to demand immediate repayment of the loan because such an action is not permitted
under the detailed terms of the loan. Therefore the entity approaches the lender with a view to amending
those terms to permit the planned expansion, but without changing the cash flows on the loan. On
1 January 2018, the lender agrees to amend the terms in return for which it charges the entity a fee of
$450,000. The entity also incurs directly attributable legal costs of $50,000, bringing the total fees and
costs incurred to $500,000.
It can be shown that the net present value of the cash flows under the new terms, including the $0.45 million
of fees paid (but excluding the $0.05 million of legal costs in line with the Interpretations Committee’s
tentative conclusion noted at 6.2 above), discounted at the original effective interest rate is $97.89 million.
This compares to the carrying amount of $97.44 million and because the remaining cash flows have not
changed, the difference between the two simply represents the fees paid. This difference is just 0.46% of the
original carrying amount, significantly less than 10%. The entity does not consider the changes to the detailed
terms of the loan to be substantial and therefore concludes the modification should not result in the
extinguishment of the liability.
Accordingly the carrying amount of the liability is adjusted by the $500,000 fees and costs incurred so that
the revised carrying amount is $96.94 million ($97.44 million less $0.50 million). In order to amortise this
adjustment over the remaining term of the loan, the entity could reset the effective interest rate of the loan, in
this case to 7.169%, so that it is amortised in accordance with the effective interest method as follows.
Interest
Year Liability
b/f
at 7.169%
Cash paid
Liability c/f
$m
$m
$m
$m
1.1.2018 96.94
96.94
2018 96.94
6.95
(6.00)
97.89
2019 97.89
7.02
(6.00)
98.91
2020 98.91
7.09
(106.00)
–
Another way would be to view the liability as comprising two components: the unadjusted carrying
amount of $97.44 million, to which the effective interest method would be applied using the original
effective interest rate of 6.975%; and the adjustment of $500,000 which would be amortised on some
other basis, such as straight line. This would give rise to substantially the same interest expense in each
period, detailed calculations showing a slight change in 2018 and 2020 to $6.96 million and
$7.08 million respectively.
6.2.2
Modification gains and losses
In Example 48.18 above, the remaining cash flows on the loan remained the same after
the modification, but in practice they will often change. For example, in the situation
set out in Example 48.18, the lender might have agreed to charge additional interest of,
say, $170,000 per year for the remaining three year term of the loan instead of the
$450,000 fee at the time of the modification. Detailed calculations show an almost
Financial
instruments:
Derecognition
3953
identical outcome when applying the 10% test to these revised facts, with the net present
value of the cash flows under revised terms being $97.89 million excluding the $50,000
of costs, a difference of $0.45 million or 0.46%. Again it would be concluded that the
; modification does not result in derecognition of the liability.
IFRS 9 requires modifications of financial liabilities that do not result in derecognition
to be accounted for similarly to modifications of financial assets (see Chapter 46 at 3.3.1).
The amortised cost of the financial liability should be recalculated by computing the
present value of estimated future contractual cash flows that are discounted at the
financial instrument’s original EIR. Any consequent adjustment should be recognised
immediately in profit or loss. [IFRS 9.BC4.252, BC4.253].
The requirements of IAS 39 were less clear. Under IAS 39 the EIR was often amended
to reflect the new terms and no gain or loss was recognised.
Applying the requirements of IFRS 9 to the situation discussed above would result in
the entity recognising a modification loss of $0.45 million, being the net present value
of the additional interest payable of $170,000 per annum, discounted at the original
effective interest rate of 6.975%. This might seem counter-intuitive to some when
compared to the original facts in Example 48.18. The only difference between the
two scenarios is that in the first the borrower makes an immediate cash payment to
the lender of $0.45 million in the form of a fee, whereas in the second it makes
payments to the lender over the next three years (in the form of additional interest)
which have a net present value of $0.45 million. Nevertheless, the requirements of
IFRS 9 are clear.
Treating all modifications in this way will represent a change in practice for many
entities compared to the approach applied under IAS 39. If a modified financial liability
remains in the entity’s statement of financial position on adoption of IFRS 9 it should
apply the transition requirements of IFRS 9.
Those requirements are covered in more detail in Chapter 44 at 10.2, Chapter 46 at 6.2
and Chapter 47 at 16.2, but in summary: [IFRS 9.7.2.1, 7.2.11, 7.2.15]
• the new policy should be applied retrospectively unless it is impracticable (as
defined in IAS 8) to do so;
• comparatives need not be restated and, in fact, may only be restated if this can be
done without the use of hindsight;
• if it is impracticable to apply the new policy retrospectively and comparatives are
not restated, the entity should treat the fair value of the financial liability at the
date of initial application as its new amortised cost at that date;
• if it is impracticable to apply the new policy retrospectively and comparatives are
restated, the entity should treat the fair value of the financial liability at the end of
each comparative period presented as its new amortised cost at that date; and
• any difference between the previous carrying amount and the carrying amount at
the date of initial application (or the beginning of the earliest comparative period
if comparatives are restated) should be recognised in retained earnings.
3954 Chapter 48
6.2.3 Illustrative
examples
Examples 48.19 and 48.20 below illustrate some more complex modifications of debt.
Example 48.19: Modification of debt not treated as extinguishment
On 1 January 2012 an entity borrowed £100 million on, at that time, arm’s length market terms, so that
interest of 7% was to be paid annually in arrears and the loan repaid in full on 31 December 2021.
Transaction costs of £5 million were incurred. Assuming that the loan had run to term, the entity would
have recorded the following amounts using the effective interest method. The loan is originally recorded
at the issue proceeds of £100 million less transaction costs of £5 million, and the effective interest rate
is 7.736%.
Interest
Year Liability
b/f
at 7.736%
Cash paid
Liability c/f
£m
£m
£m
£m
1.1.2012 95.00
95.00
2012 95.00
7.35
(7.00)
95.35
2013 95.35
7.38
(7.00)
95.73
2014 95.73
7.40
(7.00)
96.13
2015 96.13
7.44
(7.00)
96.57
2016 96.57
7.47
(7.00)
97.04
2017 97.04
7.51
(7.00)
97.55
2018 97.55
7.55
(7.00)
98.10
2019 98.10
7.59
(7.00)
98.69
2020 98.69
7.63
(7.00)
99.32
2021 99.32
7.68
(107.00)
–
During 2016 the entity is in financial difficulties and approaches the lender for a modification of the terms of
the loan. These are agreed on 1 January 2017, as follows. No cash interest will be paid in 2017 or 2018,
although a fee of £2 million must be paid to the lender immediately. From 2019 onwards interest of 9% will
be paid annually in arrears and the term of the loan will be extended for two years until 31 December 2023.
Legal fees and other costs incurred are not material.
The entity is required to compute the present value of the new arrangement using the original effective interest
rate of 7.736%. This gives a net present value for the modified debt of £92.53 million, calculated as follows:
Discount
Year Cash
flow
£m
factor
£m
1.1.2017 Fee
2.00
1
2.00
2019 Interest 9.00
1/1.077363
7.20
2020 Interest 9.00
1/1.077364
6.68
2021 Interest 9.00
1/1.077365
6.20
2022 Interest 9.00
1/1.077366
5.75
2023
Interest and principal
109.00
1/1.077367
64.70
Total
92.53
This represents 95.4% of the current carrying value of the debt as at the end of 2016 of £97.04 million, so
that the net present value of the modified loan (discounted at the effective interest rate of the original loan) is
4.6% different from that of the original loan. This is less than 10%, so that the modification is not
automatically required to be treated as an extinguishment under IFRS 9.
As noted at 6.2.2 above, under IFRS 9 the entity will have to recognise an immediate gain or loss when
cash flows on a loan are modified and the liability is not derecognised. Applying the requirements under
IFRS 9 to this situation would result in the recognition of a gain of £6.51 million (£97.04 million current
carrying value less £90.53 million recalculated net present value, excluding the fees, which as set out
Financial
instruments:
Derecognition
3955
at 6.2.1 above adjust the carrying amount of the liability and are amortised over its remaining term).
Allocating the fee based upon the effective interest method would result in an increase in the effective
interest rate to 8.1213%.
> The adjusted carrying amount of the liability £88.53 million (£90.53 million net present value of cash flows
on the borrowing less £2 million fee) would be accreted using the effective interest method as follows:
Interest
Year Liability
b/f
at 8.1213%
Cash paid
Liability c/f
£m
£m
£m
£m
2017 88.53
7.19
–
95.72
2018 95.72
7.77
–
103.49
2019 103.49
8.41
(9.00)
102.90
2020 102.90
8.36
(9.00)
102.26
2021 102.26
8.30
(9.00)
101.56
2022 101.56
8.25
(9.00)
100.81
2023 100.81
8.19
(109.00)
–
Example 48.20: Modification of debt treated as extinguishment
Assume the same facts as in Example 48.19 above, except that on 1 January 2017 the entity comes to an
arrangement with the lender to modify the terms of the loan as follows.
No cash interest will be paid in 2017 or 2018, although a fee of £2 million must be paid to the lender
immediately. From 2019 onwards interest of 12.5% will be paid annually in arrears, and the term of the loan
will be extended for three years until 31 December 2024. Legal fees and other costs incurred are not material.
As in Example 48.19 above, the entity is required to compute the net present value of the new arrangement
using the original effective interest rate of 7.736%. This gives a net present value for the modified debt of
£107.3 million calculated as follows.
Discount
Year Cash
flow
£m
factor
£m
1.1.2017 Fee
2.00
1
2.00
2019 Interest 12.50
1/1.077363
10.00
2020 Interest 12.50
1/1.077364
9.28
2021 Interest 12.50
1/1.077365
8.61
2022 Interest 12.50
1/1.077366
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 782
