International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 783
7.99
2023 Interest 12.50
1/1.077367
7.42
2024
Interest and principal
112.50
1/1.077368
61.98
Total
107.28
This represents 110.6% 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
10.6% different from that of the original loan. This is greater than 10%, so that the modification is required
to be treated as an extinguishment under IFRS 9.
This will involve derecognising the existing liability and recognising a new liability. The issue is then at what
amount the new liability should be recognised. It is not the £107.28 million above, since this includes the fee
of £2 million, which is required to be treated as integral to the cash flows of the modified loan for the purposes
of comparing it with the original loan, but is then required to be expensed immediately if the test identifies
an extinguishment.
Moreover, as the accounting treatment is intended to represent the derecognition of an existing liability and
the recognition of a new one, the modified loan must – in accordance with the initial measurement provisions
of IFRS 9 (see Chapter 45) – be recognised at fair value and amortised using its own effective interest rate,
not that applicable to the original loan.
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The difficulty is obviously in determining the fair value of the modified loan. If the loan was in the form of a
quoted bond, a market value might be available. Another possible approach might be to discount the cash
flows of the modified loan at the interest rate at which the entity could have issued a new loan on similar
terms to the modified loan. However, where (as may well be the case) the modification is being undertaken
because the entity is in serious financial difficulty, it might be that no lender would be prepared to advance
new finance, so that there is no readily available ‘notional’ borrowing rate. Nevertheless, IFRS 9 contains no
exemption from making an estimate of the fair value of the modified loan.
If the view were taken that the fair value of the modified loan was £98 million, the accounting treatment for
the modification would be (see also 6.3 below):
£m
£m
Original loan
97.04
Loss on extinguishment of debt (income statement)
2.96
Modified loan
98.00
Cash (fee)
2.00
In this particular case, this has the result that the actual gain or loss recognised is actually somewhat smaller
than the difference calculated between the net present value of the original and modified loan that led to the
requirement to recognise the gain or loss in the first place. This differential will obviously be reflected in
higher interest costs as the transaction matures. If the borrower was in financial difficulties, it is possible for
the fair value of the modified loan to be significantly below its principal amount, which could give rise to a
large profit on modification followed by very high interest charges over the remaining term.
6.2.4
Settlement of financial liability with issue of new equity instrument
A related area is the accounting treatment to be adopted where an entity issues non-
convertible debt, but subsequently enters into an agreement with the debt-holder to
discharge the liability under the debt in full or in part for an issue of equity instruments.
This most often occurs when the entity is in financial difficulties. This topic is now dealt
with in IFRIC 19 – Extinguishing Financial Liabilities with Equity Instruments – which
is discussed in Chapter 43 at 7.
6.3
Gains and losses on extinguishment of debt
When a financial liability (or part of a liability) is extinguished or transferred to another
party, IFRS 9 requires the difference between the carrying amount of the transferred
financial liability (or part of a liability) and the consideration paid, including any non-
cash assets transferred or liabilities assumed, to be recognised in profit or loss.
[IFRS 9.3.3.3].
If an entity repurchases only a part of a financial liability, it calculates the carrying value
of the part disposed of (and hence the gain or loss on disposal) by allocating the previous
carrying amount of the financial liability between the part that continues to be
recognised and the part that is derecognised based on the relative fair values of those
parts on the date of the repurchase. [IFRS 9.3.3.4]. In other words, the carrying amount of
the liability is not simply reduced by consideration received.
This is illustrated in Example 48.21 below.
Financial
instruments:
Derecognition
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Example 48.21: Partial derecognition of debt
On 1 January 2016 an entity issues 500 million €1 10-year bonds which are traded in the capital markets.
Issue costs of €15 million were incurred and the carrying value of the bonds at 31 December 2019 is
€490 million. On 31 December 2019 the entity makes a market purchase of 120 million bonds at their then
current market price of €0.97. The entity records the following accounting entry:
€m
€m
Bonds (120/500 × €490m)
117.6
Cash (120m × €0.97)
116.4
Gain on repurchase of debt 1.2
In some cases, as discussed in 6.2 above, a creditor may release a debtor from its
present obligation to make payments, but the debtor assumes an obligation to pay if
the party assuming primary responsibility defaults. In such a case, IFRS 9 requires
the debtor to recognise:
(a) a new liability based on the fair value for the obligation for the guarantee; and
(b) a gain or loss based on the difference between:
(i) any proceeds; and
(ii) the carrying amount of the original liability (including any related unamortised
costs) less the fair value of the new liability. [IFRS 9.B3.3.7].
6.4
Derivatives that can be financial assets or financial liabilities
Historically, IAS 39 did not address the required treatment for the transfer of a non-
optional derivative, such as a swap or forward contract, that by its nature can be either a
financial asset or a financial liability at various times during its life. However, in finalising
the amendments made to IAS 39 and carried forward to IFRS 9 that addressed hedge
accounting when a hedging instrument is novated to a central counterparty (see 3.4.3
above and Chapter 49 at 8.3), the IASB noted that ‘a derivative should be derecognised
only when it meets both the derecognition criteria for a financial asset and the
derecognition criteria for a financial liability in circumstances in which the derivative
involves two-way payments between parties, i.e. the payments are or could be from and
to each of the parties’. [IFRS 9.BC6.333]. In practice, any transfer of such derivatives is likely
to require the consent of the counterparty to the entity’s legal release from its obligations
under the contract, and the possible payment of a fee to compensate the counterparty for
; the difference between the creditworthiness of the entity and that of the transferee. Such
procedures are much closer to those envisaged in the derecognition rules for financial
liabilities than those implicit in the derecognition rules for financial assets.
On many occasions, the IASB has made it clear that a non-optional derivative that could
be either an asset or liability can be derecognised only if the derecognition criteria for
both assets and liabilities are satisfied (see 3.3.2 above).
6.5 Supply-chain
finance
An increasingly common type of arrangement involves the provision of finance linked to
the supply of goods or services. These arrangements, which can vary significantly in both
form and substance, are often referred to as ‘supply-chain finance’, but other terms are also
used including ‘supplier finance’, ‘reverse factoring’ and ‘structured payable transactions’.
3958 Chapter 48
Whilst the terms of such arrangements can vary widely, they typically contain a number of
the following features:
• they involve a purchaser of goods and/or services, a group of its suppliers and a
financial intermediary;
• the purchaser is often a large, creditworthy entity that uses a number of suppliers,
many of which will have a higher credit risk than the purchaser;
• the arrangement is nearly always initiated by the purchaser rather than the supplier;
• the arrangements operate continuously for all future purchases until the
arrangement is cancelled;
• they are often put in place in connection with the purchaser attempting to secure
extended payment terms from its suppliers;
• the intermediary/service provider is often a financial institution who will normally
make available IT systems to facilitate the arrangement;
• the intermediary makes available to suppliers an optional invoice discounting or
factoring facility for invoices accepted or agreed by the purchaser, often on terms
that enable the supplier to derecognise the receivable;
• the purchaser will commit to pay the invoice on the due date, sometimes by using
a payment facility operated by the intermediary;
• interest terms will be included in the supply agreement to protect the intermediary
in the event of the purchaser defaulting or missing the payment date;
• those interest terms will be similar to ones included in most supply agreements,
although they are rarely enforced by suppliers;
• the credit risk the intermediary is taking on is that of the purchaser, but it may be
able to charge a higher financing cost to the supplier (in the form of the discount)
than it would if lending to the supplier directly; and
• it can be difficult to determine the overall financing costs of the arrangement, and
who bears those costs, especially if the supply involves items for which the pricing
is subjective/unobservable.
The primary accounting concern with these types of arrangement is whether the
purchaser should present the resulting financial liability as debt or as a trade or similar
payable. This determination could have a significant impact on the purchaser’s financial
position, particularly its leverage or gearing ratios. However, whilst IFRS does not
address the issue directly, a number of standards could be regarded as relevant.
IAS 1 – Presentation of Financial Statements – addresses the presentation of the
statement of financial position and can certainly be relevant to this determination. IAS 1
requires that entities include line items that present (a) trade and other payables and
(b) other financial liabilities. [IAS 1.54]. These are considered sufficiently different in
nature or function to warrant separate presentation, [IAS 1.57], but additional line items
should be presented when relevant to an understanding of the entity’s financial position,
for example depending on the size, nature or function of the item. This may be achieved
by disaggregating the two line items noted above. [IAS 1.55, 57]. In addition, it may be
appropriate to amend the descriptions used and the ordering of items or aggregation of
similar items according to the nature of the entity and its transactions. [IAS 1.57].
Financial
instruments:
Derecognition
3959
These requirements provide a framework for determining the structure of an entity’s
statement of financial position. Liabilities that are clearly financing in nature, for
example those arising from bonds, bank borrowings and other loans, are normally
presented together and described as debt or another similar term. Conversely, liabilities
that are more clearly in the nature of working capital are normally presented within
trade and other payables, with further analysis of the component balances within the
notes. In this context, IAS 7 might also be considered relevant given an entity is required
to classify its cash flows according to whether they arise from operating, financing or
investing activities and one would expect broad consistency between the statement of
cash flows and the statement of financial position. Therefore the definitions of operating
activities and financing activities (see Chapter 36 at 4) might assist an entity in
determining the appropriate presentation of liabilities.
The requirements in IFRS 9 dealing with derecognition of financial liabilities can be relevant
in determining the appropriate presentation of liabilities arising from supply-chain financing
arrangements. If the arrangement results in derecognition of the original liability (e.g. if the
purchaser is legally released from its original obligation to the supplier), an entity will need to
determine the appropriate classification of the new liability which may well represent an
amount due to the intermediary rather than the supplier. As the intermediary is typically a
financial institution, presentation as debt could be more appropriate than as a trade or other
payable. Derecognition can also occur and presentation as debt can also be appropriate if the
purchaser is not legally released from the original obligation but the terms of the obligation
are amended in a way that is considered a substantial modification. Where those revised
terms are more consistent with a financing transaction than a trade or other payable,
classification of that new liability as debt will be appropriate.
However, even when the arrangement results in derecognition of the original trade
payable, there is a view that if there are no significant changes to the payment terms, the
new liability is not necessarily in the nature of debt and so presentation as trade or other
payables might be appropriate. Conversely, even if the original liability is not derecognised,
other factors may indicate that the substance and nature of the arrangements mean that
the liability should no longer be presented as a trade payable. Instead the liability would be
reclassified and presented as debt (in a similar way to transferred assets that are not
derecognised, which IFRS 9 requires to be reclassified within the statement of financial
position – see 4.1.1.A above). Circumstances which could result in reclassification include
the payment of referral fees or commissions by the intermediary to the purchaser.
Analy
sis of supply-chain finance is a complex exercise and requires careful examination
of the individual facts and circumstances. Obtaining an understanding of the following
factors would aid in making this determination:
• the roles, responsibilities and relationships of each party (i.e. the entity, bank and
the supplier) involved in the supply-chain financing transactions;
• discounts or other incentives received by the entity that would not have otherwise
been received without the bank’s involvement; and
• any extension of the date by the bank by which payment is due from the entity
beyond the invoice’s original due date.
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In practice, the appropriate presentation of any such arrangement is likely to involve a
high degree of judgement in the light of specific facts and circumstances. Whatever the
presentation adopted, we believe additional disclosures will often be necessary to
explain the nature of the arrangements, the financial reporting judgements made and
the amounts involved. In fact, the need for clear disclosure of complex supplier
arrangements under IFRS is something that has been emphasised by at least one
European regulator20 and the SEC has, in the past, highlighted the presentation of these
arrangements under US GAAP as an area of focus. Therefore, it is quite possible this
topic will become the focus of wider regulatory scrutiny in the future, and perhaps also
be subject to consideration by the IFRS Interpretations Committee.
7 FUTURE
DEVELOPMENTS
In March 2018 the IASB published Conceptual Framework for Financial Reporting (the
Framework). This fully revised document replaced the sections of the 2010 version
previously carried-forward from the 1989 framework and also made amendments to the
sections produced in 2010. The Framework contain a new chapter addressing both
recognition and derecognition of assets and liabilities and highlights that accounting
requirements for derecognition should aim to represent faithfully both:21
(a) the assets and liabilities retained after the transaction or other event that led to the
derecognition (including any asset or liability acquired, incurred or created as part