Loan modifications and derecognition

Company P has a $10 million loan from a bank with the following key terms:

• 5 years remaining on the loan
• Fixed interest rate of 7% p.a.* (monthly interest of 0.583%)
• Monthly payments of $58,333 with $10 million principal due on maturity
• The loan can be repaid early at any time without significant penalty.

Company P successfully renegotiates the terms of the loan and the bank agrees to reduce the interest rate to the current market rate of 5% (monthly interest of 0.417%).

QUESTION 1

Is this a substantial modification that would require the original loan to be derecognised and a new loan recognised?

Interpretive response

This is not a substantial modification. The present value of the revised contractual cash flows ($41,667 per month, based on 5% p.a.) discounted at the original effective interest rate of 7% p.a. is $9,158,333. This is less than 10% different (8.5%) to the carrying amount of the original loan ($10m).

In accordance with AASB 9, terms of a loan are substantially different if the discounted present value of the cash flows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is at least 10 percent different from the discounted present value of the remaining cash flows of the original financial liability (the so-called ’10 percent test’ or ‘quantitative assessment’). [AASB 9.B3.3.6]

The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, shall be recognised in profit or loss. [AASB 9.3.3.3]

If the exchange or modification is not accounted for as an extinguishment (i.e. because the modification is non-substantial), then the amortised cost of the liability is recalculated by discounting the revised estimated future cash flows at the instrument’s original effective interest rate or, when applicable, the revised effective interest rate.