What’s the issue?
During times of economic uncertainty, borrowers may request and/or be granted concessions in respect of their issued liabilities. For example, economic disruption following the COVID-19 pandemic continues to cause a financial burden for many borrowers. Therefore, they might approach lenders to ask for concessions on the current terms of their borrowings – e.g. request relaxation of covenants, delayed repayment of interest or principal, or a reduction in the interest rate. Governments continue to encourage banks to provide concessions for particular types of customers.
In addition, geopolitical events may result in associated sanctions on various institutions and individuals, which might cause financial difficulty for a borrower. This could occur if, for example, the company has material contracts or sales in Russia or Ukraine and the sanctions impact payments from sanctioned customers or because the company itself is the direct recipient of sanctions.
When debt terms are renegotiated, borrowers will need to analyse these arrangements carefully to determine the appropriate accounting.
If borrowers have received concessions on their liabilities, then different accounting might apply.
Getting into more detail
When the contractual terms of a financial liability are substantially modified, it is accounted for as an extinguishment of the original debt instrument and the recognition of a new financial liability. The new debt instrument is recorded at fair value and any difference from the carrying amount of the extinguished liability, including any non-cash consideration transferred, is recorded in profit or loss. Any costs or fees incurred are generally included in profit or loss, too. [IFRS 188.8.131.52–3.3.3, 5.1.1, B3.3.6]
If a modification to the terms of a financial liability is not substantial, then the amortised cost of the liability is recalculated as the present value of the estimated future contractual cash flows, discounted at the original effective interest rate. The resulting gains or losses are recognised in profit or loss. Any costs or fees incurred adjust the carrying amount of the modified financial liability and are amortised over its term. The periodic re-estimation of cash flows to reflect movements in market rates of interest will change the effective interest rate of a floating-rate financial liability. [IFRS 9.B3.3.6, B5.4.6, Insights 7.7.350]
To determine whether a modification of terms is substantial, a borrower performs a quantitative assessment – i.e. a ‘10 percent test’1. If the difference in the present values of the cash flows is less than 10 percent, then the borrower needs to perform a qualitative assessment to identify substantial differences in terms that by their nature are not captured by the quantitative assessment. Performing a qualitative assessment may require a high degree of judgement based on the facts and circumstances. [IFRS 9.B3.3.6, Insights 7.6.420.10–20]
Extinguishing liabilities with equity instruments
Borrowers might use their own equity instruments to settle their debt instruments (e.g. debt-for-equity swaps) because of the liquidity impact from the COVID-19 pandemic. If equity instruments are issued to a creditor to extinguish all or part of a financial liability in a debt-for-equity swap, then the equity instruments are consideration paid. [IFRIC 19.5]
The equity instruments are measured at fair value, unless that fair value cannot be measured reliably. In this case, the equity instruments are measured with reference to the fair value of the financial liability extinguished. When measuring the fair value of an extinguished financial liability that includes a demand feature, paragraph 472 of IFRS 13 Fair Value Measurement is not applied. [IFRIC 19.6–7]
The difference between the carrying amount of the financial liability and the fair value of the equity instruments is recognised in profit or loss. [IFRIC 19.9]
If only part of the financial liability is extinguished by the issue of equity instruments, then a borrower needs to assess first whether a part of the consideration is for a modification of the liability still outstanding. If it is, then the consideration paid is allocated between the extinguished part and the part that remains outstanding. The consideration allocated to the debt still outstanding forms part of the assessment of whether the modification is substantial. All relevant facts and circumstances need to be taken into account in making this allocation [IFRIC 19.8, 10, Insights 7.6.450.40–50]
Support from governments
See our related web articles for further guidance on accounting for government assistance:
- Are government grants recognized in the right period and appropriately measured?
- How should companies account for different forms of government assistance?
Reversal of modifications granted during a period of uncertainty
Measures taken during a period of uncertainty are often quickly reversed afterwards. For example, many economies are gradually returning to pre-pandemic conditions because of the successful roll-out of vaccination programmes.
Additional modifications granted to return the payments on a loan to its previous state are generally treated in the same way as those made to alter the payments in the first place (see the section on modification above).
However, when assessing the impact of an additional modification, the ‘original’ debt instrument that is assessed is that just before its additional modification: it is not the original loan granted before its modification during the pandemic.
Actions for management
- whether there are any changes to the terms and conditions of a financial liability and, if so, whether those changes are substantial;
- if equity instruments have been issued to settle a financial liability, whether the fair value of those equity instruments can be measured reliably; and
- if an equity instrument has been issued to settle part of a financial liability, whether part of the consideration is for the modification of the liability that is still outstanding.
1 Terms are considered to have been ‘substantially modified’ when the net 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, differs by at least 10 percent from the present value of the remaining cash flows under the original terms.
2 The fair value of a financial liability with a demand feature (e.g. a demand deposit) is not less than the amount payable on demand, discounted from the first date on which the amount could be required to be paid.
References to ‘Insights’ mean our publication Insights into IFRS
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