• Stephan Lego-Deiber, Partner |

IFRS 9 has now been applicable for over a year, but some of its changes have often been either overseen or neglected—even when they could have a material impact on the accounts. One of these is the treatment of non-substantial modifications of financial assets or financial liabilities when amending contractual terms within a restructuring transaction. There is actually an essential change compared to the old requirements—or, let’s rather say, IFRS 9 now provides guidance on how to treat such modifications whereas IAS 39 did not.

How do you determine if a modification is substantial or not?

Both IAS 39 and IFRS 9 refer to the so called “10% test”. In other words, if the net present value of the cash flows under the modified terms including net fees—which are not specified yet—is at least 10% different from the net present value of the remaining cash flows under the old terms, with the original effective interest rate (EIR) discounted for both, then the modification is considered to be substantial. If the modification is indeed substantial, then the asset or liability must be derecognized and again recognized under the modified terms. The International Accounting Standards Board (IASB) is currently preparing a proposal to amend IFRS 9, with the aim of clarifying which fees should be included in the calculation for the assessment if a financial asset or liability is derecognized or not.

Although there was no guidance prior to IFRS 9, there was a best practice related to accounting for gains or losses on non-substantial contract modifications. Under that best practice, any non-substantial difference is amortized over the remaining term of the instrument by amending the EIR accordingly, but not directly recognized in the profit or loss account. It seems that entities were free to decide on how to account for those kinds of modifications. This practice differed significantly to IFRS 9, under which gains or losses on non-substantial modifications are to be recognized immediately, at the restructuring date. This treatment is explicitly required for financial assets, and additionally applicable for non-substantial modifications of financial liabilities. The reasoning behind this is that the IASB wants filers to recognize a modification gain or loss for all revisions of estimated payments or receipts which include both financial assets and liabilities.

What are the impacts?

Clearly, entities should be careful when first applying IFRS 9. First of all, the accounting policies need to be amended according to the new requirements and applied retrospectively to all existing instruments that are still recognized at the date of initial application. Secondly, this change might lead to adjustments to the retained earnings if comparatives are not restated. Thirdly, entities must be clear about whether the change in the contractual terms due to restructuring should be classified as a modification or as an expiration or re-estimation of cash flows. The accounting treatment of the cash flows as well as possible transaction costs differs depending on the outcome of the assessment.

Accounting for non-substantial modifications of both assets and liabilities remains a challenge in terms of assessing which paragraph of IFRS 9 applies. However, according to the IFRIC discussion paper (PDF, 0.5MB) on this topic, the IASB is considering offering more guidance on this topic, through a webcast for example, and they do not see the need to revise the standard.

This article has been written by Melanie Goetz.