Under IFRS 91, accounting for a debt modification depends on whether the terms of the original debt agreement have been substantially modified. When they are substantially modified (i.e. the modification is ‘substantial’), the original debt instrument is considered extinguished and is derecognized for accounting purposes, and a new debt instrument is recognized in its place. Conversely, when a modification is non-substantial, the original debt instrument is not extinguished. Similarly, the impact to profit or loss differs based on whether the terms of the original debt have been substantially modified.
A debt modification is considered substantial under a quantitative and qualitative assessment as follows.
|Quantitative assessment (the 10% test)
Is the net present value of the debt cash flows under the new terms different by at least 10% from the present value of the remaining cash flows under the original terms?
Cash flows are defined as net of any fees paid and/or received2 and are discounted using the effective interest rate of the original debt.
(only performed if the 10% quantitative test is not met)
In our view, the purpose of a qualitative assessment is to identify substantial differences in terms that by their nature are not captured by a quantitative assessment.
Accordingly, we believe that modifications whose effect is included in the quantitative assessment, and that are not considered substantial based on that assessment, cannot generally be considered substantial on their own from a qualitative perspective. These may include changes in principal amounts, maturities, interest rates, prepayment options and other contingent payment terms. However, if a debt instrument has an effective interest rate of zero, a change in the timing of cash flows will have no effect on the quantitative assessment, so should be incorporated into the qualitative assessment to ensure that its impact is considered.