Accounting for changes in debt terms under IFRS 9 – This may surprise you!
Published on June 28, 2017
Background
IFRS 9 (Financial Instruments) is a new accounting standard that is superseding IAS 39 with an effective date of January 1, 2018. The new standard will apply to all companies, not just banks and financial institutions, and will result in many fundamental changes to how a company accounts for financial instruments, including financial liabilities (debt). It also brings a new hedge accounting model that is aligned with risk management and extensive new disclosures.
The purpose of this article is to bring some attention to a perhaps unexpected aspect of accounting for debt payable that has been modified. Changes in debt terms are common in today’s environment and at first glance, it may appear that IFRS 9 does not change the accounting for financial liabilities as it retains almost all of the existing guidance under IAS 39. However, the devil is in the details. IFRS 9 has introduced new guidance on how to account for changes in debt terms and this new requirement is expected to result in a significant change in practice for many companies.
What is the issue?
Modifications to debt can occur when the borrower and lender negotiate changes to the terms of the debt such as increasing the interest rate or extending the maturity date. Currently, under IAS 39, a change that is considered “substantial”1 would be accounted for as an extinguishment, which means that the original debt is derecognized, with a gain or loss is recorded in profit and loss, and a new financial liability recorded based on the new terms. If the change is not considered to be substantial, the original debt remains on the books and there is no current profit and loss impact.
However, under IFRS 9, a gain or loss at the date of the modification would be recognized regardless of whether the change in terms are considered substantial. This means that the original debt would have to be derecognized and replaced with the present value of the modified debt. In addition, if there were any costs or fees incurred to change the terms, they would be adjusted to the carrying amount of the modified debt and amortized over the remaining term of the modified debt.
This issue has been discussed by the IFRS Interpretation Committee. A tentative agenda decision supporting the accounting treatment discussed above was published at its March 2017 meeting. However on its June 13, 2017 meeting, the Committee did not approve finalizing the agenda decision and hence a final decision on this issue is still pending.
What does this mean for Canadian reporting issuers transitioning to IFRS 9?
If the agenda decision is finalized as originally release, on transition to IFRS 9, the new requirement will result in a change in practice for many companies. Specifically, companies would be required to retrospectively apply IFRS 9 guidance to any outstanding debt at the date of adoption (i.e. January 1, 2018) that has been modified in prior periods. This means that the carrying amount of the debt may need to be changed as at January 1, 2018, as well as any comparative periods.
What if my company has already adopted IFRS 9 or an earlier version of IFRS 9?
As noted above, once the decision agenda is finalized, this change will likely need to be applied on adoption of IFRS 9. But what if my company has early adopted IFRS 9? Companies with debt outstanding that has been modified in the past and that are already following some version of IFRS 9 will need to develop plans to be ready to adopt this change on a retrospective basis, should the agenda decision be finalized as originally released.
As always, should you have any questions or concerns, or need help with any aspects of the new requirements for debt modifications under IFRS 9, feel free to reach out to your Deloitte contact.
Let’s take a look at a simple example:
Question: How would the difference of $85,000 be accounted for under IAS 39 and IFRS 9? Answer: Under IAS 39, the gain of $85,000 would not be recognized in profit and loss. Instead, it would be recorded in profit and loss in future periods as interest expense. The old debt would not be derecognized. Under IFRS 9, the gain of $85,000 would have been recognized in profit and loss at January 1, 2016. The old debt would have been derecognized and replaced with the amortized cost of the new debt of $865,000. On adoption of IFRS 9 on January 1, 2018, a transitional adjustment would be needed to adjust the debt to what it would have been if the carrying amount had been changed to $865,000 and the original effective rate applied from that date.2 |
Contacts
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Kerry Danyluk Kerry joined Deloitte in 2006 with over 20 years of experience in industry, public practice and standard setting. She is currently the National Director of Accounting Services at Deloitte, with overall responsibility for accounting consultations. She serves clients in a variety of sectors, most significantly resources, financial services, retail, public sector and utilities. |
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An Lam An joined Deloitte in 2005 and has over 16 years of experience in public practice. She is currently a senior manager in the National Services Accounting Group. In this role, she researches technical positions under various frameworks. An also develops and reviews technical accounting resources aimed to assist engagement teams across the country. |
1 “Substantial” is determined either by a quantitative test or qualitatively. Under the quantitative test the amortized cost of the original debt is compared to the present value of the cash flows of the modified debt under the new terms. If this difference in cash flows is not greater than 10%, the change is not considered to be substantial.
2 The other side of the entry would be to opening retained earnings as of January 1, 2018 or the opening date of the comparative period if the company elects to restate the prior period on adoption
of IFRS 9.