Date recorded:

Modification and extinguishment of financial liabilities

The Board discussed the accounting for 'substantive modification' of a financial liability or an exchange of one debt instrument for another debt instrument with 'substantially different terms'.

Most Board members agreed that a quantitative '10% test' should be abolished as it was arbitrary, represented a bright line that was inconsistent with principle-based Standards, and led to diversity in practice.

Some Board members expressed concerns about how the 'substantive modification' notion defined in a purely qualitative manner would capture more subtle notions (for instance, changes in seniority of the liabilities that would influence fair value). Other Board members discussed the point of view from which the modification should be addressed (issuer or lender).

One Board member proposed that a substantive modification would be any modification that changes the fair value of the instrument. Another Board member expressed his opinion that the ultimate question behind the approach was when to recognise an unrecognised change of fair value of a financial instrument. He was particularly concerned that any of the discussed approaches would lead to a free choice and proposed to recognise only a change of the fair value. Other Board members disagreed because they felt that this proposal would result to a new measurement attribute that was inconsistent with other measurement attributes defined. Moreover, in their opinion, identical economic positions would be treated differently.

After a lengthy discussion the Board adopted an approach that defined 'substantive modification' that leads to extinguishment of financial liability from a qualitative standpoint: 'change in the nature of the investment the original contract represented', which would be assessed based on all the facts and circumstances. The Board agreed to provide additional guidance in the form of non-exhaustive examples as to when the nature of the original investment changed. The Board also agreed to include substantive changes in the timing, amounts, or uncertainty of the cash flows or the fair value of the original contract from that of the amended contract as indicators of 'substantive modification' of the financial liability.

Accounting for extinguishment and modifications of financial liabilities

After a brief discussion the Board confirmed the mechanics of the 'extinguishment accounting' as proposed in the exposure draft and currently defined in IAS 39.

The Board agreed to recognise in profit or loss all costs and fees related to the instruments being extinguished. On the other hand, costs and fees directly attributable to the issue of the debt instrument associated with the new liability should be accounted for in accordance with the requirements of IAS 39.

For the financial liabilities that do not fulfil the criteria for the 'extinguishment accounting' the Board confirmed the mechanics of the 'modification accounting' as proposed in the exposure draft and currently defined in IAS 39. The modification accounting would lead to adjustment of the carrying amount of the liability for any costs or fees incurred. The Board decided that an entity should recognise the gain or loss in a transaction that qualified for modification accounting immediately into profit or loss, and not include the gain or loss as part of an adjustment to the effective interest rate over the remaining term of the modified financial liability.

The Board confirmed the mechanics of the 'partial extinguishment accounting' in the context of an entity repurchasing of its original financial liability as proposed in the exposure draft and currently defined in IAS 39.

The Board continued with the deliberations on the 'debt-for-equity' swaps. The Board confirmed the guidance based on the consensus reached by the IFRIC in IFRIC 19 subject to modification of the derecognition approach on 'substantial modification' of an instrument or a portion thereof. Moreover, the Board decided that if there was a difference between the fair value of the liability that was extinguished and the fair value of the equity instruments issued as consideration, the difference should adjust the gain or loss to be recognised to the extent that the difference qualified as an asset or liability.

Modification of financial liabilities

The Board agreed in principle that in a contract modification that met substantial modification criteria (and, therefore, is accounted for as an extinguishment of a financial liability by the debtor/borrower), derecognition requirements for the financial asset of the creditor/lender should be symmetrical.

The Board discussed implication of this decision on broader financial instruments project and asked the staff to provide additional analysis on the following meeting. The staff expressed its initial view that this decision would lead to recognition of any 'day one gain or loss'. The Board asked the staff to include in the analysis also effects on the reclassification criteria in IFRS 9 and recognition and presentation of any impairment of financial assets in case concessionality was embedded in the 'substantial modification'.

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