The IFRIC considered a request for guidance on the application of the effective interest rate method (EIRM) to a debt instrument with future cash flows (principal and interest) linked to changes in an inflation index. The request was limited to 'inflation-linked instruments' that are not classified at fair value through profit or loss and in which the embedded derivative (the inflation linked mechanism) is determined to be closely related to the host contract.

The following views were discussed:

View A: Apply AG 7 of IAS 39

AG7 of IAS 39 Financial Instruments: Recognition and Measurement applies to floating rate financial instruments and states that re-estimations of cash flows alter the effective interest. AG7 of IAS 39 assumes that "(i)f a floating rate financial asset or floating rate financial liability is recognised initially at an amount equal to the principal receivable or payable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or liability".

Supporters of View A argue that an inflation-linked instrument is analogous to a floating rate instrument because varying interest amounts are a contractual term of the instrument. Consequently, changes in the inflation index result in changes to the instrument's effective yield and it would be inappropriate to determine a single effective interest rate for the life of the instrument.

View B: Apply AG 8 of IAS 39

According to AG8 of IAS 39 re-estimations of cash flows alter the carrying amount of the financial instrument since the carrying amount is to be recalculated using the original effective interest rate.

Supporters of View B argue that an inflation-linked instrument is not within the scope of paragraph AG7 because the changes in estimated future cash flows do not reflect movements in market interest rates. In their view paragraph AG8 applies to changes in estimated future cash flows other than those that are explicitly addressed in paragraph AG7.

View C: Analogise to the requirements of IAS 29 Financial Reporting in Hyperinflationary Economies

The IFRIC agreed with a staff analysis that it would be inappropriate for entities in non-hyperinflationary economies to analogise to IAS 29 Financial Reporting in Hyperinflationary Economies.

An IASB Observer noted that this issue might be resolved by applying paragraph AG6 of IAS 39; that is, if the link to an inflation index represents a repricing to market rates, no adjustments may need to be made.

The IFRIC unanimously decided not to add this item to its agenda as any guidance would be more in the nature of application guidance.

The staff was asked to redraft the proposed agenda decision by referring to AG6 rather than AG7 and AG8 and to submit the redrafted version to the IFRIC as soon as possible. The IFRIC will then examine whether the inclusion of AG6 requires further research. If yes, the issue will be discussed again at the July meeting. Otherwise a tentative agenda decision will be published in the IFRIC Update for this meeting.