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2018-020: IFRS 9 Alert – Modification of Liabilities for Non-Financial Institutions (Updated*)
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Overview: IFRS 9 was initially expected to have a limited impact on financial liabilities. However, a major late breaking change has arisen through an interpretation by the IASB of its intention with respect to IFRS 9 which may have a significant impact on non-financial companies.
January 2018
IFRS 9 was initially expected to have a limited impact on financial liabilities. For those entities that had designated liabilities at fair value through profit and loss (“FVPL”) the standard requires changes in fair value due to credit risk to be recognized in other comprehensive income. The impact of this change on non-financial institutions would be fairly limited because it only applies to “designated” liabilities, not those which are mandatorily carried at FVPL, such as derivatives.
However, a major late breaking change has arisen through an interpretation by the IASB of its intention with respect to IFRS 9 which may have a significant impact on non-financial companies.
Under IAS 39, when an entity modified a financial liability (e.g. extended the term, changed the payment structure, etc.), it would decide whether this modification was significant enough to constitute an extinguishment (either qualitatively or where the change in present value of cash flows exceeded 10% in accordance with the entity’s accounting policy). If the modification was considered an extinguishment of the initial debt, the new modified debt was recorded at fair value and a gain/loss recognized in income for the difference between the carrying amount of the old debt and the new debt. This extinguishment accounting remains the same under IFRS 9.
However, accounting under IFRS 9 differs where the change was not significant enough to be an extinguishment. Under IAS 39 modifications would not lead to an immediate income charge because the entity would typically discount the cash flows of the modified debt at a revised effective interest rate. Essentially, this recognized the impact of the change in cash flows over the remaining term of the debt.
However, under IFRS 9, the IASB believes that the cash flows under the modified debt should be rediscounted at the
original effective interest rate
. This will lead to an immediate income charge on the date of modification. As highlighted at a recent Canadian IFRS Discussion Group meeting, this guidance also can apply to liabilities subject to variable rates of interest.
In the case of a variable rate debt, the original effective interest rate used in the computation should be the rate in effect immediately prior to the modification. For example, if the margin on a LIBOR based liability changes from LIBOR + 2% to LIBOR + 2.5%, the revised cash flows would be re-discounted at the LIBOR + 2% rate in effect immediately before the modification.
Note, where a debt is revolving, or otherwise prepayable without significant penalties, qualitative factors may give rise to an extinguishment despite the results of the cash flow assessment; this possibility should be considered, taking into account a company’s accounting policy for such factors. For further information, see PwC’s manual of accounting {link}.
Determining whether a variable rate debt has been modified for accounting purposes and the subsequent accounting for such modifications may be complex and is the topic of ongoing discussions. Therefore, please be on the lookout for additional guidance which may be available subsequent to the publication of this Newsletter.
IFRS 9 classification and measurement is adopted on either a retrospective basis with adjustments to comparative figures or modified retrospective basis without adjustment to comparatives. Therefore, entities will need to consider whether there have been past modifications of liabilities that were not accounted for as extinguishments for debts that remain outstanding at the transition date. For a calendar year entity, depending on the transition method chosen this will require an adjustment to opening retained earnings at January 1, 2017 or January 1, 2018 to reflect the amount at which the loan would have been carried, if the IFRS 9 approach had been applied.
Many entities have long-term loans and determining whether there have been past modifications may be challenging, particularly where there have been multiple modifications for existing debts.
The Appendix to this Alert presents an example to illustrate the difference in the IFRS 9 approach and IAS 39 approach and the required journal entries on transition for a fixed rate debt.
* The Newsletter has been updated to comment on variable rate debt based on recent discussions at the Canadian IFRS Discussion Group. The Appendix has been updated to clarify that certain transaction costs may be recognized over the term of the modified debt.
For more information, see IFRIC staff paper 6E attached.
ap6e-financial-instruments-modification-of-financial-liabilities (pdf 2,821kb)
Should you have any questions please feel free to contact:
Scott Bandura | 403 509 6659 | scott.bandura@pwc.com |
Robert Marsh | 604 806 7765 | robert.marsh@pwc.com |
David Clement | 514 205 5122 | david.clement@pwc.com |
Larissa Dyomina | 416 869 2320 | larissa.dyomina@pwc.com |
Chris Wood | 416 365 8227 | christopher.r.wood@pwc.com |
*** *** ***
Appendix – Example
Assumptions:
- On January 1, 2015, an entity borrowed $10M under a 10 year interest only loan @ 10% interest with a bullet repayment on maturity.
- The loan does not contain prepayment features or other embedded derivatives.
- Interest is payable on January 1 annually.
- Transaction costs amounted to $500k resulting in a net carrying amount at January 1, 2014 of $9.5M.
- On January 1, 2016 after making the latest interest payment, the company extended the maturity by 2 years and changed the interest rate for the remaining term to 11% and paid an additional $100k in transaction costs (e.g. legal costs paid to a third party to redraft the agreement).
- The Company determined that the change in the present value of cash flows was less than 10% and chose to treat as a modification under IAS 39.
- The entity will transition to IFRS 9 on a modified retrospective basis on January 1, 2018.
The original Amortization before modification is as follows:
Original Loan | |||
EIR | 10.84% | ||
Interest | Payment | Carrying Amount | |
1-Jan-14 | 9,500,000 | ||
1-Jan-15 | 1,030,127 | (1,000,000) | 9,530,127 |
1-Jan-16 | 1,033,394 | (1,000,000) | 9,563,521 |
1-Jan-17 | 1,037,015 | (1,000,000) | 9,600,536 |
1-Jan-18 | 1,041,028 | (1,000,000) | 9,641,564 |
1-Jan-19 | 1,045,477 | (1,000,000) | 9,687,041 |
1-Jan-20 | 1,050,409 | (1,000,000) | 9,737,450 |
1-Jan-21 | 1,055,875 | (1,000,000) | 9,793,325 |
1-Jan-22 | 1,061,933 | (1,000,000) | 9,855,258 |
1-Jan-23 | 1,068,649 | (1,000,000) | 9,923,907 |
1-Jan-24 | 1,076,093 | (11,000,000) | 0 |
Under IAS 39 the following calculation was performed and the EIR was recalculated such that there was no gain or loss.
Modified Loan (IAS 39 method) | |||
Revised EIR | 11.95% | ||
Interest | Payment | Carrying Amount | |
1-Jan-16 | (100,000)* | 9,463,521 | |
1-Jan-17 | 1,130,649 | (1,100,000)** | 9,494,170 |
1-Jan-18 | 1,134,310 | (1,100,000) | 9,528,480 |
1-Jan-19 | 1,138,410 | (1,100,000) | 9,566,890 |
1-Jan-20 | 1,142,998 | (1,100,000) | 9,609,888 |
1-Jan-21 | 1,148,136 | (1,100,000) | 9,658,024 |
1-Jan-22 | 1,153,887 | (1,100,000) | 9,711,911 |
1-Jan-23 | 1,160,325 | (1,100,000) | 9,772,236 |
1-Jan-24 | 1,167,532 | (1,100,000) | 9,839,768 |
1-Jan-25 | 1,175,600 | (1,100,000) | 9,915,368 |
1-Jan-26 | 1,184,632 | (11,100,000) | 0 |
* Additional transaction costs/fees reduce the carrying amount (i.e. they are debited against the loan balance).
** Interest payments are now calculated as 11% of $10M to new maturity date of January 1, 2026.
However, under IFRS 9 the effective interest rate on the loan is held constant and the company is required to take a charge to profit and loss (“P&L”) on the date of modification:
Modified Loan (IFRS 9 method) | |||
Original EIR | 10.84% | ||
Interest /P&L | Payment | Carrying Amount | |
1-Jan-16 | 529,288** | - | 10,092,809 |
1-Jan-17 | 1,094,408 | (1,100,000)* | 10,087,217 |
1-Jan-18 | 1,093,801 | (1,100,000) | 10,081,018 |
1-Jan-19 | 1,093,129 | (1,100,000) | 10,074,147 |
1-Jan-20 | 1,092,384 | (1,100,000) | 10,066,531 |
1-Jan-21 | 1,091,559 | (1,100,000) | 10,058,090 |
1-Jan-22 | 1,090,643 | (1,100,000) | 10,048,733 |
1-Jan-23 | 1,089,629 | (1,100,000) | 10,038,362 |
1-Jan-24 | 1,088,504 | (1,100,000) | 10,026,866 |
1-Jan-25 | 1,087,257 | (1,100,000) | 10,014,123 |
1-Jan-26 | 1,085,877 | (11,100,000) | 0 |
* Interest payments are now calculated as 11% of $10M to the new maturity date of January 1, 2026.
** A P&L charge of $529,289 would be recorded under IFRS 9 on the date of modification.
In order to amortize the transaction costs a revised EIR is computed as follows:
Modified Loan (Spread transaction costs) | |||
Revised EIR | 11.01% | ||
Interest | Payment | Carrying Amount | |
1-Jan-16 | (100,000)*** | 9,992,809 | |
1-Jan-17 | 1,100,430 | (1,100,000) | 9,993,239 |
1-Jan-18 | 1,100,477 | (1,100,000) | 9,993,716 |
1-Jan-19 | 1,100,530 | (1,100,000) | 9,994,246 |
1-Jan-20 | 1,100,588 | (1,100,000) | 9,994,834 |
1-Jan-21 | 1,100,653 | (1,100,000) | 9,995,487 |
1-Jan-22 | 1,100,725 | (1,100,000) | 9,996,212 |
1-Jan-23 | 1,100,804 | (1,100,000) | 9,997,016 |
1-Jan-24 | 1,100,893 | (1,100,000) | 9,997,909 |
1-Jan-25 | 1,100,991 | (1,100,000) | 9,998,900 |
1-Jan-26 | 1,101,100 | (11,100,000) | 0 |
* Additional transaction costs/fees reduce the carrying amount (i.e. they are debited against the loan balance) and after calculating the gain/loss above a revised effective interest rate is calculated to amortize such fees.
If fees are paid to the lender upon modification, the substance of these fees would need to be carefully evaluated to determine whether it is appropriate to spread these over the term of the modified arrangement. Accounting for such fees paid to the lender has not been illustrated in this Newsletter. Additional information can be found in PwC’s Manual of Accounting {link}.
The entity is adopting a modified retrospective approach to transition to IFRS 9. Therefore, it will need to make an entry to retained earnings at January 1, 2018.
Carrying amount
January 1, 2018****
| |
Old Method | 9,528,480 |
New Method | 9,993,716 |
Difference | (465,236) |
**** Assumes payment owing of $1.1M is recorded as interest payable.
Therefore, the entry on January 1, 2018 will be:
DR Retained Earnings $465,236
CR Loan Payable $465,236
{To record adjustment on January 1, 2018 for change to modification approach required by IFRS 9.}
Going forward, interest will be recognized according to the amortization schedule under the modified loan. In this example, the ongoing rate of interest will be different under IFRS 9 compared to IAS 39 because of the use of the original effective interest rate of 10.8% (11.01% after adjusting for transaction costs) and the fact an immediate P&L charge was taken at the date of modification.
Alternatively, if the retrospective with restatement of comparatives method had been applied by the company, accrued interest expense in the 2017 comparative figures would be amended from the previously reported $1,134,310 to $1,100,477 as shown in the revised amortization schedule. Thus, the entry to opening retained earnings at January 1, 2017 would be $499,070.
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