Does the renegotiation of terms on your financial liabilities impact on the accounting thereof?

If an entity enters into negotiations with a lender to extend repayment terms, decrease interest rates charged or receive repayment holidays on its borrowings, it cannot just leave the loan balance as it is. IFRS 9 Financial Instruments contains different requirements when accounting for modifications for financial liabilities, which depend on whether the modification is considered ‘substantial’ or ‘non-substantial’.

What is a ‘substantial’ modification?

A ‘substantial’ modification occurs where either:

  • The difference between the discounted presented value (PV) of the revised loan cash flows* (discounted at the original effective interest rate) and the carrying amount of the existing liability is greater than 10%, or
  • If the above difference is less than 10%, the modified terms are qualitatively substantially different to the original terms, e.g., if there is a change in currency of the loan, a change from fixed to floating interest rates or vice versa, significant changes in loan covenants, or the introduction or removal of an equity conversion feature).

*  Includes fees paid/received between the lender and the entity, including fees paid/received by either borrower or lender on the other’s behalf

The assessment of whether a modification is ‘substantial’ or ‘non-substantial’ may involve significant judgement, which may require specific disclosure under IAS 1 Presentation of Financial Instruments, paragraph 122.

Difference in accounting for ‘substantial’ and ‘non-substantial’ modifications

It is important to correctly determine whether a modification to a loan is substantial or not because the accounting is different as shown in the diagram below.

As can be seen from the above diagram, the accounting requirements for substantial modifications are significantly different to the accounting requirements for non-substantial modifications, and if this is not correctly applied, an entity can run the risk of its financial statements being materially misstated.

For more on the above, please contact your local BDO Representative.


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