Derecognition of Financial Liabilities (IFRS 9)

Derecognition is the removal of a previously recognised financial liability from an entity’s statement of financial position. See also separate page on derecognition of financial assets.

An exchange between an existing borrower and lender of debt instruments with substantially different terms should be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.

Similarly, a substantial modification of the terms of an existing financial liability or a part of it should be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability (IFRS 9.3.3.2).

The terms of a financial liability are substantially different if the discounted present value of the cash flows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is at least 10% different from the discounted present value of the remaining cash flows of the original financial liability (IFRS 9.B3.3.6).

It should be noted that IFRS 9 does not prohibit derecognition of the original financial liability and the recognition of a new financial liability if the 10% test is failed. Some entities do that when the terms of a liability are modified substantially, e.g. a liability is denominated in a different currency after the modification.

Example: modification of a financial liability that does not result in a derecognition

Entity A takes out a bank loan on 1 January 20X1. The loan amounts to $100,000 and bank fees paid amount to $5,000. Interest of 5% is to be paid each year on 31 December and the principal of the loan should be repaid on 31 December 20X5. On 1 January 20X4, Entity A has liquidity problems and approaches the bank to restructure the loan. The bank agrees to revise the terms of the loan so that Entity A will repay the loan on 31 December 31 20X7, but the interest will be increased to 6% and Entity A pays also a one-off fee  of $3,000.

All calculations presented in this example can be downloaded in an excel file.

First, Entity A calculates the effective interest rate of the loan:

datecash flow
20X1-01-01(95,000)
20X1-12-315,000
20X2-12-315,000
20X3-12-315,000
20X4-12-315,000
20X5-12-31105,000
EIR6.2%

Accounting schedule for the loan before modification is as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

yearopening balance
1 Jan
interest in P/Lcash flowclosing balance
31 Dec
20X195,0005,867(5,000)95,867
20X295,8675,938(5,000)96,805
20X396,8055,996(5,000)97,801
20X497,8016,075(5,000)98,876
20X598,8766,124(105,000)-

As we can see in the table above, the amortised cost of the loan at the modification date (1 January 20X4) amounts to $97,801. Entity A compares this amount to the present value of cash flows under the new terms, including $3,000 of fees paid, discounted using the original effective interest rate of 6.2%. These are calculated as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

datecash flowdiscount factorpresent value
20X4-01-013,0001.00003,000
20X4-12-316,0000.94175,650
20X5-12-316,0000.88685,321
20X6-12-316,0000.83505,010
20X7-12-31106,0000.786383,351
total:102,332

As present value after the modification ($102,332) comprises 105% of the present value before the modification ($97,801), Entity A concludes that terms of the loan before and after modification are not substantially different. Liability is therefore not derecognised. Additional fee of $3,000 is not recognised as a one-off gain/loss but is amortised (IFRS 9.B3.3.6). There is however a one-off loss of $1,530 recognised on the modification that results from the increase of present value of the liability after modification. The present value of liability before modification ($97,801) is compared to present value after modification, but excluding the additional fee, which is amortised as mentioned above ($99,332).

Accounting schedule for the loan after modification is as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

yearopening balance
1 Jan
one-off loss
in P/L
fee paid*interest in P/Lcash flowclosing balance
31 Dec
20X497,8011,530(3,000)6,825(6,000)97,157
20X597,157--6,884(6,000)98,040
20X698,040--6,946(6,000)98,987
20X798,987--7,013(106,000)-

* (decrease in liability)


If an exchange of debt instruments or modification of terms is accounted for as an extinguishment, any costs or fees incurred are recognised as part of the gain or loss on the extinguishment. If the exchange or modification is not accounted for as an extinguishment, any costs or fees incurred adjust the carrying amount of the liability and are amortised over the remaining term of the modified liability (IFRS 9.B3.3.6). The amortisation can be most easily effected by increasing EIR on the loan. IFRS 9 does not specify what kind of fees can adjust the carrying amount of the liability, but the IASB plans to clarify that only fees payable to lender can be accounted for in this way. Other fees, such as legal fees, would be immediately recognised in P/L.

When a financial liability measured at amortised cost is modified without this modification resulting in derecognition, an entity recalculates the amortised cost of the financial liability as the present value of the future contractual cash flows that are discounted at the financial instrument’s original effective interest rate. As a result, a one-off gain or loss is recognised in P/L (IFRS 9.B5.4.6). The wording of paragraph IFRS 9.B5.4.6 may not be clear as to whether this rule applies also to financial liabilities, but this was confirmed by the IASB in 2017 and IASB intends to amend basis for conclusions to IFRS 9 so that they make it clear that IFRS 9.B5.4.6 applies to modifications of financial liabilities that do not result in derecognition.

The difference between the carrying amount of a financial liability extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, is recognised in P/L (IFRS 9.3.3.3).

Supply-chain financing / reverse factoring agreements are increasingly popular, though their terms and forms vary significantly. Derecognition criteria of IFRS 9 are very relevant here, as the key question that needs to be answered in such arrangements is whether payables to the original supplier should be derecognised by the buyer. Buyers usually want to keep the original trade payable in their balance sheet, as this will keep their financial debt lower.

The question that should be answered is whether the original liability to the original supplier is extinguished. This will be the case if the financial intermediary pays the trade payable on behalf of the buyer and the buyer is legally released from its obligation to the supplier. In such cases, the original trade payable is derecognised and a new liability is recognised. Such a liability is rather a financial liability (debt) in nature, but it is not unusual for entities to present such liabilities as trade payables even though they are liabilities to a financial institution.

In other cases, the financial intermediary purchases the rights to cash flows from a receivable from the supplier, but the buyer is not legally released from its obligation to pay the buyer. If this is the case, the trade payable is not derecognised, unless there is a significant modification of terms (the 10% threshold discussed above).

Another instance when entity derecognises a financial liability (or a part of a financial liability) is when it is extinguished—i.e. when the obligation specified in the contract is discharged, cancelled or expires (IFRS 9.3.3.1).

A financial liability (or part of it) is extinguished when the debtor either (IFRS 9 B3.3.1):

  1. discharges the liability (or part of it) by paying the creditor, normally with cash, other financial assets, goods or services; or
  2. is legally released from primary responsibility for the liability (or part of it) either by process of law or by the creditor.

When it comes to legal release by creditor, IFRS 9 takes a strict legalistic approach. Paragraph IFRS 9.B3.3.4 states that even if a debtor pays a third party to assume an obligation and notifies its creditor that the third party has assumed its debt obligation, the debtor does not derecognise the debt obligation unless it is legally released from responsibility for the liability. What is interesting, even if the debtor provides a guarantee to the creditor, this does not preclude the derecognition of a liability (IFRS 9.B3.3.1(b); B3.3.7).

If an issuer of a debt instrument repurchases that instrument, the debt is extinguished even if the issuer is a market maker in that instrument or intends to resell it in the near term (IFRS 9.B3.3.2).

See other pages relating to financial instruments:

© 2018-2020 Marek Muc

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