IFRS 9: immediate recognition of profits or losses from renegotiated debt terms

From 1 January 2018 IFRS 9 introduces substantial changes to the classification and measurement of financial assets (including the impairment model) and elements of hedge accounting. The recognition and derecognition of financial instruments were widely considered to be an area of relative stability and, whilst this is true in the most part, it is not the case when profits or losses from renegotiated debt terms have been spread forward under IAS 39.

There is common ground between IFRS 9 and IAS 39 if the renegotiated debt terms change the present value of cash flows by at least 10% and therefore the original debt is derecognised and a new liability recognised. Both standards require the difference between the derecognised carrying amount of the existing financial liability (based on the existing terms) and the fair value of the new financial liability (based on the revised terms) to be recognised immediately as a profit or loss.

However, when the original debt continued to be recognised, IAS 39 was silent on the accounting treatment. This left diversity in practice with some entities adjusting the carrying amount of the financial liability to recognise an immediate profit or loss and others spreading any profit or loss over future periods by recalculating the effective interest rate.

The IASB have recently clarified that this ‘forward spreading’ approach would not be acceptable under IFRS 9 and an immediate profit or loss is recognised when there is a modification of the contractual cash flows.

If you have outstanding debt that has been renegotiated and you recalculated the effective interest rate on application of IFRS 9, you will need to reverse the previous accounting and recognise an immediate profit or loss with an adjustment to reserves. In most cases, the profit or loss will be the difference between the carrying amount of the original financial liability (at the date of the renegotiation) and the present value of the revised cash flows, discounted using the original effective interest rate (which will also be used to calculate amortised cost going forward).

As loans and other debts are often taken out for a number of years, the practical challenges of identifying historic renegotiations of the terms of those instruments and recalculating the carrying amount using the original effective interest rate (rather than a revised rate) should not be underestimated.

As with all IFRS 9 transition adjustments, early quantification of the impact provides the information necessary to effectively manage any commercial effects on covenants, performance-related rewards and distributable reserves. 

For further information please speak to your usual RSM contact.