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Borrowers potentially impacted by IFRS 9

IFRS 9 Financial Instruments will require a different treatment for the accounting of renegotiated loans compared to IAS 39, warns LSCA technical committee member James Nayler.

James Nayler

January 2018

Entities applying IFRS may have borrowed funds and then subsequently renegotiated the terms of the loan with the lender. Clarification recently issued by the International Accounting Standards Board (IASB) means entities must revisit the accounting previously applied to such renegotiations when IFRS 9 Financial Instruments is adopted (periods beginning on or after 1 January 2018).

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Under the currently applicable financial instruments standard (IAS 39), if the renegotiated terms of a liability are not substantially different to those of the original liability (both IAS 39 and IFRS 9 have equivalent guidance on how to make such a judgment), most entities account for changes to the future cash flows reflected in the modified liability by revising the effective interest rate in subsequent periods. Therefore, no modification date gain or loss arises.

In its March 2017 meeting, however, the IFRS Interpretations Committee (IFRS IC) tentatively concluded that IFRS 9 requires a different treatment. Entities should adjust the carrying amount of the liability on the modification date to an amount equal to the present value of the future (modified) cash flows discounted at the effective interest rate applied to the original (pre-modified) loan. A modification date gain or loss arises accordingly for the change in future cash flows.

The IASB agreed with the IFRS IC that the requirements of IFRS 9 are clear. However, many will not be aware as this has been communicated by the IASB incorporating additional wording to IFRS 9’s Basis for Conclusions at the same time as it released guidance on another topic, effectively ratifying the IFRS IC’s tentative agenda decision.. Because there are no changes to the requirements of IFRS 9 for renegotiated loans, this change from IAS 39 must be applied on a fully retrospective basis when IFRS 9 is adopted.

The challenge for entities that previously applied IAS 39’s commonly accepted approach is to recalculate the carrying amount of liabilities modified in yesteryear. The length of time that has elapsed since any such modification, bearing in mind an individual loan might have been renegotiated more than once, the greater the scope for complications in calculating the required prior year adjustment on adoption of IFRS 9.

James Nayler is Senior Manager at BDO IFR Advisory and member of the LSCA Technical Committee.

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