Modification of a financial liability and the 10% test

Learning objectives

• Apply the 10 per cent test (present value of the new cash flows, including net fees, discounted at the original effective interest rate, compared with the present value of the remaining cash flows) and draw the consequence: extinguishment or continuation of the liability.L2, L3, L4
• Record the journal entries for the modification of a liability and the 10 per cent test and measure their effect on the financial position, profit or loss and other comprehensive income.L2, L3, L4
• Prepare a workpaper documenting the modification of a liability and the 10 per cent test.L2, L3, L4
• Support in writing, from the facts of the case, the judgement made on the modification of a liability and the 10 per cent test.L2, L3, L4

Normative references

• IFRS 9 §3.3.2A substantial modification of the terms of an existing financial liability (or a part of it), whether or not attributable to the financial difficulty of the debtor, is accounted for as an extinguishment of the original liability and the recognition of a new liability; the same applies to an exchange between a borrower and a lender of debt instruments with substantially different terms.
• IFRS 9 §B3.3.6For para. 3.3.2, the terms 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 per cent different from the discounted present value of the remaining cash flows of the original liability; only fees paid or received between the borrower and the lender, including fees paid or received by either on the other's behalf, are included in this calculation. The diversity in practice on which cash flows to include, noted by the Interpretations Committee, is an application matter and not a requirement of the paragraph.
• IFRS 9 §B3.3.6AIf an exchange of debt instruments or a 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; otherwise, they adjust the carrying amount of the liability and are amortised over the remaining term of the modified liability.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

4 questions

• A colleague summarises the treatment of the modification of a financial liability. Which of these sentences is wrong?L2
• Mu SA has a loan whose only remaining cash flow is a repayment of {original_flow} in 2 years; its original effective interest rate is {effective_rate}. The parties modify the terms: the only cash flow becomes {new_flow} in 3 years, and Mu pays {fees_paid} of fees to the lender and receives {fees_received}. Pedagogical assumption: a single final cash flow, no coupon. Calculate the present value of the new terms (fees net, original rate), the difference from the present value of the original cash flows and the 10% threshold.L3
• Nu SA's debt to a bank has a carrying amount of {carrying_amount_old}. The parties modify the terms and Nu concludes that the new terms are substantially different. The fair value of the new liability is {fair_value_new}; Nu pays the bank fees of {fees_paid} in cash on the occasion of the modification. Record the entry for the modification.L4
• Fiora SA renegotiates with its bank a borrowing with a carrying amount of 2,000,000 and incurs 40,000 of legal costs and fees. Case data: the 10 per cent test concludes that the new terms are not substantially different; the modification is therefore not accounted for as an extinguishment. How are the 40,000 treated?L3