The transition from IAS 39 to the new Standard IFRS 9 was considered non-critical as regards liabilities.
While IFRS 9 for financial assets contains new rules for classification, subsequent measurement and also for making provisions, the transition from IAS 39 to the new standard was considered non-critical as regards liabilities. It was thus often widely assumed that the existing accounting could continue without changes. This can no longer be generally assumed since July 2017 at the very latest, as the IASB made it clear at that point that the rules for measuring financial liabilities at amortised cost are also retroactively applicable without exception. This particularly relates to cases where modifications of contractual conditions for financial liabilities have resulted in a change to cash flows, though not a significant enough change to cause derecognition. For these liabilities, the carrying amount must be determined based on the effective interest rate on initial recognition and the adjustment must be made in profit and loss.
A contractual adjustment of financial liabilities is a rare occurrence for most entities and is generally assessed for the first time in the signing process. This has created the impression of something having changed, but which will only relatively seldom have implications (i.e. given future changes to contracts). Due to the retrospective application of IFRS 9, however, a considerably higher number of financial liabilities are potentially affected by this rule.
The background is that there are two changes concerning financial liabilities that could affect accounting and profit and loss. Either only the expectations for cash flows will be adjusted based on existing contractual provisions (e.g. if cancellation rights not separately accounted for are exercised) or the contract is amended and expectations for cash flows are adjusted due to this (e.g. new agreement on shorter term and expectation of early repayments). In the second case, involving contractual change together with changed expectation, a decision must be taken as to whether the contractual change is material or immaterial. If the change is material, the old liability is derecognised and the new liability recognised. Given an immaterial change, the liability continues to be recognised (in such a way as to minimise losses) and the effective interest rate is adjusted.
However, with IFRS 9, accounting for refinancing that does not ultimately result in derecognition is explained in detail. For immaterial modifications, IFRS 9 stipulates that the original effective interest rate is to be maintained; discounting of changed cash flows thus affects profit and loss by resulting in a jump in amortised costs in the same way as for adjustments to cash flows that have thus far been governed by IAS 39 AG 8. In practice this approach has hitherto been illustrated differently at entities, with the effective interest rate being adjusted by an immaterial modification and therefore no effect on profit and loss materialising. This also apples to financial assets, though the issue should mostly be relevant for liabilities for the majority of corporates.
Therefore, with the first-time adoption of IFRS 9 at 1 January 2018, all cash flows of existing financial instruments still outstanding that have in the past been modified, without this modification having resulted in derecognition, are discounted at the effective interest rate applicable at initial recognition. The difference to the carrying amount at 31 December 2017 is to be recognised in retained earnings. Due to amortisation during the remaining term, it is the original rather than the current effective interest rate that has an effect on profit and loss.
For entities, this means first making the relevant determinations (financial instruments modified in the past that are measured at amortised cost as well as the original effective interest rate). The impact on the balance sheet at the time of transition and on the interest income/loss to be recognised in future should then be determined through test calculations.
Source: KPMG Corporate Treasury News, Edition 71, September 2017
Author: Prof. Dr. Christian Debus, Partner, Finance Advisory, email@example.com
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