Many companies use benchmark interest rates – e.g. in their loan instruments, lease contracts and in hedge accounting. The replacement of some of these rates with alternative benchmark rates is expected to be mostly complete by the end of 2021. To ensure that financial statements best reflect the economic effects of IBOR reform, the International Accounting Standards Board (the Board) has issued amendments1 that focus on the accounting once a new benchmark rate is in place.
Despite the COVID-19 pandemic, the Board has completed its project on the financial reporting impacts arising from global reform of benchmark interest rates. These amendments aim to reduce the accounting ‘noise’ surrounding the change to an alternative benchmark rate. Allowing companies to account for this change as a continuation of a hedging relationship, for example, will not only provide welcome practical relief but also better reflect the economic effects of the reform.
The story so far...
IBOR reform refers to the global reform of interest rate benchmarks, which includes the replacement of some interbank offered rates (IBOR) with alternative benchmark rates. The Board identified two groups of accounting issues arising from IBOR reform that could affect financial reporting and divided its project, IBOR Reform and its Effects on Financial Reporting, into two phases:
- pre-IBOR reform: where uncertainty could arise in the run-up to transition (Phase 1 amendments); and
- post-IBOR reform: when that uncertainty goes away but companies update the rates in their contracts and the details of their hedging relationships (Phase 2 amendments).
The Phase 2 amendments principally address the following issues.
Practical expedient for modifications
Under the detailed rules of IFRS 9 Financial Instruments, modifying a financial contract can require recognition of a significant gain or loss in the income statement. However, the amendments introduce a practical expedient if a change results directly from IBOR reform and occurs on an ‘economically equivalent’ basis. In these cases, changes will be accounted for by updating the effective interest rate.
A similar practical expedient will apply under IFRS 16 Leases for lessees when accounting for lease modifications required by IBOR reform.
Specific relief from discontinuing hedging relationships
The amendments also allow a series of exemptions from the regular, strict rules around hedge accounting. See our summary of the amendments (PDF 53 KB) for details. For example, a company will not need to discontinue existing hedging relationships because of changes to hedge documentation required solely by IBOR reform. Therefore, when a hedged risk changes due to benchmark reform, a company may update the hedge documentation to reflect the new benchmark rate and the hedge may be able to continue without interruption.
However, similar to the Phase 1 amendments, there is no exception from the measurement requirements that apply for the hedged items and hedging instruments under IFRS 9 or IAS 39 Financial Instruments: Recognition and Measurement. Once the new benchmark rate is in place, the hedged items and hedging instruments are remeasured based on the new rate and any hedge ineffectiveness will be recognised in profit or loss.
New disclosures will apply
So that users of financial statements can understand the effect of the reform on a company’s financial instruments and risk management strategy, a company will need to provide additional information about:
- the nature and extent of risks to which the company is exposed arising from financial instruments subject to IBOR reform and how it manages those risks; and
- the company’s progress in completing its transition to alternative benchmark rates and how it is managing that transition.
1 Interest Rate Benchmark Reform—Phase 2: Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16
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