IFRS 9 Modified financial assets

IFRS 9 Modified financial assets – If the contractual cash flows on a financial asset are renegotiated or modified, the holder needs to assess whether the financial asset should be derecognised. While IAS 39 contains guidance on when financial liabilities that have been renegotiated or modified should be derecognised, it does not do so for financial assets.

Similarly, as the derecognition literature in IAS 39 has been carried forward to IFRS 9, the IASB has still not established criteria for analysing when a modification of a financial asset constitutes a derecognition event. However, an entity may refer to the decision made by the IFRS Interpretations Committee in May 2012.

The Interpretations Committee was asked to consider the accounting treatment of Greek government bonds (GGBs). The principal issue raised was whether the portion of the old GGBs to be exchanged for new bonds with different maturities and interest rates should result in derecognition of the whole asset, or only part of it, in accordance with IAS 39 or, conversely, be accounted for as a modification that would not require derecognition. IFRS 9 Modified financial assets

The IFRS Interpretations Committee concluded that this assessment can be made, either on the basis of: IFRFXXS 9 Modified financial assets

  • The extinguishment of the contractual rights to the cash flows from the assets (IFRS 9 3.2.3)
    Or IFRS 9 Modified financial assets IFRS 9 Modified financial assets
  • By analogising to the notion of a substantial change of the terms of financial liabilities to these assets (IFRS 9 3.3.2)

IFRS 9 acknowledges that in, some circumstances, the renegotiation or modification of the contractual cash flows of a financial asset can lead to the derecognition of the existing financial asset and subsequently, the recognition of a ‘new’ financial asset. (IFRS 9 B5.5.25) IFRS 9 Modified financial assets

This means that the entity is starting afresh and the date of the modification will also be the date of initial recognition of the new financial asset. Typically, the entity will recognise a loss allowance based on 12-month ECLs at each reporting date until the requirements for the recognition of lifetime ECLs are met. IFRS 9 Modified financial assets

However, in some unusual circumstances following a modification that results in derecognition of the original financial asset, there may be evidence that the new financial asset is credit-impaired on initial recognition (see Purchased or originated credit-impaired financial assets), and thus, the financial asset should be recognised as an originated credit-impaired financial asset.

An example may be the restructuring of Greek government bonds in 2012 (see discussion above); the IFRS Interpretations Committee noted that the new bonds may be recognised with incurred losses on initial recognition, depending on the entity’s assessment of the whether the new bonds were credit-impaired at initial recognition. IFRS 9 Modified financial assets

In other circumstances, the renegotiation or modification of the contractual cash flows of a financial asset does not lead to the derecognition of the existing financial asset as per IFRS 9. In such situations, the entity will: IFRS 9 Modified financial assets

  • Continue with its current accounting treatment for the existing asset that has been modified Record a modification gain or loss by recalculating the gross carrying amount of the financial asset as the present value of the renegotiated or modified contractual cash flows, discounted at the financial asset’s original EIR (or the credit-adjusted EIR for purchased or originated credit-impaired financial assets (see Time value of money)
  • Assess whether there has been a significant increase in the credit risk of the financial instrument, by comparing the risk of a default occurring at the reporting date (based on the modified contractual terms) and the risk of a default occurring at initial recognition (based on the original, unmodified contractual terms). A financial asset that has been renegotiated or modified is not automatically considered to have lower credit risk. The assessment should consider the credit risk over the expected life of the asset based on historical and forward-looking information, including information about the circumstances that led to the modification. Evidence that the criteria for the recognition of lifetime ECLs are subsequently no longer met may include a history of up-to-date and timely payment in subsequent periods. This means a minimum period of observation will often be necessary before a financial asset may qualify to return to a 12-month expected credit loss measurement IFRS 9 Modified financial assets
  • Make the appropriate quantitative and qualitative disclosures required for renegotiated or modified assets to enable users of financial statements to understand the nature and effect of such modifications (including the effect on the measurement of ECLs) and how the entity monitors its assets that have been modified. IFRS 9 Modified financial assets

The following example has been adapted from one in the standard to illustrate the accounting treatment of a loan that is modified. (IFRS 9 Example 11 IE66 – IE73)

Modification of contractual cash flows

Bank A originates a five-year loan that requires the repayment of the outstanding contractual amount in full at maturity. Its contractual par amount is CU1,000 with an interest rate of 5 per cent, payable annually.

The EIR is 5 per cent. At the end of the first reporting period in Year 1, Bank A recognises a loss allowance at an amount equal to 12-month ECLs beInputs to valuation techniquescause there has not been a significant increase in credit risk since initial recognition.

A loss allowance balance of CU20 is recognised. In Year 2, Bank A determines that the credit risk on the loan has increased significantly since initial recognition.

As a result, Bank A recognising lifetime ECLs on the loan. The loss allowance balance is CU150.

At the end of Year 3, following significant financial difficulty of the borrower, Bank A modifies the contractual cash flows on the loan. It forgoes interest payments and extends the contractual term of the loan by one year so that the remaining term at the date of the modification is three years.

The modification does not result in the derecognition of the loan by Bank A.

As a result of that modification, Bank A recalculates the gross carrying amount of the financial asset as the present value of the modified contractual cash flows discounted at the loan’s original EIR of 5 per cent.

The difference between this recalculated gross carrying amount and the gross carrying amount before the modification is recognised as a modification gain or loss.

Bank A recognises the modification loss (calculated as €136) against the gross carrying amount of the loan, reducing it to CU864, and a modification loss of CU136 in profit or loss.

Bank A also remeasures the loss allowance, taking into account the modified contractual cash flows and evaluates whether the loss allowance for the loan should continue to be measured at an amount equal to lifetime ECLs.

Bank A compares the current credit risk (taking into consideration the modified cash flows) to the credit risk (on the original unmodified cash flows) at initial recognition.

Bank A determines that the loan is not credit-impaired at the reporting date but that credit risk has still significantly increased compared to the credit risk at initial recognition.

It continues to measure the loss allowance at an amount equal to lifetime ECLs, which are CU110 at the reporting date.

At each subsequent reporting date, Bank A continues to evaluate whether there has been a significant increase in credit risk by comparing the loan’s credit risk at initial recognition (based on the original, unmodified cash flows) with the credit risk at the reporting date (based on the modified cash flows).

Two reporting periods after the loan modification (Year 5), the borrower has outperformed its business plan significantly compared with the expectations at the modification date. In addition, the outlook for the business is more positive than previously envisaged.

An assessment of all reasonable and supportable information that is available without undue cost or effort indicates that the overall credit risk on the loan has decreased and that the risk of a default occurring over the expected life of the loan has decreased, so Bank A adjusts the borrower’s internal credit rating at the end of the reporting period.

Given the positive overall development, Bank A re-assesses the situation

and concludes that the credit risk of the loan has decreased and there is no longer a significant increase in credit risk since initial recognition. As a result, Bank A once again measures the loss allowance at an amount equal to 12-month ECLs.

Year

(Amounts in CU)

Beginning gross carrying amount

Impairment (loss)/gain

Modification (loss)/gain

Interest revenue

Cash flows

Ending gross carrying amount

Loss allowance

Ending amortised cost amount

A

B

C

D1

E

F = A + C + D – E

G

H = F – G

1

1,000

-20

50

50

1,000

20

980

2

1,000

-130

50

50

1,000

150

850

3

1,000

40

-136

50

50

864

110

754

4

864

24

43

907

86

821

5

907

72

45

953

14

939

6

953

14

48

1,000

Originated credit impaired financial asset – Modification of contractual terms

IFRS References: IFRS 9 5.4.1 (b), IFRS 9 5.5.13, IFRS 9 B5.5.25-B5.5.26 IFRS 9 Modified financial assets

On 1 January 2014, Company B purchased 100 5 year, CU100 bonds from TP Limited at par. The bonds are redeemable at par and bear interest at 5% per annum. The market rate on equivalent bonds i s 5% on 1 January 2014 and 4.2% on 31 December 2014. IFRS 9 Modified financial assetsIFRS 9 Modified financial assets

On 1 January 2014, Company B incurred direct costs on this transaction of CU1,000. IFRS 9 Modified financial assets

Assumptions: IFRS 9 Modified financial assets

  • On 1 January 2014, the risk of TP Limited Limited defaulting on payments to Company B was assessed as low (2%). TP Limited defaulted on its first payment of CU500 due on 31 December 2014. At this stage, Company B and TP Limited renegotiated the terms of bonds and agreed that TP Limited would only pay the amounts due on 31 December 2018 (ie. final payment of CU500 + principle amount due of CU10,000).
    The risk of default on the renegotiated payments was assessed at 20% on 31 December 2014 and at 25% on 31 December 2015.
  • Similar instruments (to the post-negotiated bonds) were yielding market related interest of 7.8% at 31 December 2014.

Considerations: IFRS 9 Modified financial assets

  • A detrimental event has occurred (default in payment has occurred and significant risk of default remains once asset is modified). This is therefore an originated credit- impaired asset (IFRS 9 B5.5.26). IFRS 9 Modified financial assets
  • The terms of the asset have been re-negotiated deeming the ‘resulting’ asset to be a ‘new financial asset’(IFRS 9 B5.5.25). IFRS 9 Modified financial assets
  • The originated credit-impaired asset or ‘new financial asset’ that is measured at amortised cost has the following characteristics: IFRS 9 Modified financial assets
  • The effective interest rate used for this asset is called a credit adjusted effective interest rate as it discounts the expected cash flows (as opposed to the contractual cash flows) to the fair value of the instrument at its origination. IFRS 9 Modified financial assets

1. Impairment of asset held at amortised costs as at 31 December 2014

Cash flows net asset (discount rate i= 7.8%):

IFRS 9 Modified financial assets IFRS 9 Modified financial assets

Nominal

Discounted

Financial assets Loans and receivables Financial assets at fair value through profit or loss

Year 1 IFRS 9 Modified financial assets

Year 2 IFRS 9 Modified financial assets

Year 3 IFRS 9 Modified financial assets

IFRS 9 Modified financial assets IFRS 9 Modified financial assets

Year 4 CU10,500 x 80% IFRS 9 Modified financial assets

8,400

6,220

= 8,400 / ((1 + 0.078)^4)

Total

6,220

Carrying amount original asset

— direct costs

— interest CU 11,0002 * 2.83%

— final payment

CU10,0003

+ 1,000

+ 311

– 500 =

.

.

.

.10,811

IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

Impairment

4,591

Date

Description IFRS 9 Modified financial assets

DT

CR

31/12/14

Impairment loss in profit or loss IFRS 9 Modified financial assets

4,591

IFRS 9 Modified financial assets

31/12/14

Financial asset – Bonds IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

4,591

2. Financial closing 31 December 2016 journal entries

Date

Description IFRS 9 Modified financial assets

DT

CR

31/12/15

Financial asset – Bonds  IFRS 9 Modified financial assets

485

31/12/15

Interest income CU 6,220 x 7.8% IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

485

  • Impairment calculation update

Life-time expected credit loss allowance – change in expected cash flows:

IFRS 9 Modified financial assets

Nominal

Discounted

IFRS 9 Modified financial assets

Year 2 IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

Year 3 IFRS 9 Modified financial assets

IFRS 9 Modified financial assets

Year 4 CU10,500 x 5%

525

419

= 525 / ((1 + 0.078)^3)

Total

419

Date

Description IFRS 9 Modified financial assets

DT

CR

31/12/15

Impairment loss in profit or loss IFRS 9 Modified financial assets

485

31/12/15

Financial asset – Bonds Life-time expected credit loss allowance IFRS 9 Modified financial assets

485

IFRS 9 Modified financial assets

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