Source: https://library.croneri.co.

uk/cch_uk/igaap-vb/b8-3-2#:~:text=When%20doing%20so%2C%20a
%20modification,prior%20to%20the%20modification%2C%20both

3.2 Modification of a financial asset

In accordance with IFRS 9:3.2.3, an entity should derecognise a financial asset when, and only
when:

•the contractual rights to the cash flows from the financial asset expire (see 3.1.3); or

•it transfers the financial asset as set out in IFRS 9:3.2.4 and 3.2.5 (see 3.1.4) and the transfer
qualifies for derecognition in accordance with IFRS 9:3.2.6 (see 3.1.5 to 3.1.7).

For modifications of financial assets (e.g. a renegotiation of the asset’s contractual cash flows),
derecognition can only occur when then contractual cash flows expire (i.e. IFRS 9:3.2.3(a) applies
instead of IFRS 9:3.2.3(b) because the cash flows are not transferred but modified). This was
clarified by the IFRS Interpretations Committee as follows.

In September 2012 the IFRS Interpretations Committee considered the accounting treatment for
various aspects of the restructuring of Greek Government Bonds (GGBs). One of the aspects the
Committee received a request for guidance on was whether the restructuring of GGBs should result
in derecognition of the whole asset, or only part of it, in accordance with IAS 39 (although the
Committee referred only to IAS 39 in their draft rejection notice the equivalent paragraphs in IFRS 9
apply and therefore have been included below). Specifically, the Committee was asked whether the
portion of the old GGBs that are exchanged for 20 new bonds with different maturities and interest
rates should be derecognised, or conversely accounted for as a modification or transfer that would
not require derecognition.

The Committee noted that the request has been made within the context of a narrow fact pattern.
The narrow fact pattern highlighted the diversity in views that had arisen in relation to the accounting
for the portion of the old GGBs that is exchanged for 20 new bonds with different maturities and
interest rates. The submitter asked the Committee to consider whether these should be
derecognised, or conversely accounted for as a modification or transfer that would not require
derecognition.

In addition, the Committee has been asked to consider whether IAS 8 Accounting Policies, Changes
in Accounting Estimates and Errors would be applicable in analysing the submitted fact pattern, and
whether the exchange can be considered a transfer within the scope of IFRS 9:3.2.3(b).

The Committee observed that the term ‘transfer’ is not defined in IFRS 9. However, the potentially
relevant portion of IFRS 9:3.2.4 states that an entity transfers a financial asset if it transfers the
contractual rights to receive the cash flows of the financial asset. The Committee noted that, in the
fact pattern submitted, the bonds are transferred back to the issuer rather than a third party.
Accordingly, the Committee believed that the transaction should be assessed against IFRS
9:3.2.3(a).
In applying IFRS 9:3.2.3(a), the Committee noted that, in order to determine whether the financial
asset is extinguished, it is necessary to assess the changes made as part of the bond exchange
against the notion of ‘expiry’ of the rights to the cash flows. The Committee also noted that, if an
entity applies IAS 8 because of the absence in IFRS 9 of an explicit discussion of when a
modification of a financial asset results in derecognition, applying IAS 8 requires judgement to
develop and apply an accounting policy. IAS 8:11 requires that, in determining an appropriate
accounting policy, consideration must first be given to the requirements in IFRS Standards dealing
with similar and related issues. The Committee noted that, in the fact pattern submitted, that
requirement would lead to the development of an analogy to the notion of a substantial change of
the terms of a financial liability in IFRS 9:3.3.2.

IFRS 9:3.3.2 sets out that such a change can be effected by the exchange of debt instruments or by
way of modification of the terms of an existing instrument. Hence, if this analogy to financial liabilities
is applied to financial assets, a substantial change of terms (whether effected by exchange or by
modification) would result in derecognition of the financial asset.

The Committee noted that if the guidance for financial liabilities is applied by analogy to assess
whether the exchange of a portion of the old GGBs for 20 new bonds is a substantial change of the
terms of the financial asset, the assessment needs to be made taking into consideration all of the
changes made as part of the bond exchange.

In the fact pattern submitted, the relevant facts led the Committee to conclude that, in determining
whether the transaction results in derecognition of the financial asset, both approaches (i.e.
extinguishment under IFRS 9:3.2.3(a) or substantial change of the terms of the asset) would result in
derecognition.

The Committee considered the following aspects of the fact pattern in assessing the extent of
change that results from the transaction:

•A holder of a single bond has received, in exchange for one portion of the old bond, 20 bonds with
different maturities and cash flow profiles as well as other instruments in accordance with the terms
and conditions of the exchange transaction.

•All of the bondholders received the same restructuring deal irrespective of the terms and conditions
of their individual holdings. This indicates that the individual instruments, terms and conditions were
not taken into account. The different bonds (series) were not each modified in contemplation of their
respective terms and conditions but instead replaced by a new uniform debt structure.

•The terms and conditions of the new bonds are substantially different from those of the old bonds;
this includes many different aspects such as the change in governing law, the introduction of
contractual collective action clauses and the introduction of a co-financing agreement that affects the
rights of the new bond holders, and modifications to the amount, term and coupons.

The Committee noted that the starting point that was used for its analysis was the assumption in the
submission that the part of the principal amount of the old GGBs that was exchanged for new GGBs
could be separately assessed for derecognition. The Committee emphasised that this assumption
was more favourable for achieving partial derecognition than looking at the whole of the old bond.
Hence, its conclusion that the old GGBs should be derecognised would apply even more so when
taking into account that the exchange of the old GGBs, was as a matter of fact, the result of a single
agreement that covered all aspects and types of consideration for surrendering the old GGBs. As a
consequence, the Committee noted that partial derecognition did not apply.
Consequently, the Committee decided not to add the issue to its agenda.

Further guidance on how to assess whether a modification of a financial asset results in

derecognition is provided at 3.2.3.

If a modification of a financial asset does not result in derecognition the gross carrying amount of the
asset is recalculated and a modification gain or loss is recognised in profit or loss. Therefore, in most
cases a modification to the contractual terms of a financial asset will result in a gain or loss
recognised in profit or loss (i.e. a derecognition gain or loss or a modification gain or loss).

If a financial asset is modified but not derecognised, the gross carrying amount of the asset is
recalculated as the present value of the revised contractual cash flows discounted at the original
effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-
impaired financial assets) or, when applicable, the revised effective interest rate calculated in
accordance with IFRS 9:6.5.10. Any costs or fees incurred adjust the carrying amount of the
modified financial asset and are amortised over the remaining term of the modified financial asset.
[IFRS 9:5.4.3] Guidance on the credit risk assessment of modified financial assets and the
measurement of expected credit losses, with examples, is included at 5.2.3 in chapter B6.

3.2-1

Presentation of modification gains and losses

IFRS Standards do not include any specific presentation requirements in respect of modification
gains and losses, and the appropriate presentation will therefore be determined in accordance with
general principles.

In accordance with paragraph 85 of IAS 1 Presentation of Financial Statements, modification gains

and losses should be presented separately if such presentation is deemed to be relevant to an
understanding of an entity’s financial performance.

The general requirement in IAS 1:32 is that an entity should not offset income and expenses, unless
required or permitted by an IFRS. IAS 1:35 acknowledges that an entity presents on a net basis
gains and losses arising from a group of similar transactions; however, even in such circumstances,
gains and losses are required to be presented separately if they are material.

3.2.1 Identification of modification

3.2.1-1

Identification of a modification

A modification of a financial asset occurs if the contractual cash flows of the financial asset are
renegotiated or otherwise modified between initial recognition and maturity of a financial asset. More
specifically, the changes to the original contractual terms must be legally binding and enforceable by
law.

A change in the timing and/or amount of contractual cash flows does not constitute a modification for
the purposes of IFRS 9:5.4.3 if the changes to the contractual cash flows are made pursuant to the
original contractual terms. For example, the following do not constitute a modification if they are
based on the original contract terms:

•the amount of interest changes based on changes in EURIBOR;

•the amount of interest changes in a specified manner as a result of events that were already
foreseen in the original terms of the instrument (e.g. change of control clauses, stepped interest or
margin grids); and

•the exercise of an option included in the original contract terms.

Modification of financial asset does not necessarily mean that a change to the contractual terms
must have a direct and immediate cash flow impact in order to be considered a modification in the
period in which it occurred. A modification may affect the amount and/or timing of the contractual
cash flows immediately or at a future date. To illustrate an immediate effect, a deferral of payments
or an adjustment of the applicable interest rate would immediately affect the timing or amount of the
contractual cash flows. The same applies if embedded features are removed from or added to the
contractual terms.

The introduction or adjustment of existing covenants (including a waiver in case of a covenant

breach) of an existing loan would also constitute a modification even if these new or adjusted
covenants do not affect the cash flows immediately but may affect the cash flows depending on
whether the covenant is or is not met (e.g. an increase in the interest rate according to a margin grid
which is based on covenants).

3.2.1-2

Identification of modification date – example

On 30 August 20X0, there is a covenant breach within one of Bank A’s lending arrangements.

On 30 September 20X0, Bank A and Entity B (i.e. the parties to the contract) begin renegotiations of
the terms of the loan arrangement.

On 31 December 20X0, both parties contractually agree to modify the original contract but the
modification will only change the contractual cash flows from 31 March 20X1 onwards if the
covenant breach continues to exist at that date.

In the circumstances described, the date of the modification is 31 December 20X0 because, at that
date, the contractual terms are modified to alter the contractual cash flows under the original
contract. This is the date to assess, and to account for, the contract modification. However, the
covenant breach occurring in August 20X0 together with the ongoing renegotiation will impact the
loss allowance recognised by Bank A prior to the contract being modified and could affect
current/non-current classification of the lending arrangement prior to the modification.

3.2.2 Purpose underlying a modification

3.2.2-1

Purpose underlying a modification

Modifications or renegotiations of contractual cash flows can be prompted by varying circumstances.

Frequently, a modification occurs when there has been a change in credit risk (e.g. a troubled debt
restructuring). When changes to the contractual cash flows are made due to the financial difficulty of
the borrower and the lender grants to the borrower a concession that the lender would not otherwise
consider, this indicates that the underlying financial asset is credit-impaired (see IFRS 9:Appendix A:
credit-impaired financial asset).

The motivation for a modification or renegotiation can also be commercial. For example, in a
competitive environment and in order to strengthen its business relationship with the borrower, a
lender may accept or offer a change in spread or a switch from floating interest rate to fixed interest
rate to adjust the contractual terms to the current market conditions.

However, the purpose or motivation underlying a modification or renegotiation is irrelevant for the
purposes of a derecognition assessment. In particular, the distinction between modifications
prompted by changes in the credit risk of the borrower and those arising from commercial
motivations should not by itself determine whether the accounting for a modification or renegotiation
results in derecognition of the financial asset or continued recognition. Rather, the determining factor
in assessing whether a modification of a financial asset leads to derecognition is whether the
modification is considered to be substantial.

IFRS 9:BC5.234 and BC5.235 state as follows. [Emphasis added]

“The IASB also noted that even if the intention of a modification could be clearly identified to be for
commercial purposes, any change in the contractual terms of a financial instrument will have a
consequential effect on the credit risk of the financial instrument since initial recognition and will
affect the measurement of the loss allowance. Furthermore, the difficulty involved in discerning the
purpose of modifications, and to what extent a modification is related to credit risk reasons, could
create opportunities for manipulation. This could happen if entities were able to select a ‘preferred’
treatment for modifications simply because of the purpose of the modification. Limiting the scope of
the modification requirements in Section 5.5 of IFRS 9 to those undertaken for credit reasons could
therefore result in different accounting treatments for the same economic event.

... Consequently, ... the modification requirements should apply to all modifications or renegotiations
of the contractual terms of a financial instrument.”

3.2.3 Assessing whether a modification results in

derecognition
IFRS 9 only provides guidance for modifications of financial liabilities in IFRS 9:3.3.2, stating that “a
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) shall be accounted for as an extinguishment of the
original financial liability and the recognition of a new financial liability”.

The Standard does not include similar guidance for financial assets.

In May 2016, the IFRS Interpretations Committee issued a final agenda decision on Derecognition of
modified financial assets and whether to undertake a potential narrow-scope project to clarify the
requirements in IFRS 9 about when a modification or exchange of financial assets results in
derecognition of the original asset.
Many Committee members observed that, in their experience, the circumstances in which an entity
should derecognise financial assets that have been modified or exchanged is an issue that arises in
practice. However, because of the broad nature of the issue, the Committee noted that it could not
resolve it in an efficient manner. Consequently, the Committee decided not to further consider such
a project.

However, in the context of the 2012 Greek government bond restructuring (see 3.2), the Committee
concluded as follows.

“In applying paragraph 17(a) [of IAS 39 because IFRS 9 was not in issue], the Interpretations
Committee noted that, in order to determine whether the financial asset is extinguished, it is
necessary to assess the changes made as part of the bond exchange against the notion of ‘expiry’
of the rights to the cash flows. The Interpretations Committee also noted that, if an entity applies IAS
8 because of the absence in IAS 39 of an explicit discussion of when a modification of a financial
asset results in derecognition, applying IAS 8 requires judgement to develop and apply an
accounting policy. Paragraph 11 of IAS 8 requires that, in determining an appropriate accounting
policy, consideration must first be given to the requirements in IFRS Standards that deal with similar
and related issues. The Interpretations Committee noted that, in the fact pattern submitted, that
requirement would lead to the development of an analogy to the notion of a substantial change of
the terms of a financial liability in IAS 39:40.”

“Paragraph 40 sets out that such a change can be effected by the exchange of debt instruments or
by modification of the terms of an existing instrument. Hence, if this analogy to financial liabilities is
applied to financial assets, a substantial change of terms (whether effected by exchange or by
modification) would result in derecognition of the financial asset.”

The Committee’s discussion related to IAS 39. However, IFRS 9:IN11 states that “the requirements
in IAS 39 for the derecognition of financial assets and financial liabilities were carried forward
unchanged to IFRS 9”. Also, the wording of the paragraphs that the Committee specifically referred
to in its conclusion is unchanged from the wording in IAS 39. Consequently, it is appropriate to apply
the Committee’s reasoning under IAS 39 when interpreting the equivalent requirements of IFRS 9.

Therefore, in the absence of more specific guidance on modifications or renegotiations of financial

assets, an appropriate way to assess whether a modification or renegotiation of a financial asset
gives rise to derecognition is to consider the guidance on substantial modifications of financial
liabilities.

In doing so, a financial asset is derecognised if a modification or renegotiation gives rise

to substantially different terms which, applying the reasoning in IFRS 9:3.3.2, should be accounted
for as an extinguishment of the original financial asset and the recognition of a new financial asset.