What does modification and derecognition cover?
IFRS 9 splits this topic along the balance sheet. On the liability side the question is whether a renegotiation of borrowings is a "substantial modification" that must be accounted for as an extinguishment of the old debt and recognition of a new one (IFRS 9.3.3.2), or a non-substantial modification that leaves the original liability on the books with a re-measured carrying amount (IFRS 9.5.4.3, B5.4.6). On the asset side the question is whether the entity has transferred enough of the risks and rewards of a receivable to remove it from the balance sheet at all (IFRS 9.3.2.1–3.2.6). The two analyses use different tests and must not be blended.
The reason the distinction is worth this much care is that it drives when a gain or loss hits profit or loss and on what base future interest accrues. A substantial liability modification crystallises the whole difference between the old carrying amount and the fair value of the new debt immediately (IFRS 9.3.3.3); a non-substantial one spreads a smaller catch-up and then unwinds the rest through interest over the remaining life at the original effective interest rate (EIR). Because the same renegotiation can fall either side of the line, IFRS 9 provides a bright-line quantitative screen for liabilities, backed by a qualitative overlay, so preparers cannot simply assert the answer that suits the income statement.
How does the 10% test decide if a liability modification is substantial?
The terms of a modified or exchanged financial liability are "substantially different" — and therefore an extinguishment — if the present value of the cash flows under the new terms, discounted at the original EIR, differs by at least 10% from the present value of the remaining cash flows of the original liability (IFRS 9.B3.3.6). The revised cash flows must include any fees paid net of any fees received between the borrower and lender, and the same original EIR is used on both sides of the comparison so that the difference isolates the change in cash flows, not a change in discount rate (IFRS 9.B3.3.6, 3.3.2).
Two points trip preparers up. First, the 10% test is necessary but not sufficient: even where the numerical difference is below 10%, a change can still be substantial on qualitative grounds — for example a switch of currency, the insertion or removal of an equity-conversion feature, or a move from fixed to a profit-linked return — and IFRS 9 requires that qualitative overlay alongside the arithmetic (IFRS 9.B3.3.6, and the IASB's own analysis in developing the 2016 clarifications). Second, the test looks only at the borrower–lender relationship; fees paid to third parties such as lawyers or arrangers are excluded from the 10% cash-flow comparison but are then treated differently depending on the outcome (IFRS 9.B3.3.6, B3.3.6A).
Worked example: the 10% test, two scenarios
A borrower has a £10,000,000 term loan with a remaining carrying amount (equal to the present value of remaining contractual cash flows at the original 8% EIR) of £10,000,000 and four years to run. Two renegotiations are on the table. In both, the revised cash flows are discounted at the original 8% EIR per IFRS 9.B3.3.6.
| Input | Scenario A: rate cut only | Scenario B: rate cut + extension + fee |
|---|---|---|
| Revised coupon | 6% on £10m | 5% on £10m |
| Revised term | 4 years (unchanged) | Extended to 8 years |
| Fee paid to lender | None | £150,000 |
| PV of revised cash flows at original 8% EIR | £9,337,578 | £8,426,020 |
| Original remaining PV | £10,000,000 | £10,000,000 |
| Difference | £662,422 (6.6%) | £1,573,980 (15.7%) |
| Conclusion (IFRS 9.B3.3.6) | < 10% → non-substantial | ≥ 10% → substantial |
Scenario A clears the 10% hurdle by a wide margin, so — absent any qualitative trigger — the original liability stays on the books and is re-measured. Scenario B, combining a deeper rate cut, a doubled tenor and an arrangement fee, crosses the 10% line and is accounted for as an extinguishment. Note how sensitive the answer is to term: the extension alone does most of the work in pushing Scenario B over the threshold (IFRS 9.B3.3.6).
How do you account for a substantial vs non-substantial modification?
A substantial modification is an extinguishment: derecognise the old liability at its carrying amount, recognise the new liability at fair value, and take the entire difference — together with any fees and costs paid — to profit or loss immediately (IFRS 9.3.3.2–3.3.3, B3.3.6A). A non-substantial modification keeps the original liability: recalculate its gross carrying amount as the present value of the revised cash flows discounted at the original EIR, and recognise the resulting adjustment immediately in profit or loss (IFRS 9.5.4.3, B5.4.6). The IASB confirmed in its 2016 clarification that this same 5.4.3/B5.4.6 catch-up mechanic applies to non-substantial modifications of liabilities, mirroring the treatment written explicitly for assets.
Fees follow the outcome. On an extinguishment, all costs and fees are part of the gain or loss recognised in profit or loss (IFRS 9.3.3.3). On a non-substantial modification, fees paid to the lender adjust the carrying amount and are amortised over the remaining term via the original EIR, while fees paid to third parties are expensed as incurred (IFRS 9.B3.3.6, B5.4.6). This asymmetry is a recurring source of restatement, because preparers often expense arrangement fees that should have been capitalised into a surviving liability.
Journal: substantial modification (extinguishment)
Take Scenario B. The old carrying amount is £10,000,000; the fair value of the new, restructured liability is £8,600,000 (market yield on the new terms exceeds the 8% original EIR, so fair value sits below par); a £150,000 fee is paid to the lender. The gain on extinguishment is £10,000,000 − £8,600,000 − £150,000 = £1,250,000, recognised in profit or loss (IFRS 9.3.3.3).
| Dr Borrowings (old liability, derecognised) | 10,000,000 | |
| Cr Borrowings (new liability, at fair value) | 8,600,000 | |
| Cr Cash (fee to lender) | 150,000 | |
| Cr Gain on extinguishment (P&L) | 1,250,000 |
From day one, interest on the new liability accrues on the £8,600,000 fair value using a fresh EIR derived from the new cash flows (IFRS 9.5.4.1). The old EIR is gone.
Journal: non-substantial modification (catch-up)
Take Scenario A. The recalculated carrying amount is the £9,337,578 present value of the revised cash flows at the original 8% EIR. Against the £10,000,000 old carrying amount, that is a £662,422 modification gain recognised immediately in profit or loss (IFRS 9.5.4.3, B5.4.6).
| Dr Borrowings (carrying amount reduced) | 662,422 | |
| Cr Modification gain (P&L) | 662,422 |
The liability continues at the original 8% EIR. The £662,422 gain booked now is unwound over the remaining life as interest expense accretes the carrying amount back toward the revised contractual cash flows, so the modification does not create free profit — it only re-times it (IFRS 9.B5.4.6). Had a lender fee been paid, it would have been added to the £9,337,578 carrying amount and amortised, not expensed.
When can a financial asset be derecognised?
A financial asset is derecognised only when either the contractual rights to its cash flows expire, or the entity transfers the asset in a way that qualifies for derecognition under the risks-and-rewards test (IFRS 9.3.2.3). "Transfer" itself has a defined meaning: the entity either transfers the contractual right to receive the cash flows, or retains that right but assumes an obligation to pay the cash flows on to a third party under a qualifying "pass-through" arrangement (IFRS 9.3.2.4–3.2.5). Only after a transfer is confirmed does the risks-and-rewards evaluation in IFRS 9.3.2.6 decide the accounting.
Pass-through arrangements
A pass-through qualifies as a transfer only if all three conditions in IFRS 9.3.2.5 are met: the entity has no obligation to pay amounts to the eventual recipients unless it collects equivalent amounts from the original asset; it is prohibited from selling or pledging the original asset (other than as security to the recipients); and it must remit any collected cash without material delay, with no right to reinvest except in cash equivalents over the short settlement period (IFRS 9.3.2.5). Miss any one of these and there is no transfer, so the asset stays on the balance sheet regardless of the commercial intent (IFRS 9.3.2.5–3.2.6). Securitisation vehicles and factoring structures live or die on these three conditions.
Risks and rewards, and continuing involvement
Once a transfer is established, IFRS 9.3.2.6 sorts it into three outcomes. If the entity has transferred substantially all the risks and rewards of ownership, it derecognises the asset in full and recognises separately any rights and obligations created (IFRS 9.3.2.6(a)). If it has retained substantially all the risks and rewards — the classic example being a sale with a full recourse guarantee or a repo — it continues to recognise the asset in its entirety (IFRS 9.3.2.6(b)). If it has neither transferred nor retained substantially all risks and rewards, the answer turns on control: if the transferee can sell the asset unilaterally the entity derecognises, otherwise it recognises the asset to the extent of its continuing involvement (IFRS 9.3.2.6(c), 3.2.16). Trade-receivable factoring frequently lands in this middle band, which is why disclosure of retained recourse and late-payment risk is a standard audit focus.
What are the auditor red flags?
Modification and derecognition sit at the intersection of judgement and incentive, so auditors treat them as areas prone to management bias. Three recurring red flags, each tied to a specific ISA, are worth naming.
Case study: Premier Oil 2017 refinancing
What happened. In its 2017 full-year results, the oil and gas group Premier Oil completed a comprehensive refinancing of multiple debt facilities and disclosed that it had assessed each facility against the "substantially different terms" test (the same 10% quantitative test carried unchanged from IAS 39 AG62 into IFRS 9.B3.3.6).
The split outcome. Premier disclosed that the refinancing represented a substantial modification of its US private placement notes (USPPs), its super senior loan (SSL) and its convertible bonds — so extinguishment accounting applied, derecognising the old carrying amounts and recognising new liabilities at fair value. For the revolving credit facility, term loan and retail bonds, the same test concluded the terms were not substantially different, so modification (not extinguishment) accounting was applied to those facilities. The company disclosed costs in relation to the refinancing of US$83.7 million recognised on derecognition.
Why it is instructive. A single refinancing package produced both answers across different instruments — the clearest possible illustration that the 10% test is applied facility by facility, not to the restructuring as a whole. It also shows the scale of the P&L consequence: tens of millions of dollars turned on which side of the 10% line each facility fell.
Source: Premier Oil plc Full Year 2017 Results announcement (published accounting disclosures on refinancing of financial liabilities). Figures and outcomes as publicly disclosed by the company; treatment paraphrased, not reproduced.
Frequently asked questions
Which discount rate do you use in the 10% test — old or new?
The original effective interest rate, on both sides of the comparison (IFRS 9.B3.3.6). You discount the revised cash flows (including fees paid net of fees received between borrower and lender) at the original EIR and compare the result to the present value of the remaining original cash flows, also at the original EIR. Using the new market rate would contaminate the test with a discount-rate change and is wrong.
Can a modification be substantial even if it fails the 10% test numerically?
Yes. The 10% test is a quantitative screen, not the whole answer. Qualitative changes — switching the currency of the debt, adding or removing an equity-conversion feature, or moving to a profit- or index-linked return — can make terms substantially different even where the discounted-cash-flow difference is below 10% (IFRS 9.B3.3.6). Auditors expect the qualitative assessment to be documented, not assumed away.
Why does a modification gain not just increase profit permanently?
Because on a non-substantial modification the immediate catch-up recognised under IFRS 9.5.4.3 and B5.4.6 is unwound over the remaining life of the liability. The liability continues at the original EIR, so interest expense accretes the reduced carrying amount back toward the revised contractual cash flows. The day-one gain is a re-timing of profit, not new value.
How are fees paid to third parties treated?
They are excluded from the 10% cash-flow comparison, which only captures fees between borrower and lender (IFRS 9.B3.3.6). On an extinguishment they form part of the gain or loss in profit or loss (IFRS 9.3.3.3). On a non-substantial modification, third-party fees are expensed as incurred, while lender fees are added to the surviving carrying amount and amortised over the remaining term.
Is the derecognition test the same for financial assets and liabilities?
No. Liability derecognition turns on whether the obligation is discharged, cancelled or expires, with modification assessed via the 10% test (IFRS 9.3.3.1–3.3.3, B3.3.6). Asset derecognition turns on expiry of rights or a transfer that passes the risks-and-rewards analysis, with a control fallback and continuing-involvement accounting (IFRS 9.3.2.1–3.2.6). They are separate frameworks and must not be conflated.
Does selling receivables under a factoring arrangement always allow derecognition?
No. Derecognition depends on whether substantially all the risks and rewards have been transferred (IFRS 9.3.2.6). Factoring with full recourse, retained dilution risk or a first-loss position typically means the entity has retained substantially all the risks and rewards, so the receivables stay on the balance sheet and the cash received is a secured borrowing, not a sale.
Is a covenant waiver a modification?
Usually it changes little in cash-flow terms, so it will almost always fail the 10% test and be non-substantial, if it is a modification at all. But watch the cash-flow consequences: if a waiver is granted in exchange for a higher margin, an extension or a fee, those revised cash flows go into the 10% test in the normal way (IFRS 9.B3.3.6), and a step-up in margin can be larger than it first appears.
→ IFRS 9 Financial Instruments Hub
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• IFRS 9 Impairment Accounting: Lifetime ECL vs 12-Month ECL & Stage Movements
About the author
Usman Qureshi is a Chartered Certified Accountant (ACCA) working in audit and advisory. He writes the IFRS, FRS 102 and US GAAP guides published on this site. Membership is listed on the ACCA public register.