This ICAEW Know-How was created by the Financial Reporting Faculty.

FRS 102 accounting requirements

FRS 102 states that if an existing borrower and lender substantially modify the terms of an existing loan, they should account for the transaction as the extinguishment, and so derecognition, of the original loan and the recognition of a new one (FRS 102 paragraph 11.37). In such circumstances, the difference between the carrying amount of the loan that has been derecognised and the consideration paid (including any non-cash assets transferred or liabilities assumed) is recognised in profit or loss. The consideration paid is in the form of the new loan.

The standard does not define what is meant by ‘substantially’ different terms. This is therefore a matter of judgement. The guidance in AG62 of IAS 39 Financial Instruments: Recognition and Measurement and B3.3.6 of IFRS 9 Financial Instruments, which may be referred to when making this judgement, suggests that a difference of greater than 10% is considered to be ‘substantially different’. There is, however, no obligation to follow this guidance when applying FRS 102. Whatever threshold an entity chooses to apply, it will need to ensure that it is consistent in its approach in deciding what is and is not a substantial modification. 

FRS 102 does not specify how to account for modifications that are not ‘substantial’. One generally accepted approach is to treat the change in terms in the same way as a change in expected cash flows. In this case the new carrying amount of the loan should be determined by computing the present value of the revised cash flows at the loan’s original effective interest rate with any adjustment recognised in profit or loss at the date of the revision together with any fees incurred. This approach is illustrated in the example below. 

Care should be taken as it is also possible that a loan that was classified as ‘basic’ is replaced by one that does not meet the qualifying criteria or principles-based definition (FRS 102 paragraphs 11.9-9A) and is therefore classified as an ‘other’ financial instrument or vice versa. The terms of the new arrangement will therefore need to be closely examined. Section 11 of FRS 102 contains several examples to illustrate the classification of debt instruments.   

FRS 102 disclosure requirements

FRS 102 requires an entity to disclose information that enables users to evaluate the significance of financial instruments on the entity’s financial position and performance (FRS 102 paragraph 11.42). For long-term debt, such information would normally be expected to include the terms and conditions of the debt instrument. When the terms and conditions have been modified, the changes should be clearly disclosed. 

FRS 102 also requires an entity to disclose any material judgements made in applying its accounting policies that have a significant effect on the amounts recognised in the financial statements. Therefore, it may be appropriate to disclose judgements made in determining whether or not a modification is substantial (FRS 102 paragraphs 8.5-8.6).

Example 1

On 1 January 20X1, an entity takes out a bank loan for £5m, incurring an arrangement fee of £100,000. Interest of £400,000 is payable annually, in arrears, over the next four years. The loan is repayable on 31 December 20X4. The effective interest rate can be calculated as 8.61%. The contractual interest and repayments terms are assessed to be on market terms. 

Assuming that the loan qualifies as a basic financial instrument, it would be initially measured at £4.9m being the transaction price of £5m less the arrangement fee of £100,000. Subsequently, it would be accounted for at amortised cost, using the effective interest rate method, as shown below. Over the life of the instrument, the interest charged to profit will be £1.7m, being four years of annual interest of £400,000 plus the £100,000 arrangement fee.

On 31 December 20X1, the bank agrees to modify the terms of the loan so that it will not be repayable until the end of 20X6. Interest payments will increase to £550,000 per annum. The bank was paid a fee of £40,000 relating to the modification. For the purpose of this example, this fee is treated as being directly attributable to the issue of the ‘new’ loan rather than being a termination fee attributable to the original loan. 

The present value of the revised cash flows, including the arrangement fee, using the original effective interest rate of 8.61% can be calculated as £5.508m (see appendix). When compared with the book value of the original loan as at 31 December 20X1 of £4.922m, there is a difference of £0.586m or 11.9%. 

Substantial modification 

If the entity concludes that the revised terms are substantially different from the old ones, it derecognises the existing loan and recognises a ‘new’ one. The difference between the carrying value of the existing loan of £4.922m and the ‘new’ loan of £5m is £0.078m; this loss is recognised in profit or loss for the year ended 31 December 20X1. Being directly attributable to the issue of the ‘new’ loan, the arrangement fee of £40,000 is off-set against the new loan’s face value and therefore the carrying value of the liability at the end of the year will be £4.960m.

Note: the carrying value of the ‘new’ loan is at its transaction price of £5m, adjusted for the transaction costs of £40,000. The present value of the revised cash flows of the ‘new’ loan, discounted at the original effective interest rate of £5.508m is solely calculated to help determine whether the modification was a substantial modification or not.

From 1 January 20X2 the ‘new’ loan, for which an effective interest rate can be calculated as 11.22%, is accounted for as follows. 

The interest charged to profit or loss over the period 20X2 to 20X6 is £2.790m, being five years of revised annual interest at £550,000 per annum plus the modification arrangement fee of £40,000. 

Note: if the arrangement fee of £40,000 were considered to be a termination fee attributable to the extinguishment of the original loan, the fee paid would be charged to profit or loss on derecognition such that a loss of £0.118m would be recognised, instead of £0.078m. The carrying value of the liability at 31 December 20X1 would then be £5m, instead of £4.960m.

Not a substantial modification 

If the entity concludes – perhaps surprisingly given the outcome of the 10% test – that this does not represent a substantial modification then there is no need to derecognise the existing loan. If the approach discussed above was adopted, the difference between the current carrying value of the loan of £4.922m and the present value of the revised cash flows, excluding the arrangement fee and discounted at the original effective interest rate, of £5.468m (see appendix) would give rise to a loss of £0.546m to be recognised in profit or loss for the year ended 31 December 20X1. The arrangement fee of £40,000 would be expensed as incurred on 31 December 20X1.

The amortised cost method would then be applied to the adjusted carrying amount of the loan using its original effective interest rate as follows: 

Irrespective of whether the modification is classed as substantial or non-substantial, over the life of the instrument, a total expense of £3.290m would be charged to profit or loss representing the annual contractual interest payments of £400,000 in 20X1 and £550,000 per annum from 20X2 to 20X6 inclusive, plus the arrangement fees of £100,000 at the outset and £40,000 at the date of the modification.

Example 2

As previously, on 1 January 20X1, an entity takes out a bank loan for £5m, incurring an arrangement fee of £100,000. Interest of £400,000 is payable annually, in arrears, over the next four years. The loan is repayable on 31 December 20X4. The effective interest rate can be calculated as 8.61%. The contractual interest and repayments terms are assessed to be on market terms. 

This time however, on 31 December 20X1, the bank agrees to modify the terms so that under the revised arrangement, the loan remains repayable on 31 December 20X4 but that interest payments from 20X2 to 20X4 would be reduced to £200,000. The lender charges a fee of £40,000 relating to the modification. For the purpose of this example, this fee is treated as being directly attributable to the issue of the ‘new’ loan rather than being a termination fee attributable to the original loan. 

The present value of the revised cash flows, including the arrangement fee, using the original effective interest rate of 8.61% can be calculated as £4.453m (see appendix). This compares with the book value of the original loan as at 31 December 20X1 of £4.922m, a difference of £0.469m or 9.5%. 

Substantial modification 

If the entity concludes that the revised terms are substantially different from the old ones, it would derecognise the existing loan and recognise a new one. The difference between the carrying value of the old loan of £4.922m and the ‘new’ £5m loan will give rise to a loss of £0.078m to be recognised in profit or loss in the year ended 31 December 20X1. Being directly attributable to the issue of the ‘new’ loan, the arrangement fee of £40,000 is off-set against the ‘new’ loan’s face value and therefore the carrying value of the liability at the end of the year will be £4.960m.

From 1 January 20X2 the loan, for which an effective interest rate can be calculated as 4.29%, is accounted for as follows. 

The interest charged to profit or loss over the period 20X2 to 20X4 is £0.640m, being three years of revised annual interest at £200,000 per annum plus the modification arrangement fee of £40,000.  

Not a substantial modification 

If the entity concludes that this does not represent a substantial modification then there is no need to derecognise the existing loan. Adopting the approach above, the difference between the current carrying value of the loan of £4.922m and the present value of the revised cash flows, excluding the arrangement fee and discounted at the original effective interest rate, of £4.413m (see appendix) would give rise to a gain of £0.509m to be recognised in profit or loss in the year ended 31 December 20X1. The arrangement fee of £40,000 would be expensed as incurred on 31 December 20X1.

The amortised cost method would then be applied to the adjusted carrying amount of the loan using its original effective interest rate as follows: 

Irrespective of whether the modification is classed as substantial or non-substantial, over the life of the instrument, a total expense of £1.140m would be charged to profit or loss representing the annual contractual interest payments of £400,000 in 20X1 and £200,000 per annum from 20X2 to 20X4 inclusive, plus the arrangement fees of £100,000 at the outset and £40,000 at the date of the modification.

Further resources 

• Financial Reporting Coronavirus hub – guidance for preparers of financial statements on the coronavirus outbreak, including advice on disclosure of risks and treatment of events after the reporting period. 
• ICAEW coronavirus hub – bringing together all resources related to COVID-19 including information on tax, help for business and much more. 

Further resources on FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland are accessible at icaew.com/frs102. 

For more guidance on the requirements of IFRS and UK GAAP visit icaew.com/financialreporting 

ICAEW members, affiliates, ICAEW students and staff in eligible firms with member firm access can discuss their specific situation with the Technical Advisory Service on +44 (0)1908 248 250 or via live web chat.