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Initial recognition
An entity should recognise a financial liability
when it becomes a party to the contractual provisions
of the instrument [IAS39R.14].
Initial measurement
Initial measurement of financial liabilities is
at fair value which is normally the transaction
price (ie the proceeds received on issuance). In
addition, any transaction costs directly attributable
to the issue of debt are deducted in arriving at
the initial carrying amount, unless the liability
is to be measured subsequently at fair value through
profit or loss [IAS39R.43]. These costs are subsequently
amortised through the income statement over the
life of the debt using the effective interest method
and form part of interest expense for the period
[IAS39R.47]
[IAS39R.IG.E.1.1]
Debt denominated in a foreign currency is initially
recognised by translating the issue proceeds at
the spot exchange rate between the entity's functional
currency and the foreign currency on the date of
the transaction [IAS21R.21].
Debt issued at a premium or discount
The fair value of a debt instrument on initial recognition
will not necessarily equal its nominal amount or
face value. A bond may carry a lower or higher than
market nominal interest rate and be issued at a
discount or premium. Since the debt instrument is
initially recognised at its fair value (the issue
price), the discount or premium is included as part
of the initial carrying amount of the liability.
It is subsequently amortised over the life of the
financial liability using the effective interest
method, and forms part of interest expense
[IAS39R.47] .
Related parties
Entities may provide loans to related parties at
an interest rate lower than would be charged in
an arm's length transaction. These loans should
be recognised initially at fair value, using a market-based
interest rate to determine fair value [IAS39R.AG64].
Within group entities
A parent entity may provide a loan to a subsidiary
at an interest rate that is lower than the market
rate, or which is interest free. From the perspective
of the parent entity, where the interest concession
is non-reciprocal, any difference between the fair
value of the loan and the cash transferred should
usually be recognised as a capital contribution
to the subsidiary that increases the parent's investment.
From the perspective of the subsidiary, any difference
between the financial liability's fair value and
the cash transferred should either be recognised
as a capital contribution or in the income statement
depending on the substance of the transaction [IAS39R.AG64-65].
Zero coupon bond
A zero coupon bond is a bond with no periodic coupon
interest payments. The holder of such a bond receives
a return by the gradual appreciation of the bond,
which is redeemed at face value at maturity. The
difference between the original proceeds the entity
received on issuing the bond and the amount repaid
at maturity (principal) is called the discount.
An entity may choose to issue a zero coupon bond
because it allows the issuer to raise funds without
making current debt service payments. This advantage
is typically increased by current tax deductions
for accrued interest, even though the interest is
not paid until maturity.
A zero coupon bond should initially be recognised
at fair value which is normally the transaction
price (ie the proceeds received on issuance) [IAS39R.AG64].
Subsequent measurement
After initial recognition an entity should measure
financial liabilities, other than financial liabilities
at fair value through profit or loss at amortised
cost [IAS39R.47]. Amortised cost is the amount at
which the debt was measured at initial recognition
minus repayments, plus interest calculated using
the effective interest method [IAS39R.9]. Stated
another way, the initial proceeds from issuing debt,
net of transaction costs, are adjusted over the
life of the debt so that the carrying amount at
maturity is the amount repayable. The adjustments
are calculated using the effective interest method
[IAS39R.9] .
Foreign currency debt should be re-measured using
the closing rate at each balance sheet date [IAS21R.23]
.
Derecognition
A financial liability is removed from the balance
sheet when it is extinguished; that is when the
obligation is discharged, cancelled or expired [IAS39R.39].
That condition is met when the liability is settled
by paying the lender, or when the borrower is released
from primary responsibility for the liability either
by process of law or by an agreement with the lender
[IAS39R.AG57].
On derecognition, the difference between the amount
paid and the carrying amount of the liability is
included in the income statement as a gain or loss
[IAS39R.41].
An entity may enter into an in-substance defeasance
arrangement for its debt. The entity places cash
or another risk-free monetary asset into a structure,
typically a trust, which uses the asset and the
return arising from its investment to make repayments
on the outstanding debt. Derecognition under these
arrangements is not permitted under IFRS because
the entity has not been legally released from its
primary responsibility for the debt [IAS39R.AG57]
.
Entities may negotiate with the banks or bondholders
to cancel existing debt and replace it with new
debt on different terms. For example, an entity
may decide to cancel its exposure to high-interest
fixed-rate debt and replace it with variable rate
debt. IFRS provide guidance to distinguish between
(a) the settlement of debt that is replaced by new
debt from the same lenders; and (b) restructuring
of existing debt. This distinction is based on whether
or not the new debt has substantially different
terms from the old one [IAS39R.40] [IAS39.AG62]
.
Presentation and disclosure
IFRS require the following disclosures:
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the entity's risk
management objectives, including its policy
for hedging the forecasted issue of debt [IAS32R.56]; |
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| b) |
information about the terms and conditions
of debt instruments such as [IAS32R.60] [IAS32R.63]
[IAS32R.71] [IAS32R.94(j)]: |
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i. |
principal or other notional
value on which future payments are based; |
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ii. |
the date of maturity, expiry
or execution; |
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iii. |
early settlement option held
by any party; |
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iv. |
conversion or exchange options; |
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v. |
the amount of timing and scheduled
future cash receipts or payments of the principal; |
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vi. |
stated rate or
amount of interest, dividend or other return
on principal; |
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vii. |
collateral held |
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viii. |
the currency in which receipts
or payments are required if the instrument is
denominated in a currency other than the entity's
functional currency; |
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ix. |
any condition of the instrument
or an associated covenant that if contravened
would significantly alter the other terms; |
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x. |
exposure to interest rate risk,
indicating whether they are subject to interest
rate fair value risk or to interest rate cash
flow risk; and |
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xi. |
Any defaults or breaches with
regards to principal, interest or redemption
provisions on loans payable during the period
including the amount on which the breaches occurred
and whether the default has been remedied or
the terms renegotiated before the financial
statements were authorised for issue. |
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