CFM33197 - Loan relationships: core rules: amounts not brought into account: debt releases: corporate rescue exemption: meaning of ‘substantial modification’

This guidance is applicable to certain events that take place on or after 1 January 2015.

CTA09/323A

The terms ‘modification’ and ‘replacement’ refer to the accountancy treatment of a ‘substantial modification’ of the terms of the debt which gives rise to a credit. There is no definition of a ‘substantial’ modification in IAS 39, IFRS9 or FRS102, other than meaning ‘more than insignificant’. Examples of cases where credits may be recognised in the accounts are:

• where the debtor’s contractual terms are eased – in effect, an accounting profit from having a less onerous obligation to meet;
• where the modification is substantial, as explained further below.

The accounting treatment under IAS39, IFRS 9 or FRS 102 is to derecognise the existing debt and recognise a new debt instrument based on the new terms. Even though the instrument is accounted for on an amortised cost basis of accounting, the ‘new’ instrument is measured on initial recognition at its fair value.

The difference between the carrying value of the ‘old’ instrument and the fair value of the ‘new’ instrument will be recognised as an item in profit or loss.  Typically, in the case of distressed debt, this will be a profit of the debtor company comprising

• the relaxation of conditions under the instrument; and
• the deterioration in the creditworthiness of the company. 

This means that the fair value of the instrument in the books of the creditor is worth less than it was originally. In other words, a larger discount factor is used to calculate the present value of the future obligations under the revised instrument.