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Financial Reporting · Financial Instruments: Equity and Financial Liabilities

Derecognition of Financial Liabilities and Modifications (Ind AS 109)

Updated 5 October 2026 · Fact-checked

Under Ind AS 109 you derecognise a financial liability when it is extinguished: discharged, cancelled or expired. A substantial modification is also treated as extinguishment. Apply the 10% test: discount new cash flows, including net fees, at the original effective interest rate. If the result differs by 10% or more from the old liability's present value, derecognise and book the gain or loss in profit or loss.

Understand Derecognition of Financial Liabilities and Modifications

A financial liability stays on the balance sheet until the obligation is over. Ind AS 109 (para 3.3.1) says you remove it only when it is extinguished. That means the obligation is discharged (you pay), cancelled (the lender waives it), or expires. A legal release by the creditor or by law also counts.

The harder question is what happens when the borrower and lender renegotiate. Para 3.3.2 says an exchange of debt instruments with substantially different terms, or a substantial modification of the terms of an existing liability, is accounted for as extinguishment of the old liability and recognition of a new one. This applies to the whole liability or a part of it.

The test for "substantially different" is in para B3.3.6. Terms are substantially different if the present value of the cash flows under the new terms, including any fees paid net of any fees received, discounted at the original effective interest rate, differs by at least 10% from the present value of the remaining cash flows of the original liability. Both sets of cash flows are discounted at the same original EIR, so the comparison is like for like and is not distorted by the new coupon rate.

The accounting depends on the result. If the test is met, it is extinguishment. You derecognise the old liability, recognise the new one at fair value, and take the difference between the old carrying amount and the consideration paid (para 3.3.3) to profit or loss. Costs or fees incurred are part of that gain or loss. If the test is not met, it is a non-substantial modification. The liability continues. You recalculate its carrying amount as the present value of the modified cash flows at the original EIR and book the difference in profit or loss (para B5.4.6). Costs or fees adjust the carrying amount and are amortised over the remaining term.

The same logic covers buying back your own debt. The difference between the carrying amount and the price paid goes to profit or loss.

Key rules to remember

Derecognition condition
Derecognise when the obligation is discharged, cancelled or expires (para 3.3.1)
Also applies to a substantial modification or an exchange with substantially different terms (para 3.3.2).
10% test
Difference % = (PV of new cash flows incl. net fees − PV of remaining original cash flows) ÷ PV of remaining original cash flows × 100
Discount both at the original EIR. Fees paid are added and fees received are deducted. Substantial if the absolute difference is ≥ 10%.
Gain or loss on extinguishment
Gain or loss = Carrying amount of liability extinguished − Consideration paid (cash + non-cash assets transferred + liabilities assumed, including the new liability at fair value)
Recognised in profit or loss (para 3.3.3). Costs and fees go into this gain or loss.
Non-substantial modification
New carrying amount = PV of modified contractual cash flows at original EIR
The difference from the old carrying amount is a gain or loss in profit or loss (para B5.4.6). Costs or fees adjust the carrying amount and are amortised over the remaining term.

How to solve Derecognition of Financial Liabilities and Modifications questions

Use the same sequence for any question on derecognition or modification of a financial liability.

  1. 1Identify the event: repayment, waiver, buyback, exchange of debt, or change in terms.
  2. 2Find the original EIR and the carrying amount (amortised cost) at the date of change.
  3. 3List the remaining original cash flows and compute their present value at the original EIR. This normally equals the carrying amount.
  4. 4List the new cash flows and add any fees paid by the borrower to the lender. Deduct any fees received. Discount at the original EIR.
  5. 5Compute the percentage difference against the original PV. If it is 10% or more, it is extinguishment. If it is below 10%, it is a non-substantial modification.
  6. 6If extinguishment: derecognise the old liability, recognise the new one at fair value, and take the difference to profit or loss, with all costs and fees included in that gain or loss.
  7. 7If non-substantial: carry the liability at the PV of modified cash flows at the original EIR, take the difference to profit or loss, and amortise costs or fees over the remaining term.
  8. 8Pass the journal entries and state the paragraph logic in one line.

Quickest way: 10% test in four lines

When to use it: Use it when the question gives old and new terms and asks you to classify the change and compute the gain or loss.

  1. Old PV at original EIR is usually the carrying amount, so you often do not need to recompute it.
  2. Discount only the new cash flows at the original EIR and add net fees paid.
  3. Divide the difference by the carrying amount. Compare with 10%.
  4. Extinguishment: gain or loss = old carrying amount − (fair value of new liability + fees). Modification: gain or loss = old carrying amount − PV of new cash flows.

Common mistakes in Derecognition of Financial Liabilities and Modifications

  • Discounting the new cash flows at the new interest rate in the 10% test.

    The new loan has a new coupon, so students assume it has a new discount rate.

    Fix: For the test, always use the original effective interest rate.

  • Ignoring fees paid to the lender in the 10% test.

    Students treat fees as a separate expense item.

    Fix: Add fees paid and deduct fees received in the test. A fee can push a case from just under 10% to over 10%.

  • Capitalising fees after an extinguishment.

    Students remember that fees adjust the carrying amount and apply that rule everywhere.

    Fix: If it is extinguishment, fees are part of the gain or loss in profit or loss. If it is a non-substantial modification, fees adjust the carrying amount and are amortised.

  • Recognising the new liability at its face value after extinguishment.

    Students carry the contractual principal across.

    Fix: Recognise the new liability at fair value. The gain or loss is carrying amount less consideration paid.

  • Skipping the gain or loss when the change is non-substantial.

    Students think no derecognition means no entry.

    Fix: Under para B5.4.6 the carrying amount is recalculated at the original EIR and the difference goes to profit or loss.

  • Treating the 10% threshold as exclusive, or stopping at 9.9% without thinking.

    Students read it as "more than 10%".

    Fix: The standard says at least 10%, so exactly 10% is substantial.

Worked examples

Example 1

Case: Meru Ltd has a bank loan with a carrying amount of ₹10,00,000, three years remaining, 10% interest paid annually and principal repaid at the end of year 3. The original EIR is 10%. The bank agrees to cut interest to 8% from now, with the same maturity. Meru pays the bank a fee of ₹20,000. Classify the change and give the accounting.

Show the solution
  1. Original PV at 10% = carrying amount = ₹10,00,000.
  2. New cash flows: ₹80,000, ₹80,000, ₹10,80,000. The 3-year annuity factor at 10% is 2.486852 and the year-3 discount factor is 0.751315.
  3. PV of new flows = 80,000 × 2.486852 + 10,00,000 × 0.751315 = 1,98,948 + 7,51,315 = ₹9,50,263.
  4. Add the fee paid: 9,50,263 + 20,000 = ₹9,70,263.
  5. Difference = 10,00,000 − 9,70,263 = ₹29,737, which is 2.97% of ₹10,00,000. This is below 10%, so it is not substantial.
  6. Treat it as a modification. New carrying amount = ₹9,50,263 (PV of modified cash flows at original EIR). Gain = 10,00,000 − 9,50,263 = ₹49,737, recognised in profit or loss.
  7. The fee of ₹20,000 adjusts the carrying amount, which becomes ₹9,70,263. It is amortised over the remaining three years.

Answer: Non-substantial modification (2.97%). Recognise a gain of ₹49,737 in profit or loss. The liability continues at ₹9,70,263 after the fee, and the fee is amortised over the remaining term.

Example 2

Case: Kaveri Ltd has a loan with a carrying amount of ₹50,00,000, two years remaining, 9% interest paid annually and a bullet repayment. The original EIR is 9%. The lender agrees to cut interest to 2% for the two years, with the same principal and maturity. Kaveri pays a fee of ₹1,00,000. The fair value of the modified loan is ₹44,00,000. Apply Ind AS 109.

Show the solution
  1. Original PV at 9% = carrying amount = ₹50,00,000.
  2. New cash flows: interest of ₹1,00,000 for each of two years and principal of ₹50,00,000 at the end of year 2. The 2-year annuity factor at 9% is 1.759111 and the year-2 discount factor is 0.841680.
  3. PV = 1,00,000 × 1.759111 + 50,00,000 × 0.841680 = 1,75,911 + 42,08,400 = ₹43,84,311.
  4. Add the fee paid: 43,84,311 + 1,00,000 = ₹44,84,311.
  5. Difference = 50,00,000 − 44,84,311 = ₹5,15,689, which is 10.31%. This is at least 10%, so it is substantial.
  6. Treat it as extinguishment of the old loan and recognition of a new loan at fair value (para 3.3.2).
  7. Consideration = fair value of new liability 44,00,000 + fee 1,00,000 = ₹45,00,000.
  8. Gain = 50,00,000 − 45,00,000 = ₹5,00,000 in profit or loss. The fee is included in this gain and is not capitalised.
  9. Entry: Dr Old loan ₹50,00,000; Cr New loan ₹44,00,000; Cr Bank ₹1,00,000; Cr Gain on extinguishment ₹5,00,000.

Answer: Substantial modification (10.31%), so the old loan is derecognised. The new loan is recognised at ₹44,00,000 and a gain of ₹5,00,000 goes to profit or loss.

Exam tips

  • In MCQs, the fee often decides the answer. Always check whether a fee is paid or received and add it before you compare with 10%.
  • In written answers, name the paragraph logic: para 3.3.1 for extinguishment, 3.3.2 and B3.3.6 for modification, 3.3.3 for gain or loss.
  • Show the PV working neatly. Marks usually go to the discounting at the original EIR and the percentage computed.
  • State the fee treatment explicitly in both outcomes: part of gain or loss for extinguishment, adjusts carrying amount for modification.
  • If the question involves settling debt by issuing shares, switch to the separate topic on extinguishing financial liabilities with equity instruments.

Practice questions from Financial Instruments: Equity and Financial Liabilities

Derecognition of Financial Liabilities and Modifications in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Derecognition of Financial Liabilities and Modifications: frequently asked questions

What is the 10% test in Ind AS 109?

It checks whether new terms are substantially different from the old. You discount the new cash flows, including net fees, at the original EIR and compare with the PV of remaining original cash flows. A difference of 10% or more means extinguishment.

What is the difference between modification and extinguishment of a financial liability?

In a modification below 10%, the same liability continues. Its carrying amount is reset to the PV of modified cash flows at the original EIR. In extinguishment the old liability is removed and a new one is recognised at fair value, with the gain or loss in profit or loss.

How are fees treated in a loan modification?

If the change is extinguishment, fees are included in the gain or loss. If it is a non-substantial modification, they adjust the carrying amount and are amortised over the remaining term.

Where does the gain or loss on derecognition go?

It goes to profit or loss. It is the carrying amount of the liability extinguished less the consideration paid, which includes any non-cash assets transferred or liabilities assumed.