Derecognition of Financial Liabilities under Ind AS 109

Understand Derecognition of Financial Liabilities

Key rules to remember

Derecognition condition

Derecognise only when the obligation is discharged, cancelled or expires

Applies to the whole or a part of a financial liability. Legal release by the creditor or by law also counts.

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 sets at the original effective interest rate. Fees paid to the lender are added; fees received from the lender are deducted. Substantially different if the difference is 10% or more (use the absolute value).

Gain or loss on extinguishment

Gain or (loss) = Carrying amount of liability extinguished − (Consideration paid + non-cash assets transferred + liabilities assumed)

Recognised in profit or loss. Where a new liability is issued, its fair value is part of the consideration.

Fees on extinguishment

Costs or fees = part of the gain or loss on extinguishment

Recognised in profit or loss immediately. They are not capitalised into the new liability.

Fees where not extinguished

Adjusted carrying amount = PV of modified cash flows at the original effective rate + fees paid (− fees received); this amount is amortised over the remaining term of the modified liability

The liability is not derecognised. The gain or loss from recalculating the carrying amount as the PV of modified cash flows at the original effective rate goes to profit or loss. The fee is added to the revised carrying amount (or deducted if received) and then amortised through the effective interest rate over the remaining term.

How to solve Derecognition of Financial Liabilities questions

1. 1Identify what happened: repayment, legal release, expiry, swap with the same lender, or a change of terms.
2. 2If the liability was paid, cancelled or legally released, treat it as extinguished and go to step 6.
3. 3If terms were changed or swapped with the same lender, list the remaining cash flows of the original liability and the cash flows under the new terms.
4. 4Discount both sets at the original effective interest rate. Add net fees paid to the lender (deduct fees received) to the new set.
5. 5Compute the percentage difference against the PV of the original cash flows. If it is 10% or more, treat as extinguishment. If it is below 10%, treat as a modification only.
6. 6For extinguishment: derecognise the old liability, recognise the new liability at fair value, put all costs and fees in the gain or loss, and compute the gain or loss as carrying amount less consideration. For modification: keep the liability, revise carrying amount to the PV of modified cash flows at the original rate, recognise the change in profit or loss and amortise fees over the remaining term.
7. 7Write the journal entries and state the conclusion in one line.

Quickest way: Test first, then book

Common mistakes in Derecognition of Financial Liabilities

• Using the new effective interest rate to discount the new cash flows in the 10% test.

  Students want to value the new loan at its own market rate.

  Fix: The test discounts at the original effective interest rate. The new rate matters only for recognising the new liability later.

• Ignoring fees in the 10% test, or adding fees received instead of deducting them.

  The fee looks like a separate item from the cash flows.

  Fix: Include fees paid to the lender and deduct fees received from the lender, net, within the new cash flows.

• Capitalising fees into the new liability when the exchange is an extinguishment.

  Students carry over the rule for transaction costs on initial recognition.

  Fix: On extinguishment, fees and costs are part of the gain or loss in profit or loss. Capitalise or amortise fees only if the liability is not derecognised.

• Computing the gain as old carrying amount minus the face value of the new loan.

  Face value is easy to see in the question.

  Fix: Recognise the new liability at its fair value and use that in the gain or loss computation.

• Treating a difference of exactly 10% as not substantial.

  Students read the rule as 'more than 10%'.

  Fix: The test is a difference of at least 10%, so exactly 10% means substantially different.

• Derecognising a liability when only the risk of payment is remote or a payment is made to a third party without release.

  Students link derecognition with economic substance alone.

  Fix: Derecognise only when the debtor is legally released from the liability, either by the creditor or by process of law. Paying a third party without such a release leaves the liability in place. Paying part of it extinguishes only that part; the remainder stays on the balance sheet until it is discharged.

Worked examples