The replacement of interest reference rates such as EURIBOR and LIBOR is approaching fast, with the transition to alternative benchmark rates such as €STR and SONIA expected to be mostly complete by the end of 2021. 

Although some might think such changes will mostly affect companies operating in financial services, the number of companies which could be affected by the switch is actually much greater than that. Benchmark interest rates are often used by companies in their loan and lease contracts, and a replacement of these rates could have accounting consequences. For example, if a change in the type of reference rate used to determine the interest charged on a loan causes related payments to change, IFRS would normally require an assessment as to whether there is a modification gain or loss which should be taken to profit or loss. The new amendments could change this.

The IASB recently completed their two-phase project on how the replacement of the interest rate benchmarks might affect financial reporting, issuing amendments to help companies as they transition to use of the new rates.

Phase 1 of the IASB’s project is perhaps of less interest to smaller companies, focussing as it does on pre-replacement issues relating to hedge accounting. Phase 2 of the project, however, is relevant for companies with loan and lease contracts using these reference rates as it covers changes in contractual cash flows because of the switch.

The amendments to IFRS 9 Financial Instruments require a company to account for a change in the interest reference rate used for loans receivable or payable through an adjustment to the effective interest rate if certain conditions are met. This provides a similar accounting treatment for the change as would be applied to normal interest rate changes for a floating-rate financial asset or liability. There is no remeasurement of the asset or liability, and no gain or loss taken to profit or loss. 

The conditions required to provide this expedient are that the change in the interest reference rate is necessary as a direct consequence of benchmark reform, and the new basis for determining the contractual cash flows is economically equivalent to the previous basis. If additional changes other than those required by benchmark reform are made, those should be accounted for either as an extinguishment or modification of the previous asset and liability. The result for those other changes would be the recognition of a gain or loss in profit or loss.

The amendments to IFRS 16 Leases provide a practical expedient that, if certain conditions are met, lessees do not apply the normal requirements for lease modifications where interest rate benchmark reform changes the basis for determining future lease payments. Instead, lessees follow the reassessment guidance to remeasure the lease liability. The benefit of this is that lessees do not need to reassess the entire incremental borrowing rate used in their lease accounting. Lessees would instead only need to use a revised discount rate that reflects movement in the interest rate, in the same way as they would normally account for changes in lease payments based on floating interest rates.

The conditions required to allow this expedient are similar to those for the IFRS 9 expedient. However, if additional modifications other than those required by benchmark reform are made, the normal lease modification guidance in IFRS 16 needs to be applied to ALL changes. In that situation, lessees would need to determine an entirely new incremental borrowing rate.

The amendments to IFRS 7 Financial Instruments: Disclosure introduce some new disclosure requirements, including the risks to which an entity is exposed from interest rate benchmark reform and their progress in managing the transition to the new rate. This would include disclosing quantitative information about financial instruments that have yet to transition to an alternative benchmark rate as at the end of the reporting period.

Although the amendments to IFRS 9, IFRS 7 and IFRS 16 are not mandatory until periods beginning on or after 1 January 2021, the reliefs provided by the amendments mean that for some it might be beneficial to apply early if they are already renegotiating their contracts to reflect the new reference rates. 

How we can help

At Euromanagement we can provide support as you consider the impact of IBOR reform.

The above content is for general information purposes only and should not be used as a substitute for consultation with professional advisors.