Debt accounting

Accounting Standards Board proposes to amend Financial Reporting Standard 26 Financial Instruments: Recognition and Measurement

Following on IASB amendments to IAS 39 on the treatment of loan prepayment penalties as “closely related ”embedded derivatives, the Accounting Standards Board has proposed to amend FRS 26.

The Board identified an apparent inconsistency in the guidance in IAS 39, which related to embedded prepayment options in which the exercise price represented a penalty for early repayment (i.e. prepayment) of the loan. The inconsistency related to whether these options are considered “closely related” to the loan.

The Board decided to remove this inconsistency by amending paragraph AG30(g). The amendment makes an exception to the examples in paragraph AG30(g) of embedded derivatives that are not “closely related” to the underlying. The exception is for any prepayment option, the exercise price of which compensates the lender for the loss of interest income because the loan was prepaid. The exception is said to be conditional on the exercise price compensating the lender for loss of interest, by reducing the economic loss from reinvestment risk.

The Application Guidance, paragraph AG30(g) has also been amended as follows.

Embedded derivatives: The economic characteristics and risks of an embedded derivative are not “closely related” to the host contract in certain examples in which an entity accounts for the embedded derivative separately from the host contract.

“(g) A call, put, or prepayment option embedded in a host debt contract ... is not “closely related” to the host contract, unless: