Chapter 15 — Comparison of U.S. GAAP and IFRS Accounting Standards

15.2.1 Background

The table below summarizes key differences between U.S. GAAP and IFRS Accounting Standards related to the issuer’s accounting for debt. The table is followed by a detailed explanation of each difference.

15.2.2 Interest Method

15.2.2.1 Changes in Contractual Cash Flows

If the timing or amount of the cash flows under a debt contract are modified or vary on the basis of an underlying that does not have to be bifurcated as a derivative, a question arises about how to apply the effective interest method to changes in those contractual cash flows.

Under U.S. GAAP, different methods are appropriate or acceptable for different types of debt transactions (see Sections 6.2.4, 6.2.5, 7.2, 7.3, 7.4, 10.4.3, and 11.4.4). For example, there are three acceptable methods for applying the interest method to sales of future revenue when there are changes to the timing or amount of the estimated future cash flows (see Section 7.2.4). When debt is modified or exchanged and the terms of the modified debt are not substantially different from the terms of the original debt, ASC 470-50 requires the debtor to make a prospective yield adjustment (see Section 10.4.3). When a debt modification or exchange represents a TDR, ASC 470-60 requires the interest rate to be reduced and potentially reset to zero so that a restructuring gain is only recognized if the carrying amount exceeds the total undiscounted future cash flows (see Section 11.4.4).

If an entity revises its estimate of future contractual cash flows of a financial liability (e.g., as a result of a debt modification or exchange that is not accounted for as an extinguishment of the original debt), the entity is required under paragraph B5.4.6 of IFRS 9 to (1) adjust the amortized cost to the present value of the estimated future contractual cash flows discounted by using the liability’s original effective interest rate and (2) recognize the resulting adjustment in profit or loss.

15.2.2.2 Special Accounting for Certain Debt Transactions

Under U.S. GAAP, special accounting models apply to certain transactions involving the sales of future revenue (see Section 7.2), participating mortgages (see Section 7.3), indexed debt (see Section 7.4), and extendable increasing-rate debt (see Section 6.2.4.5). IFRS 9 does not contain similar guidance. Instead, it requires entities to account for such liabilities in a manner similar to other liabilities (i.e., typically at amortized cost by using the interest method).

15.2.3 Fair Value Option

15.2.3.1 Qualifying Criteria

IFRS 9 requires entities to meet certain qualifying criteria before they can elect the fair value option for an otherwise eligible item; there are no such qualifying criteria in ASC 825-10 (see Section 4.4). For financial liabilities, an entity is permitted under paragraph 4.2.2 of IFRS 9 to elect the fair value option when either of the following apply:

The fair value option “eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as ‘an accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases.”
“[A] group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity’s key management personnel.”

Further, paragraph 4.3.5 of IFRS 9 permits an entity to elect the fair value option for a financial liability (or other host contract that is not an asset within the scope of IFRS 9) if it contains one or more embedded derivatives unless either of the following conditions is met:

“[T]he embedded derivative(s) do(es) not significantly modify the cash flows that otherwise would be required by the contract.”
“[I]t is clear with little or no analysis . . . that separation of the embedded derivative(s) is prohibited, such as a prepayment option embedded in a loan that permits the holder to prepay the loan for approximately its amortised cost.”

15.2.3.2 Fair Value Changes Attributable to Credit Risk

Under both ASC 825-10 and IFRS 9, changes in the fair value of a financial liability for which the fair value option has been elected are recognized in earnings (profit or loss) except for the portion of the change that is attributable to the liability’s credit risk, which is recognized in OCI (see Section 6.3.2). However, unlike ASC 825-10, paragraph 5.7.8 of IFRS 9 contains an exception under which recognition of the credit risk component through OCI is precluded if it would “create or enlarge an accounting mismatch in profit or loss.”

Upon derecognition of a liability for which fair value changes attributable to the liability’s credit risk have been recognized through OCI, ASC 825-10 requires the credit risk component to be released through earnings (see Section 9.3.2). Under paragraph B5.7.9 of IFRS 9, an entity is not permitted to subsequently release the AOCI component into earnings (or profit or loss) upon derecognition of the liability.

15.2.4 Convertible Debt — Separation of an Equity Component

The issuer of convertible debt is precluded by ASC 470-20 from allocating to equity any of the proceeds received upon its issuance unless a special accounting model applies. If the conversion feature does not have to be bifurcated as a derivative liability under ASC 815-15, recognition of an equity component may be required in accordance with special accounting models for convertible debt that (1) was issued at a substantial premium (see Section 7.6.3), (2) was modified or exchanged if extinguishment accounting did not apply and the fair value of the conversion feature increased (see Section 10.4.3.3), or (3) has a bifurcated conversion option derivative that was reclassified as equity (see Section 8.5.4.3). If the equity conversion feature fails to satisfy the equity classification conditions in ASC 815-40, it is bifurcated as an embedded derivative only if it meets the bifurcation conditions in ASC 815-15 (including the net settlement characteristic in the definition of a derivative in ASC 815-10; see Chapter 8).

Under paragraph 28 of IAS 32, the issuer of a convertible debt instrument must separate it into liability and equity components if the feature meets the equity classification conditions in IAS 32. The issuer separates the instrument into its components by determining the fair value of the liability component and then deducting that amount from the fair value of the instrument as a whole; the residual amount is allocated to the equity component. If the equity conversion feature does not satisfy the equity classification conditions in IAS 32, it is bifurcated as an embedded derivative unless the issuer elects to apply the fair value option to the convertible debt.

Note that the definition of a derivative and the conditions for equity classification under U.S. GAAP and IFRS Accounting Standards are not identical. Therefore, depending on the specific facts and circumstances, the assessment of whether an equity conversion option must be separated as an embedded derivative may differ under the two sets of standards (see Chapter 8 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity).

15.2.5 Embedded Derivatives

15.2.5.1 Debt With Embedded Put or Call Option

Under both ASC 815-15 and IFRS 9, an entity must evaluate put, call, and prepayment features embedded in debt host contracts to determine whether they must be accounted for separately as a derivative. One of the criteria for bifurcation is that the economic characteristics and risks of the embedded feature are not “clearly and closely related” (or, under IFRS 9, simply “closely related”) to those of the host contract (see Section 8.4.4). However, the guidance in each set of standards differs on whether such features are considered clearly and closely related.

In accordance with ASC 815-15, a put, call, or prepayment option that is embedded is not clearly and closely related to a debt host contract if (1) it is indexed to an underlying other than interest rates, credit risk, or inflation (see Section 8.3.2); (2) the debt involves a substantial discount or premium and the option is contingent (see Section 8.4.4); or (3) the option is not contingent and either the negative-yield or double-double test is passed (see Section 8.4.1).

Under paragraph B4.3.5(e) of IFRS 9, a put, call, or prepayment option is not closely related to a debt host contract unless (1) the option’s exercise price is approximately equal to the debt’s amortized cost on each exercise date (before separating any equity component) or (2) a prepayment option’s exercise price “reimburses the lender for an amount up to the approximate present value of lost interest for the remaining term of the host contract.” Lost interest is computed, as of the prepayment date, as the prepaid principal amount multiplied by the difference between the effective interest rate of the host contract and the effective rate the lender would receive if it reinvested the prepaid principal amount in a similar contract for the remaining term of the host contract.

15.2.5.2 Debt With Embedded Equity Conversion Feature

Under both ASC 815 and IFRS 9, an embedded equity conversion feature is exempt from the requirements for the bifurcation of a derivative if it qualifies as equity. However, the circumstances in which an equity conversion feature qualifies as equity differ. Further, the definition of a derivative differs between ASC 815 and IFRS 9.

In accordance with ASC 815-15, an equity conversion feature embedded in a debt contract qualifies as equity and is exempt from derivative accounting if (1) it is considered indexed to the entity’s own equity under ASC 815-40-15 and (2) the debtor could not be forced to settle it in cash under ASC 815-40-25 (see Section 8.4.7). A down-round protection feature does not affect the assessment of whether a conversion feature is considered indexed to the entity’s own equity. However, exercise contingencies preclude a conclusion that the conversion feature is indexed to the entity’s own stock if they are based on an observable market other than the market for the issuer’s stock or an observable index other than one calculated or measured solely by reference to the issuer’s operations. In addition, some settlement terms preclude an embedded equity conversion feature from being considered indexed to the issuer’s stock. See Deloitte’s Roadmap Contracts on an Entity’s Own Equity for more information.

Under paragraph 10 of IAS 32, an equity conversion feature does not qualify as equity if it can be settled net by either or both parties (e.g., an equity conversion feature that can be settled net in shares). Further, an equity conversion feature does not qualify as equity if it contains down-round protection. However, exercise contingencies do not affect the assessment of whether an equity conversion feature qualifies as equity.

In accordance with ASC 815, an equity conversion feature lacks the net settlement characteristic in the definition of a derivative if it must be physically settled and the shares that would be delivered upon conversion are not readily convertible to cash (e.g., private-company stock). Therefore, such a feature would not be bifurcated under ASC 815-15 even if it does not qualify as equity under ASC 815-40. There is no net settlement requirement under the definition of a derivative in Appendix A of IFRS 9. Accordingly, equity conversion features that are settled in shares that are not readily convertible to cash must be bifurcated if they do not qualify as equity under IAS 32.

15.2.6 Debt Extinguishments

15.2.6.1 Expected Breakage

In accordance with an exception to the extinguishment conditions in ASC 405-20, an entity is required to derecognize a financial liability related to a prepaid stored-value product on the basis of expected breakage even if the obligation has not been legally extinguished (see Section 9.4). Under paragraph 3.3.1 of IFRS 9, a financial liability can only be derecognized when the obligation has been extinguished.

15.2.6.2 Convertible Debt

When convertible debt is extinguished as a result of an early redemption or repurchase, no amount is allocated to equity under U.S. GAAP if the convertible debt was presented as debt in its entirety.

Under paragraph AG33 of IAS 32, when convertible debt is extinguished as a result of an early redemption or repurchase, the issuer must allocate the consideration paid between the liability and equity components on the basis of the fair value of the liability component. This treatment does not apply if the conversion feature is bifurcated as a derivative under IFRS 9 (see Section 15.2.5.2).

15.2.7 Debt Modification or Exchange

15.2.7.1 Substantially Different Terms

Under ASC 470-50, the terms of new or modified debt are considered substantially different from the terms of the original debt (such that the original debt is accounted for as being extinguished) if the 10 percent cash flow test is passed (see Section 10.3.3), a substantive conversion option is added or removed (see Section 10.3.4.3), or the change in fair value of an embedded conversion option is at least 10 percent of the original carrying amount (see Section 10.3.4.2). This guidance does not apply to TDRs.

Under IFRS 9, paragraph B.3.3.6 specifies that the terms of new or modified debt are considered substantially different from the terms of the original debt (such that the original debt is accounted for as being extinguished) if the 10 percent cash flow test is passed or, in limited circumstances, the terms are determined to be qualitatively different.

15.2.7.2 Terms Not Substantially Different

Under ASC 470-50, if the terms of new or modified debt are not considered substantially different from the terms of the original debt, the debtor should account for the effect of the modification or exchange on the debt’s cash flows prospectively as a yield adjustment (see Section 10.4.3). Under IFRS 9, paragraph B5.4.6, the debtor should recognize a modification gain or loss in profit or loss on the basis of the difference between (1) the carrying amount immediately before the modification or exchange and (2) the present value of the modified contractual cash flows discounted by using the original effective interest rate. This treatment is described in paragraph BC4.253 of IFRS 9.

15.2.7.3 Increase in the Fair Value of Embedded Conversion Option

Under ASC 470-50, if the terms of the new or modified debt are not considered substantially different from the terms of the original debt, the debtor must recognize an increase (but not a decrease) in the fair value of an embedded conversion option in connection with the modification or exchange by reducing the debt’s carrying amount with an offset to equity (see Section 10.4.3.3). IFRS 9 does not contain any specific guidance on such scenarios. Under IAS 32, conversion features that are recognized in equity are not remeasured.

15.2.7.4 Third-Party Costs

The guidance in ASC 470-50 and IFRS 9 differs on third-party costs incurred in connection with a debt modification or exchange.

If the terms of the new debt are substantially different from the debt’s original terms such that the original debt is accounted for as being extinguished, ASC 470-50 requires third-party costs to be amortized over the life of the new debt by using the interest method (see Section 10.4.2). Under paragraph B3.3.6 of IFRS 9, such costs must be expensed as incurred.

If the terms of the new debt are not substantially different from the debt’s original terms and the new debt is therefore accounted for as a continuation of the original debt, ASC 470-50 requires third-party costs to be expensed as incurred (see Section 10.4.3). Under paragraph B3.3.6 of IFRS 9, such costs must be amortized over the life of the new debt by using the interest method.

15.2.8 Troubled Debt Restructurings

Under ASC 470-60, a debt modification or exchange is accounted for as a TDR if the creditor grants a concession as a result of the debtor’s financial difficulties (see Section 11.3). When TDR accounting applies, the debtor accounts for the effect of the modification to the debt terms prospectively as an adjustment to the effective interest rate, except the effective interest rate cannot be reduced below zero (see Section 11.4.4). The debtor does not recognize a restructuring gain (or corresponding adjustment to the net carrying amount) unless the net carrying amount exceeds the total undiscounted future principal and interest payments of the restructured debt.

IFRS 9 does not contain any special guidance for debt modifications or exchanges that would have been accounted for as TDRs under ASC 470-60. Instead, an entity performs the 10 percent cash flow test to determine whether the modification or exchange should be accounted for as an extinguishment or a continuation of the original debt (see Section 15.2.7.1).

15.2.9 Debt Conversions — Gain or Loss Recognition

In accordance with ASC 470-20, no gain or loss is recognized upon the conversion of debt into cash, other assets, or the debtor’s equity shares in accordance with the original terms of a conversion feature unless the conversion occurred upon the debtor’s exercise of a call option and the conversion option was not substantive at inception, in which case debt extinguishment accounting applies.

Under paragraph AG32 of IAS 32, no gain or loss is recognized upon a conversion of convertible debt into the debtor’s equity shares in accordance with the original terms of a conversion feature. The conversion of debt into cash or other assets is accounted for as an extinguishment.

15.2.10 Balance Sheet Classification of Debt as Current or Noncurrent

15.2.10.1 Post-Balance-Sheet-Date Refinancing

Under ASC 470-10, certain short-term obligations (e.g., short-term debt or the currently maturing portion of long-term debt) are classified as noncurrent if the debtor has both the intent and ability to refinance the obligation on a long-term basis (see Section 13.7). To demonstrate an ability to refinance a short-term obligation on a long-term basis, the debtor must either (1) refinance the obligation on a long-term basis after the balance sheet date, but before or as of the date the financial statements are issued or available to be issued, or (2) have a financing agreement that clearly permits it to refinance the obligation on a long-term basis in place before or as of the date the financial statements are issued or available to be issued.

In accordance with paragraph 72 of IAS 1, a debtor classifies a financial liability as current if it is “due to be settled within twelve months after the reporting period” even if the debtor executes an agreement to refinance or reschedule the payments on a long-term basis after the balance sheet date and before the financial statements are authorized for issue.

15.2.10.2 Waivers of Covenant Violations

Under ASC 470-10, a long-term obligation that has become repayable on demand because of a covenant violation as of the balance sheet date is not classified as current if the creditor grants a qualifying waiver before the financial statements are issued (or available to be issued; see Section 13.5.3).

If a debtor has breached a provision of a long-term obligation before the end of the reporting period such that the obligation becomes repayable on demand, paragraph 74 of IAS 1 requires the liability to be classified as current even if the lender agrees, after the end of the reporting period and before the financial statements are authorized for issue, not to demand repayment as a consequence of the breach.