On 1st April, 20X1, a bank provides an entity with a four-year loan of 5,000 on normal market terms, including charging interest at a fixed rate of…

CA Final · Financial Reporting · MTP · January 2026
On 1st April, 20X1, a bank provides an entity with a four-year loan of 5,000 on normal market terms, including charging interest at a fixed rate of 8% per year. Interest is payable at the end of each year. The figure of 8% is the market rate for similar four-year fixed-interest loans with interest paid annually in arrears. Transaction cost of 100is incurred on originating the loan. Effective interest rate in this case is 8.612%. In 20X1-20X2, the entity experienced financial difficulties. On 31st March, 20X2, the bank agreed to modify the terms of the loan. Under the new terms, the interest payments in 20X2-20X3 to 20X4-20X5 will be reduced from 8% to 5%. The entity paid the bank a fee of 50for paperwork relating to the modification. Analyse whether the modification of the loan terms constitutes an extinguishment of the original financial liability or not.

Suggested Answer and Working Notes:

Since the interest was initially set at the market rate, on 1st April, 20X1 the entity on initial recognition will measure the loan at the transaction price, less transaction costs i.e. at 4,900. The following is the original amortised cost calculation at 1st April, 20X1: Time Carrying amount at 1st April Effective Interest @ 8.612% Cash outflow Carrying amount at 31st March (a) (b=a x 8.612%) (c=5000 x 8%) (d=a+b-c) 20 X1-20X2 4,900.00 421.99 (400.00) 4,921.99 20 X2-20X3 4,921.99 423.88 (400.00) 4,945.87 20 X3-20X4 4,945.87 425.94 (400.00) 4,971.81 20 X4-20X5 4,971.81 428.19 (5,400.00) At 31st March, 20X2: 1. The present value of the remaining cash flows of the original financial liability is 4,921.99 discounted at the original effective interest rate of 8.612%. 2. The present value of the cash flows under the new terms discounted using the original effective interest rate is 4,537.25 (Refer W.N.). Including the 50fee, the present value of the total cash flows is 4,587.25. 3. The difference between - 4,921.99 and - 4,587.25 is 334.74 which is only 6.8% (₹ 334.74 ÷ ₹ 4,921.99) of the present value of the remaining cash flows of the original financial liability. The entity applies its judgement to decide whether the terms of the instruments exchanged are substantially different. Since the difference of the discounted present value of the cash flows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is less than 10% of the present value of the remaining cash flows of the original financial liability, this modification should not be considered a substantial modification of the terms of the existing loan. Therefore, the modification would not be accounted for as an extinguishment of the original financial liability. Working Note: The calculation of the present value of the cash flows under the new terms discounted using the original effective interest rate is as follows: Time Cash outflow Discounting factor @ 8.612% Present value at 31st March 31 st March, 20X3 250.00 0.921 230.25 31 st March, 20X4 250.00 0.848 212.00 31 st March, 20X5 5,250.00 0.780 4,095.00 Total present value 4,537.25

Topics: Ind AS 109, General

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