This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to the International Financial Reporting Interpretations Committee on 5 October 2009:
Dear Sir
IFRIC Draft Interpretation D25: Extinguishing Financial Liabilities with Equity Instruments
We are pleased to comment on the above Draft Interpretation (D25) on behalf of BDO International.
We agree that it is appropriate to issue guidance in the form of an IFRIC Interpretation to clarify the appropriate accounting approach for financial liabilities that are extinguished, in whole or in part, through the issue of an entity’s own equity instruments.
We agree that in principle, where an entity’s debt is renegotiated with a third party lender, being settled (in whole or in part) through the issue of the entity’s own equity instruments, a gain or loss should be recognised in the income statement. However, we believe that the measurement of the gain or loss should be obtained primarily through the fair value of the debt instrument (or part thereof) being extinguished, with the fair value of the equity instruments only being used where the fair value of the debt instrument cannot be reliably obtained. We acknowledge that this might not result in an approach which is converged with US GAAP. If the IFRIC considers it appropriate, we would not object to the issue of an interpretation with paragraph 5 as currently drafted.
We note that there are no specific matters raised for comment in the draft interpretation. Our detailed comments are set out in the attached Appendix.
We hope that our comments and suggestions are helpful. Should you wish to discuss any of them further, please contact either Tracey-Lee Massey at +32 2 778 0130 or Andrew Buchanan, our Global Head of IFRS, at +44 (0)20 7893 3300.
Yours faithfully
BDO Global Coordination B.V.
Appendix
Scope of the interpretation
Transactions with owners in their capacity as owners
Paragraph 6 of the draft interpretation indicates that in all cases, any difference between the carrying amount of the financial liability (or part thereof) and the initial measurement amount of the equity instruments issued in settlement should be recognised in profit or loss. However, we note that paragraph BC6 addresses the IFRIC’s consideration of whether guidance should be provided for situations where the creditor is also a shareholder.
By not addressing the topic within the interpretation itself, a reader might conclude that paragraph 6 requires all differences between the carrying amount of the financial liability (or part thereof) and the initial measurement amount of the equity instruments issued in settlement should always be recognised in profit or loss. We assume that this is not the IFRIC’s intention.
Consequently, we suggest that the scope of the interpretation specifically excludes transactions in situations in which the creditor is also a shareholder and is acting in its capacity as an owner.
Timing of the issue of equity instruments
In certain circumstances, it is possible that an entity which enters into a ‘debt for equity swap’ arrangement will either choose, or be unable, to issue the shares immediately. The latter might be due to restrictions over the amount of share capital that an entity is legally permitted to have in issue or the need for it to obtain shareholder approval. We note that, depending on the terms of such an arrangement, the currency in which the financial liability and equity instruments are denominated, and the entity’s functional currency, that some of these arrangements could result in an entity recording a derivative liability due to a failure to meet the ‘fixed for fixed’ criterion in IAS 32.
We believe that to address such arrangements would be likely to bring excessive complexity into the interpretation. We suggest that the scope of the interpretation is therefore restricted to circumstances where the contractual agreement between an entity and its creditor, and the issue by the entity of its equity instruments, take place at the same point.
Measurement of the amount at which equity instruments issued are recorded
Paragraph 5 of the draft interpretation could be taken as implying that there is an element of choice in determining the initial measurement amount of the equity instruments issued. We believe that the default approach should be to measure the fair value of the liability extinguished, as the elimination of part or all or the financial liability equates to the ‘good or service’ that is being received in exchange for the equity instruments. Only if the fair value of the financial liability (or part thereof) being extinguished cannot be measured reliably should the initial measurement amount be determined with reference to the fair value of the equity instruments themselves. We note that this approach is consistent with that set out in IFRS 2.10 and the discussion in paragraphs BC12 to BC14. We do not consider that the reference to IFRS 3 is as relevant, as one of the purposes of determining the fair value of equity instruments issued by the acquirer in a business combination is to determine the amount of goodwill to be recorded.
We suggest that paragraph 5 is redrafted to read:
‘An entity shall initially measure equity instruments issued to a creditor to extinguish all or part of a financial liability at the fair value of the equity instruments issued or the fair value of the liability extinguished, whichever is more reliably determinable. unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the liability (or part thereof) extinguished, the entity shall measure the equity instruments issued at their fair value.’
As noted in our covering letter, we acknowledge that this might not result in an approach which is converged with US GAAP. If the IFRIC considers it appropriate, we would not object to the issue of an interpretation with paragraph 5 as currently drafted.
Measurement where the financial liability being exchanged for equity instruments has a demand feature
IAS 39.49 notes that:
‘The fair value of a financial liability with a demand feature (eg a demand deposit) is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid.’
No reference to this guidance is included within either the draft interpretation or the basis for conclusions. We consider that such a reference should be included in any final interpretation as being a factor to consider when determining the fair value of the financial liability (or part thereof) that is extinguished.
Partial derecognition of a financial liability and reference to IAS 39.40
Paragraph 7 of the draft interpretation notes that if only part of a financial liability is extinguished by the issue of equity instruments, then the entity should follow the guidance in IAS 39.40 if the terms of the financial liability that remains outstanding are substantially different from those of the original financial liability.
It is not clear why the reference to guidance in IAS 39 is only in circumstances where there is a substantial modification. We suggest that the guidance in the interpretation is changed to require reference in all cases to the guidance in IAS 39.40, IAS 39.41 and IAS 39.AG62.
Copies of the draft Interpretation and our comment letter in .pdf format are attached below.