Accounting for corporate finance: International Financial Reporting Standards: IAS 39: derecognition of financial liability
A financial liability should be removed from the balance sheet when, and only when, it is extinguished, that is, when the obligation specified in the contract is either discharged (for example, when a debt is repaid), cancelled (for example, a debt is released), or expires (for example, statutory limitation prevents a creditor pursuing a debt, or a written option expires without being exercised by the holder).
Where a debt between an existing borrower and lender is replaced by one with substantially different terms, or there has been a substantial modification of the terms of an existing financial liability, this transaction is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability.
Payment to a third party, including a trust (sometimes called ‘in-substance defeasance’), does not, by itself, relieve the debtor of its primary obligation to the creditor, in the absence of legal release.
The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed - in other words, the book profit or loss - must be recognised in the income statement.
In some cases, a creditor releases a debtor from its present obligation to make payments, but the debtor assumes a guarantee obligation to pay if the party assuming primary responsibility defaults. In this circumstances the debtor:
- recognises a new financial liability based on the fair value of its obligation for the guarantee; and
- recognises a gain or loss based on the difference between (i) any proceeds paid and (ii) the carrying amount of the original financial liability less the fair value of the new financial liability.