In plain words
Sometimes a regulator tells finance companies to let customers skip some payments without charging more. That makes the loans worth less today, so the company records a loss. If the government or central bank pays the company back, often through cheap funding, that support is usually a government grant. The grant is recorded once the company is reasonably sure it will meet the conditions and receive it, and is matched to the costs it covers. The loss and the grant are shown separately.
Why it matters
In a crisis, regulators may require or encourage finance companies to defer instalments for individuals or SMEs without charging extra profit or interest, and a central bank or government body may compensate them, for example with interest-free deposits or direct payments. The deferral changes the loans' contractual cash flows and usually produces an immediate modification loss, while the compensation may be a government grant that is recognised on a different pattern. Netting the two, recording the compensation as a deposit at face value, or recognising the grant before its conditions are met all misstate profit and the carrying amounts of both loans and liabilities.
Diagnostic questions
Did the deferral change the contractual cash flows without additional profit or interest, so that the present value at the original effective interest rate fell? Is the modification substantial enough to cause derecognition, or is it a non-substantial modification? Is the compensating body a government, government agency or similar body, including a central bank acting under a public mandate? Is the compensation a direct payment, a deposit or funding at below-market rates, or a guarantee? What conditions attach to it, such as passing the benefit to customers, maintaining employment in SME borrowers or not charging fees, and is there reasonable assurance that they will be met? Has the deferral been considered in the SICR assessment without being treated as automatic evidence of it?
Recognition
- Assess whether the deferral is a modification of contractual cash flows; a deferral of instalments with no compensating profit or interest is usually a non-substantial modification that does not lead to derecognition.
- Recalculate the gross carrying amount as the present value of the modified cash flows at the original effective interest rate and recognise the difference as a modification loss in profit or loss.
- Assess separately whether the deferral, together with other information, indicates a significant increase in credit risk; a general, regulator-mandated deferral is not by itself evidence of SICR, but a borrower-specific request may be.
- Determine whether the compensating body meets the definition of government in IAS 20 and whether the compensation is a government grant.
- For a below-market deposit or funding, recognise the liability at fair value under IFRS 9; the difference between proceeds and fair value is the grant.
- Recognise the grant only when there is reasonable assurance that the conditions will be met and the grant will be received.
- Recognise grant income in profit or loss on a systematic basis over the periods in which the related costs it compensates are recognised; where the compensation relates to losses already incurred, recognise it when it becomes receivable.
- Present the modification loss and the grant income separately, without offsetting, unless a policy of netting the grant against the related expense is adopted and disclosed.
Measurement
The modification loss is the difference between the gross carrying amount before the deferral and the present value of the revised cash flows discounted at the original effective interest rate. A below-market deposit is measured initially at fair value, being the present value of the repayment discounted at a market rate for similar funding; the grant equals proceeds less fair value, and the deposit then accretes interest expense up to its repayment amount. A direct cash compensation is measured at the amount received or receivable.
Presentation & disclosure
Disclose: (1) the nature and extent of deferral programmes and the gross carrying amount of loans affected; (2) modification losses recognised in the period; (3) the accounting policy for government grants, the nature and amount of grants recognised and unfulfilled conditions or contingencies; (4) the terms of below-market funding received; (5) how the deferral was considered in staging and ECL, and any overlays applied; (6) the effect on interest income in subsequent periods.
Common mistakes
- Recognising no modification loss because the nominal amount owed is unchanged
- recognising the below-market deposit at its face amount, so that the grant is never identified
- netting the modification loss against the grant without disclosure
- recognising the whole grant immediately when it compensates costs that will be incurred over time
- recognising the grant before its conditions are reasonably assured
- treating every account in a mandated deferral programme as Stage 2, or none of them, without assessment
- recalculating the effective interest rate instead of recognising a modification loss
Simple example
Under a regulator's programme, a Riyadh finance company defers six months of instalments on SME and consumer loans with a gross carrying amount of SAR 500,000,000, with no additional profit. Discounting the revised cash flows at the original effective interest rates gives SAR 492,000,000, a modification loss of SAR 8,000,000. To compensate, the central bank places a one-year interest-free deposit of SAR 408,000,000 with the company, conditional on passing the deferral to customers without fees. The market rate for similar one-year funding is 2%, and the conditions are reasonably assured. The grant is recognised on the same basis as the loss it compensates. Fair value of deposit = 408,000,000 / 1.02 = SAR 400,000,000. Grant = SAR 8,000,000. Journal entries: Dr Modification loss (P&L) 8,000,000 Cr Financing receivables (gross carrying amount) 8,000,000 Dr Cash 408,000,000 Cr Deposit from central bank (amortised cost) 400,000,000 Cr Deferred government grant 8,000,000 Dr Deferred government grant 8,000,000 Cr Government grant income (P&L) 8,000,000 (Over the year, the deposit accretes SAR 8,000,000 of interest expense up to SAR 408,000,000, and the loans recover the modification loss as interest income at the original effective interest rate.)
Professional judgment
Judgment is needed on whether a central bank or a state-owned development fund is government for IAS 20 purposes, on whether the compensation is a grant or a commercial arrangement, and on the systematic basis for recognising the grant: matching it to the modification loss when that loss is the cost being compensated is common, but where the grant compensates future funding costs or is conditional on future conduct, deferral over the condition period may be more appropriate. The SICR assessment for borrowers in mandated deferral programmes also requires judgment, using information other than the deferral itself.
Source basis
IFRS 9 / IAS 20 · Financial Instruments / Accounting for Government Grants and Disclosure of Government Assistance
Paragraph references
Verified against the official standard texts used in the IFRS Expert skill.
Related issues
- IFRS 9Classification and measurement of financial assets (SPPI and business model test)
- IFRS 9Expected credit loss staging and significant increase in credit risk (SICR)
- IFRS 9Effective interest rate and amortization of loan fees and costs
- IFRS 9Accounting for modified and restructured loan facilities
- IFRS 9 / IAS 37Financial guarantees and loan commitments: ECL and provisioning
- IFRS 9Write-off and derecognition of uncollectible loans
Educational and navigation content only. Not professional advice. Does not reproduce official IFRS/IAS text. Consult the authoritative standards and qualified professionals; professional judgment may still be required.