Quantitative Examples: Change from Going Concern to Liquidation Basis for Liabilities Under IFRS 9

Introduction

Under IFRS 9, the recognition and measurement of financial liabilities can significantly change when an entity transitions from a going concern to a liquidation basis. This report provides three quantitative examples to illustrate how the recognition and measurement of financial liabilities change during this transition.

Example 1: Corporate Bond

Going Concern Basis

A company has issued a corporate bond with a face value of R5,000,000, an annual coupon rate of 6%, and a maturity of 5 years. The bond is measured at amortized cost. The company pays interest annually.

Calculation (Going Concern):

• Annual Interest Expense = Face Value * Coupon Rate

• Annual Interest Expense = R5,000,000 * 6% = R300,000

• Present Value of Remaining Interest Payments (for 3 years) = R300,000 / (1+6%) + R300,000 / (1+6%)^2 + R300,000 / (1+6%)^3 = R772,368

• Present Value of Principal Repayment (Discounted at the bond’s effective interest rate) = R5,000,000 / (1+6%)^3 = R4,198,059

• Carrying Value (Going Concern) = Present Value of Interest Payments + Present Value of Principal Repayment

• Carrying Value = R772,368 + R4,198,059 = R4,970,427

Liquidation Basis

Upon deciding to liquidate, the company needs to settle the bond immediately. The early redemption penalty is 3% of the outstanding principal.

Calculation (Liquidation Basis):

• Early Redemption Penalty = Outstanding Principal * Penalty Rate

• Early Redemption Penalty = R5,000,000 * 3% = R150,000

• Total Settlement Amount = Outstanding Principal + Early Redemption Penalty

• Total Settlement Amount = R5,000,000 + R150,000 = R5,150,000

Summary

• Carrying Value (Going Concern): R4,970,427

• Liquidation Value: R5,150,000

Adjustment Needed: Increase in liability recognition by R179,573 (from R4,970,427 to R5,150,000).

Example 2: Bank Loan

Going Concern Basis

A company has a bank loan of R3,000,000 with an annual interest rate of 4%, payable over 10 years. The loan is initially recognized at fair value and subsequently measured at amortized cost. The company pays interest annually.

Calculation (Going Concern):

• Annual Interest Expense = Principal Amount * Interest Rate

• Annual Interest Expense = R3,000,000 * 4% = R120,000

• Present Value of Remaining Loan Payments (Discounted at the loan’s effective interest rate):

For simplicity, assume the loan is interest-only with a balloon payment at the end.

Liquidation Basis

Upon deciding to liquidate, the company needs to settle the loan immediately. The early repayment penalty is 2% of the outstanding principal.

Calculation (Liquidation Basis):

• Outstanding Principal Amount = R3,000,000 (assuming no principal payments yet, for simplicity)

• Early Repayment Penalty = Outstanding Principal * Penalty Rate

• Early Repayment Penalty = R3,000,000 * 2% = R60,000

• Total Settlement Amount = Outstanding Principal + Early Repayment Penalty

• Total Settlement Amount = R3,000,000 + R60,000 = R3,060,000

Summary

• Carrying Value (Going Concern): Present value of remaining payments (e.g., R2,800,000 after discounting)

• Liquidation Value: R3,060,000

Adjustment Needed: Increase in liability recognition by R260,000 (from R2,800,000 to R3,060,000).

Example 3: Trade Payables with Early Settlement Discounts

Going Concern Basis

A company has trade payables amounting to R1,000,000, due in 60 days. The payables are recorded at their nominal amount as the company expects to settle them in the ordinary course of business.

Calculation (Going Concern):

• Carrying Value = R1,000,000

Liquidation Basis

In liquidation, the company negotiates an early settlement of these payables with suppliers, offering a 5% discount for immediate payment.

Calculation (Liquidation Basis):

• Early Settlement Discount = Payables Amount * Discount Rate

• Early Settlement Discount = R1,000,000 * 5% = R50,000

• Total Settlement Amount = Payables Amount - Early Settlement Discount

• Total Settlement Amount = R1,000,000 - R50,000 = R950,000

Summary

• Carrying Value (Going Concern): R1,000,000

• Liquidation Value: R950,000

Adjustment Needed: Decrease in liability recognition by R50,000 (from R1,000,000 to R950,000).

Conclusion

The transition from a going concern basis to a liquidation basis under IFRS 9 significantly impacts the recognition and measurement of financial liabilities. The examples provided demonstrate how liabilities are adjusted to reflect their expected settlement amounts during liquidation, including any penalties, discounts, or accelerated settlement obligations. These adjustments ensure that financial statements provide a true and fair view of an entity’s financial position during liquidation, complying with the principles of IFRS 9.

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