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

Introduction

Under IFRS 9, the recognition, measurement, and impairment 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 and impairment issues 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).

Impairment Issues Under IFRS 9

When an entity transitions from a going concern to a liquidation basis, it must also assess the impairment of its financial assets. Under IFRS 9, the expected credit loss (ECL) model is used to evaluate impairment. This model requires entities to consider forward-looking information and assess the probability of default, loss given default, and exposure at default.

Example 4: Trade Receivables

Going Concern Basis

A company has trade receivables of R800,000. Based on historical default rates and current economic conditions, the company estimates an ECL of 2%.

Calculation (Going Concern):

• Expected Credit Loss (ECL) = Trade Receivables * ECL Rate

• ECL = R800,000 * 2% = R16,000

• Carrying Value of Trade Receivables = Trade Receivables - ECL

• Carrying Value = R800,000 - R16,000 = R784,000

Liquidation Basis

Under liquidation, the company reassesses the credit risk of its customers. Due to the increased likelihood of default during liquidation, the ECL rate increases to 10%.

Calculation (Liquidation Basis):

• Expected Credit Loss (ECL) = Trade Receivables * ECL Rate

• ECL = R800,000 * 10% = R80,000

• Carrying Value of Trade Receivables = Trade Receivables - ECL

• Carrying Value = R800,000 - R80,000 = R720,000

Summary

• Carrying Value (Going Concern): R784,000

• Carrying Value (Liquidation Basis): R720,000

Adjustment Needed: Increase in impairment loss by R64,000 (from R16,000 to R80,000).

Example 5: Loan to Subsidiary

Going Concern Basis

A parent company has provided a loan of R1,000,000 to its subsidiary, which is expected to be repaid over 5 years. Based on the subsidiary’s financial health and repayment history, the parent company estimates an ECL of 3%.

Calculation (Going Concern):

• Expected Credit Loss (ECL) = Loan Amount * ECL Rate

• ECL = R1,000,000 * 3% = R30,000

• Carrying Value of Loan = Loan Amount - ECL

• Carrying Value = R1,000,000 - R30,000 = R970,000

Liquidation Basis

With the decision to liquidate, the parent company reassesses the credit risk of the subsidiary. Given the uncertainty and financial distress, the ECL rate increases to 15%.

Calculation (Liquidation Basis):

• Expected Credit Loss (ECL) = Loan Amount * ECL Rate

• ECL = R1,000,000 * 15% = R150,000

• Carrying Value of Loan = Loan Amount - ECL

• Carrying Value = R1,000,000 - R150,000 = R850,000

Summary

• Carrying Value (Going Concern): R970,000

• Carrying Value (Liquidation Basis): R850,000

Adjustment Needed: Increase in impairment loss by R120,000 (from R30,000 to R150,000).

Conclusion

The transition from a going concern basis to a liquidation basis under IFRS 9 significantly impacts the recognition, measurement, and impairment of financial liabilities and assets. The examples provided demonstrate how liabilities and impairments are adjusted to reflect their expected settlement amounts and increased credit risks during liquidation. 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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