Rescheduling of debt is a modification in the terms of debt made by the mutual consent of lender and borrower. If a borrower is facing short term liquidity problems and is not able to pay the interest or loan installments, he can request the lender to restructure the future payments to give him some relief. For instance, defer the current installments in return for increased premium on redemption etc. If the lender agrees and both parties approve the modifications of the terms of debt, it means that the debt has been rescheduled. Consequently, future cash flows of rescheduled debt will be different from the future cash flows of original debt.
Let’s see how the rescheduling of debt is treated in accounting.
Whether an entity has a financial asset or a financial liability, after rescheduling, revised carrying amounts are calculated by discounting the revised future cash flows using the original effective interest rate. Revised carrying amount is compared with the carrying amount in the books of account, and the difference is charged to the statement of profit or loss. This adjusting entry will bring the carrying amount at amortized cost of revised future cash flows, and subsequent accounting will be done in the usual manner using the revised amortized cost table.
However, for financial liabilities, if the rescheduling of debt results in significant change in the carrying value of the financial liability i.e. more than 10%, the accounting will be different. In such cases, it is considered that the original liability is extinguished and is derecognized. A new financial liability is recognized with new effective interest rate. So, for financial liabilities, 10% test should also be done to evaluate whether rescheduling of debt should be considered as
- a modification of financial liability; or
- extinguishment of old liability and recognition of new liability.
Floating rate financial assets and financial liabilities
Estimates of future cash flows can also be changed without rescheduling of debt. Floating rate instruments derive their interest rates from the market interest rates, for e.g. an instrument having interest rate of LIBOR + 3%. In such cases, when the market interest rate changes, the instrument’s interest rate will also be changed as it is linked with the market interest rate. As a result, estimates of future interest payments will be revised.
Carrying amount is usually not adjusted because of the change in floating interest rate. An entity needs to calculate the revised effective interest rate at each reporting date. For subsequent accounting, revised amortized cost table is prepared using the revised effective interest rate and updated estimate of future cash flows.