034: How to account for financial guarantees under IFRS 9?
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IFRS Question 034: How to account for financial guarantees under IFRS 9?
Hi Silvia, we have a subsidiary in a foreign country and the subsidiary needed to take a loan.
The bank provided a loan, but we, the parent company, had to guarantee that we would pay the debt in case if our subsidiary fails to pay.
Our auditors say that we have a financial guarantee under IFRS 9 and we should account for it. But how?
Also, we issued a general guarantee to support our subsidiary in case of the negative equity – should we also account for this guarantee?
IFRS Answer 034: What is a financial guarantee?
IFRS 9 Financial Instruments defines the financial guarantee as a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payments when due in accordance with the terms of a debt instrument.
Therefore yes, you have an issued financial guarantee contract here because you as a parent agreed to reimburse lending bank just in case your subsidiary cannot pay.
And yes, your auditors are right – you have to account for this guarantee somehow.
Before I explain how, let’s take a look at the general guarantee to support your subsidiary in case of negative equity.
This is NOT a financial guarantee under IFRS 9, because it is NOT specific, you have no specific payments to make and this type of guarantee can cover pretty much anything on top of the debts.
Financial guarantees: Initial recognition and measurement
Initially, you need to recognize an issued financial guarantee at fair value.
That’s the basic measurement rule in IFRS 9.
What’s the fair value of such a guarantee?
It depends so let me give you a few hints.
Normally, when you issue a financial guarantee to the third party, not intragroup, then you would charge some premium for the guarantee, some fee for issuing that guarantee – and in this case, that would be the fair value of it.
Often, the guarantee is issued intragroup at no fee, like in today’s question.
In this case, we have to apply some alternative methods in line with IFRS 13 Fair value measurement.
For example, you can measure the benefit for the debtor as a result of that guarantee.
What interest rate does the debtor pay with the guarantee?
And, what interest rate would the debtor pay without the guarantee?
If the debtor pays 5% with the guarantee and the market interest rate on unguaranteed loans is 6%, then the fair value of the guarantee is the present value of the difference in interests charged on guaranteed and unguaranteed loans.
What are the journal entries?
Just as a short illustration, let’s say that you received a premium of CU 1 000 for issuing a financial guarantee for 5-year loan. The journal entry is:
- Debit Cash: CU 1 000;
- Credit Liabilities from financial guarantees: CU 1 000.
If you haven’t received any premium, then you:
- Debit Profit or loss: The fair value of your guarantee;
- Credit Liabilities from financial guarantees: The fair value of your guarantee
.
Financial guarantees: Subsequent measurement
First of all, you need to amortize the amount of your financial guarantee in line with IFRS 15 Revenue from Contracts with Customers.
In most cases, you would do it straight-line over the term of the loan.
And then, IFRS 9 prescribes to measure the financial guarantees at the higher of:
- The loss allowance determined as expected credit loss under IFRS 9 and
- The amount initially recognized (fair value) less any cumulative amount of income/ amortization recognized in line with IFRS 15.
Here, you have the challenge to determine the expected credit loss on the amount borrowed by your subsidiary.
So you would need to:
- Determine at which stage the loan of your subsidiary is – stage 1, 2, 3; and then
- Calculate the expected loss allowance as either 12-month expected credit loss or lifetime expected credit loss depending on the stage of the loan.
I wrote a few articles about expected credit loss on my website, there are nice explanations of ECL inside my IFRS Kit, so you might want to check that out.
On the other hand, you need to compare the amount of the expected credit loss with the carrying amount of your financial guarantee – which would be the initial fair value less any amortization:
- If the ECL is lower than the carrying amount, then you are all fine.
- If the ECL is higher than the carrying amount, then you need to revalue the financial guarantee and book the remeasurement in profit or loss.
Illustration: Subsequent measurement of financial guarantees
Let’s get back to our financial guarantee of CU 1 000 on 5-year loan.
You would amortize it straight-line over 5 years (just for simplicity) and the entry would be:
- Debit Liabilities from financial guarantees: CU 200 (1 000/5);
- Credit Profit or loss – Income from financial guarantees: CU 200.
Then you would need to determine the expected credit loss on the loan that you back up.
Let’s say the loan is OK, no significant increase in credit risk, so the expected credit loss is CU 500 (just making this up).
Your carrying amount is CU 800, the ECL is 500, so you keep measuring the financial guarantee at 800 as this amount is higher.
If the ECL on the loan is let’s say CU 1 200, then you would need to book the difference of 400 (which is ECL of 1200 less carrying amount of 800) in profit or loss.
Any questions or comments? Please let me know below. Thank you!
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52 Comments
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Hi Silvia,
Thankyou for making this podcast on Financial Guarantee.
However, I have one question.
Should we account for a performance bank guarantee that a bank has provided on our behalf to another company. Or should it be only recorded by the bank as financial guarantee and we shall only make disclosure of the same?
Hi Suman,
well, performance bank guarantees, in other words – performance bonds are contracts that meet the definition of the insurance contract under IFRS 4, so they should be accounted for under IFRS 4.
Dear Silvia, In the above example, after writing off 400 in profit or loss, does it follow that the “Liabilities from financial guarantee” will then come to 1200, and if so, shall we amortize 1200 over three years, assuming that the write-off of 400 occurred at the end of the second year, and that there are three more years for the loan to go before its full repayment?
Hi Edmund, no, you need to compare original amount of 1 000 amortized to date and ECL at the reporting date.
Hi Silvia
Thanks for clarifying on the accounting of financial guarantees. If there is no fee charged to the subsidiary company and also if the subsidiary company has not received any benefits in interest rates I.e. there is difference between market interest rate and interest rate on loan issued financial guarantee. So in that will the fair value of the guarantee considered to be Nil?
What will be the accounting treatment in this case?
Then you must propose some alternative way of setting the fair value of a guarantee. That’s another topic though. S.
Hi Silvia,
Do you have worked examples how a financial services company would account for disposal of a portfolio for performing and non performing loans in the financial statements?
I agree that that would be very beneficial example, with alternatives if the purchase price of nonperforming loan’s portfolio is above/below carrying amount of the portfolio itself
Dear Sylvia,
my company has a financial liability (loan) for which the assignment agreement has been signed, in which is specified that our customer will repay the bank loan in the name of the name of our company: The bank accepted our receivables for the repayment of the loan, so we assumed we are legally released from this obligation and recognized the original debt. We took over the However, if our customer does not pay when due the bank may seek payment from us. We got the bank confirmation, on which it stands that we are still the debtors, and not the customer on which are debt was assigned to (the bank accepted the assignment). so we are very confused what to do now.
We did not recognize any financial guarantee.
Kind regards,
As per my view, the continuing involvement provisions will be applicable in such case.
Dear Sylvia,
I am currently involved in an IFRS 9 implementation project at a bank. Basis of our discussion with our consultants and auditors, I have noted that after applying the IFRS 9 provisioning concepts, our provisions under IFRS 9 has actually decreased compared to the regulatory guidelines specified by central bank/IAS 39, since we were required to comply with very stringent local provisioning policies.
I would appreciate your advice on how we can account for the ‘gain’ upon transition as currently all literature direct us to decrease in the retained earning, upon adoption of IFRS 9
1. Should we credit ‘all gains to our retained earnings only?
2. Can we credit to retained earnings subject to a limit (based on regulatory guidance) and allocate rest to non-distributable equity reserves?
3. What will be the deferred tax impact?
4. Any other adjustments required.
I would appreciate any guidance from you on the above issues.
Thanks.
Dear Cheshma,
this is off topic, please write me a message via my Contact form. S.
Provision based on IFRS 9 or provision based on local law, whichever is higher is to be considered for FS. Disclosures and calculations have to be substantiated.
In any case, all the other points would not arise.
Hope this clarifies.
Hello Hari KV,
I am also working on bank IFRS 9 and will need little bit advise.
Hi Zahir, sorry, we do not share personal numbers here to protect your privacy. We have our online advisory service https://www.cpdbox.com/my-helpline/ where we can give the professional advice to you and also, within a short time, all IFRS Kit subscribers will have the option to discuss inside the IFRS Kit with other users. S.
Hi
When the guarantee in on continuous Over Draft facility would the subsequent measurement be PVTPL.
Hi Silvia,
Good day!
How will be the accounting treatment in the books of the debtor, if it is the other way around, that is, the financial guarantee contract was issued to a non-related party? Please see details below:
> Hermes covered
> Bank pays the guarantee premium to Hermes
> The guarantee premium may be used to pay the loans
HI Silvia,
The Company has provided a guarantee with 0 premium, but with monthly scheduled payment, which starts from the next month after signing the guarantee contract. Do this mean that at initial recognition the FV of my guarantee is equal to 0 and the ECL should totally recognized in my P&L.
Hi Silvia
I have a company that obtained a loan from a bank to purchase some shares in a listed company.
The shares form a pledge to the loan facility provided by the financial institution. Does this relate to financial guarantees? If not is there any specific accounting treatment for this pledge?
thank you in advance,
Hi Silvia,
If the financial guarantees provided by the Head Office Parent A to Subs B which lend money to Subs C (Subs B & C is 100% owned by Parent A), from Parent A consolidation financial statements, do we need to accounted the financial guarantees ?
Thanks in advance.
Well, since these are guarantees without involving any party within the group, then as an intragroup transaction the loans will be eliminated, the same as the guarantees themselves.
I am a parent provides guarantee to my subsidiaries on revolving credit, term loan and bridging loan. For example, I am providing guarantee of 100mil to my subsidiaries but, my subsidiaries might not be utilizing all the guarantee amount when the contract is issue. In this case, how should I measure the FV of the financial guarantee contract? Should it be based on utilization of the guarantee only? Or it should be based on full guarantee amount regardless of whether subsidiaries utilize the guarantee?
if I am charging fees to the subsidiaries based on the utilized portion only, does that means the FV of the liability should be based on the utilized portion only and not the full amount as the liability that I actually have is not the full guarantee amount but only the utilized portion by subsidiaries.
Hi SIlvia,
In this case I have doubts about the opposite case.
The financial entity has in its assets a sovereign debt instrument , and enters into a CDS contract with a financial entity for the same nominal and the same maturity of this bond.
At the beginning of 2018 on the basis of IFRS 9, the bond is recorded in the trading portfolio and the CDS aswell,
At the beginning of 2019 we want to apply to the CDS the accounting as financial guarantee under IFRS 4 and change the debt instrument of the trading portfolio to amortized cost.
Could you please confirm if it is possible to make this change at the beginning of 2019? In case the change can be made, how should I account for the derecognition of the CDS balance sheet to include it in off-balance sheet?
Hi Silva,
Thanks for the information. In case if it is a SME company assisting another SME company. How will it be recognised from the side of the assisting SME company.
Hello Silvia, let’s say the parent company charges a guarantee fee to its subsidiary, How does the Parent company accounts for the FCG under IFRS?
Thanks in advance,
Alfred
Hello Silvia,
what will be the accounting entry for Claim settlement against Performance Guarantee provided to Customer? the Performance Guarantee was claimed due to contract is canceled on the last stage of the project. Please advise which account I should account the claim settlement amount.
Thanks in advance.
Hello Silvia, what about the case of the subsidiary? they have to account the finance guarantee?
Hi Silvia,
Based on your example above on the parent providing a financial guarantee to its subsidiary for the bank loan, what happens to the capital contribution leg upon derecognition of the financial guarantee when the bank loan has been repaid by the subsidiary? It is measured in accordance with IAS 27 and IAS 37?
The capital contribution amount in the separate financial statements of the parent relating to investment in subsidiary can grow significantly if the subsidiary makes new borrowings, subject to impairment requirements? Would this make sense?
Hi Silvia,
If our company owner is providing a guarantee from his personal account (Bank just only pledge his account for guarantee amount but not take any cash margin) to get and performance bond for company’s project how we will record this in our financials.
Hi Silver
What if a parent issues a guarantee to a bank for a loan issued to a subsidiary. But in the event of default no cash will flow but the bank will be reimbursed using the shares the parent holds in the subsidiary. I.E if a loss of 100 is incurred by the bank the parent will give shares equivalent to 100 if value of shares is lower no top up is required. Will this meet IFRS 9 requirements especially the “specified payment” requirement ?
Hello Silvia
Which one of the following is a trigger to give a rise for financial guarantee liability: signing a guarantee agreement with the bank or drawing down loan? Sometimes these two events take place in different quarters. Should we recognize the liability right after signing a guarantee agreement with the bank or should we wait for the loan disbursement?
Hi Selvia,
I am facing a case where foreign currency exchange is involved.
Appreciate if you can advise which exchange rate ( at inception historical exchange rate , or current exchange rate each quarter) shall be used on quarterly base to amortize financial guarantee
Hi. Silvia
We asked from Bank to issue Guarantee to our supplier and we keep fixed deposit with bank to cover those bank guarantee . How can we do the accounting in our books.
Hi Silvia,
How would we classify a loan guaranteed by parent? Is it secured or unsecured from point of view of separate financials of subsidiary and from point of view of consolidated financials statement?
Thanks
Hari
Hi Silvia,
Thanks for this incredible platform. I have a scenario where a client has purchased a bond that it tied to claims that may arise from customers in their day to day business. The bond does not attract any interest. After six months they renew the bond. How should this be accounted for in the financial statements?
Samuel, as the bond is tied to claims from customers, it implies that the cash flows from the bond are not solely payments of principal and interest, so in my opinion, the bond does not meet 2 tests for classifying at amortized cost and thus must be carried at fair value through profit or loss. However, the mechanics of the bond are unclear to me, so I cannot really say (but I assume it is an asset). It seems that you would simply recognize modification gain or loss from the bond at the point of its modification and then continue recognizing it at FVTPL.
Thanks Silvia. The client is in the engineering business. The bond was purchased in case their customer makes any claims for work they did. So after every six months when no claims were made the bank just issues a new bond certificate to them with the same amount.
Hello Silvia, Thank you for the amazing article.
Suppose, do you have any guidance for treatment in the books of Subsidiary for financial guarantee given free of cost by holding company to a bank as a part of loan agreement with the bank? Like, subsidiary needs to account the fair value of financial guarantee as “Other equity” and a corresponding notional asset to be created and amortised over the period of the loan. Is it mandatory to record these transactions to create a mirror image?
Well I don’t think that the received financial guarantee creates a financial asset.
Hi Silvia,
Does that mean a subsidiary having a bank loan with guarantee from its holding company is not required to recognise anything in its book?
Definitely it does not mean that. Subsidiary definitely must recognize a bank loan.
Hi Sylvia. Thanks you for the great article. I have a few questions on financial and general guarantees:
1. Is the day one fair value and subsequent measurement (higher of FV and ECL) applicable to general guarantees or is the measurement approach different?
2. For intra-group guarantees issued to prevent negative equity and where the guaranteed amount is unknown and where the party receiving any amounts is the subsidiary and not a 3rd party and, how is the guarantee calculated? In this case, there are no known cash flows but just a contract between a parent and subsidiary stating that the parent will support the subsidiary to prevent negative equity.
3. In the case of financial guarantees, to calculate the guarantee, does one need to consider the credit risk of the guarantor and if one needs to how should this be done?
Thanks you.
Joe C
Good Day Silva, thanks for your simplified explanation as always. We have an arrangement where a subsidiary was set up to raise bond on behalf of other subsidiaries and the parent company and the subsidiary will then lend the proceeds to the related entities(including the parent) under terms that seek to mirror the terms of bond raised by the subsidiary with bond investors. The subsidiaries and the parent then provided a financial guarantee to the bond investors. How do you account for that financial guarantee given the scenario.
thanks .. Silva
Hello, I work in a bank and as per IFRS9 it is required to recognize ECL for different debt instruments including the financial guarantees we issued for our customers. My question is The guarantees are not off balance product and pricing is commission based – for example charge the customer 2% quarter commission. How can i calculate the EIR (Effective Interest Rate ) for it ?
Hi Rany,
well, financial guarantees are in fact your liabilities (if you issue them for your clients), not assets. So technically speaking, you are not recognizing ECL on financial guarantee. I assume that what you need to do is to recognize financial guarantee at the amount higher of its carrying amount (which should be its initial amount less accumulated amortization in line with IFRS 15) AND ECL on receivables/loans that you are guaranteeing. So you should be looking at underlying receivables/loans of your customers to calculate ECL on them in order to value your own guarantee (liability). I hope I understood the situation well and if you need more info, I have the full example and explanation in the IFRS Kit. Best, S.
We would like to discuss for our Capital Repayment Financial Guarantee Bond procurement with the consultant of IFRS 15 who probably has better understanding and conversant with the process.
Thank you for your anticipated co-operation and I look forward to your immediate response.
file:///C:/Users/DrZai/Downloads/WISE%20PACIFIC%20AGREEMENT%20SIGNED%20COPY%20DR%20ZAIN.pdf
Hi. I am working for a Tourism Development Fund. Part of our operations requires providing guarantees to Banks to finance the SMEs mainly for long-term loans. We will be charging a fee from the bank/customer for the same. So I understand that here the treatment would be similar as in the case of financial guarantee you explained above. However, I do not understand the ECL side of the same and recording the higher of ECL or carrying value.
Hi Syed, in general you are right, it seems that your guarantees issued would be financial liabilities. So if you provide a guarantee, you must watch the loan that you are backing up, i.e. the loan of that SME company. Is that SME company paying on time? Does it have any credit risk? You need to try to estimate ECL on that loan, because this is your risk, so yes, you must closely work with the debtor and monitor the loan.
HI Silvia,
if we received Performance bond/standby LC from a customer which covers the total credit exposure for that customer, shall we exclude it from the Aging while ECL calculation ? if it covers 50% only from the Aging for that particular customer, shall we include only the remaining 50% ? we are following the simplified approach.
Hi Silvia,
When the board of directors adopted a resolution accepting an investment banker’s offer to guarantee the marketing of $100 million of preferred shares of a company. This event is a non-adjusting event as it was suggested by the bank 2 months after the year-end. so what would be the impact/analysis of this event on the company’s financial statement?
Thank you,
Amir
Hi Silvia,
When the entity choices to designates the financial guarantee issued to fair value to through of profit and loss, does the entity continue amortize the guarantee and after “revaluate” it at end of period?
Thanks. Very good article!