IFRS 9 Financial Liabilities: Amortised Cost, Convertible Loans and Derecognition

Financial assets are the other side of the contract. A company that issues loan notes, takes a bank loan or issues convertible bonds has financial liabilities, and the amount shown depends on the interest method. An entity that sells or factors its receivables must decide whether the receivable has left the statement of financial position.

This topic covers the classification and measurement of financial liabilities, the effective interest method with issue costs and premiums, stepped and redeemable loan notes, compound instruments such as convertible loan notes, and the rules for derecognising financial assets and liabilities. The next topic covers expected credit losses.

The topic is examined directly. In May Diet, 2023, Question 5(b) asked for the amortised cost of a stepped bond at the end of each year (5 marks), and redeemable loan notes at an effective rate appeared in the compulsory question. In November Diet, 2025, Question 1 included the factoring of trade receivables. Read classification and measurement of financial assets first.

Classification and measurement

Financial liabilities are measured at amortised cost, except for liabilities at fair value through profit or loss: those held for trading, derivatives that are liabilities, and those designated at initial recognition to remove an accounting mismatch or because a group is managed on a fair value basis. Financial guarantee contracts and loan commitments have specific rules.

At initial recognition a financial liability is at fair value, less transaction costs directly attributable to its issue unless it is at fair value through profit or loss. The fair value of a loan is usually the proceeds. Transaction costs such as arrangement and legal fees therefore reduce the initial carrying amount.

Amortised cost and the effective interest method

The effective interest rate is the rate that exactly discounts the estimated future cash payments over the expected life of the liability to its initial carrying amount. Each period:

1. Finance cost = opening carrying amount × effective rate, in profit or loss.
2. Closing carrying amount = opening + finance cost − cash paid (the coupon).

If the coupon is lower than the finance cost, the carrying amount rises towards the amount to be repaid. The difference arises from issue costs, a discount, a premium on redemption or a stepped coupon.

A stepped bond

A stepped bond pays a coupon that changes over time, but the effective rate is a single rate that spreads the total cost evenly. A company issues ₦8,000,000 of bonds at par, repayable at par after four years, with coupons of 4% for two years and 6% for two years (₦320,000 then ₦480,000 a year). The effective rate is 4.95171%.

The year 4 finance cost is the balancing figure that brings the carrying amount back to the redemption amount of ₦8,000,000, with the repayment of principal then clearing the liability.

Issue costs and premiums on redemption

Issue costs reduce the initial carrying amount, so the effective rate is above the coupon rate. A company issues ₦5,000,000 of 6% loan notes at par, repayable at par after three years, and pays issue costs of ₦100,000. Net proceeds are ₦4,900,000. The effective rate is 6.7587%, so the finance cost in year 1 is ₦4,900,000 × 6.75875% = ₦331,179 and the closing carrying amount is ₦4,900,000 + ₦331,179 − ₦300,000 = ₦4,931,179. In year 2 the finance cost is ₦333,286 and the carrying amount ₦4,964,465.

A premium on redemption works the same way: the extra payable at the end is accrued over the life through a higher effective rate.

Compound instruments

A compound instrument contains both a liability and an equity component, for example convertible loan notes that the holder may convert into a fixed number of shares.

The issuer splits it at issue: the liability component is the fair value of a similar liability without a conversion option, found by discounting the cash flows at the market rate for such debt, and the equity component is the residual, the proceeds less the liability. The equity component is not remeasured later. The liability is then carried at amortised cost, accruing finance cost at the market rate used.

An entity issues ₦10,000,000 of three-year 5% convertible loan notes. The market rate for similar debt without conversion is 8%. The liability is ₦500,000 × 2.5771 + ₦10,000,000 ÷ 1.08³ = ₦1,288,548 + ₦7,938,322 = ₦9,226,871. The equity component is ₦10,000,000 − ₦9,226,871 = ₦773,129. Year 1 finance cost is ₦9,226,871 × 8% = ₦738,150, so the liability is ₦9,226,871 + ₦738,150 − ₦500,000 = ₦9,465,021. Year 2 finance cost is ₦757,202 and the liability ₦9,722,223. At maturity the liability reaches ₦10,000,000.

Derecognition

Financial assets

An entity derecognises a financial asset when the contractual rights to the cash flows expire, or when it transfers the asset and the transfer qualifies. A transfer qualifies when the entity transfers the contractual rights, or retains them but is obliged to pass the cash on, and substantially all the risks and rewards of ownership are transferred.

If substantially all are retained, the asset stays on the statement of financial position and the cash received is recognised as a liability. Where neither is true, control decides. On derecognition, the gain or loss is the difference between the carrying amount and the consideration received, in profit or loss.

The standard case is factoring of receivables. A company factors ₦10,000,000 of receivables and receives ₦9,000,000. If the sale is without recourse, the risks and rewards (including bad debts) pass to the factor, so the receivables are derecognised and the loss of ₦1,000,000 is expensed.

If it is with recourse, the company must reimburse the factor for bad debts, so it keeps the risks, does not derecognise, records a liability of ₦9,000,000 for the advance, and recognises the ₦1,000,000 as a finance cost over the period until collection.

Financial liabilities

A financial liability is derecognised when it is extinguished: the obligation is discharged, cancelled or expires. The gain or loss is the carrying amount less the consideration paid, in profit or loss. If a debt is exchanged for debt on substantially different terms, or the terms are substantially modified (a 10% test on present values), it is treated as an extinguishment of the old liability and recognition of a new one.

The ideas in more depth

Why issue costs raise the effective rate

The entity receives less than the amount it will repay. The effective rate spreads that shortfall over the life as extra finance cost, so the full cost of borrowing is recognised, not just the coupon.

Why the liability is valued first in a compound instrument

The debt part can be valued by reference to the market. The conversion right has no independent price, so it takes whatever is left. This stops an entity from showing more equity and less debt than the facts support.

Sources and references

• International Financial Reporting Standard (IFRS) 9 Financial Instruments: classification and measurement of financial liabilities, effective interest, derecognition of financial assets and liabilities.
• International Accounting Standard (IAS) 32 Financial Instruments: Presentation, for compound instruments.

These points are stated as at 5 November 2026.

Worked examples

1. Liability.
   Interest ₦500,000 × 2.5771 = ₦1,288,548; redemption ₦10,000,000 × 0.7938 = ₦7,938,322; total ₦9,226,871.
2. Equity.
   ₦10,000,000 − ₦9,226,871 = ₦773,129.
3. Year 1 finance cost.
   ₦9,226,871 × 8% = ₦738,150; closing liability ₦9,465,021.

1. Without recourse. Derecognise the receivables: Dr Cash ₦9,000,000, Dr Loss ₦1,000,000, Cr Receivables ₦10,000,000.
2. With recourse. Keep the receivables; Dr Cash ₦9,000,000, Cr Liability ₦9,000,000. The ₦1,000,000 is a finance cost.

1. Net proceeds.
   ₦5,000,000 − ₦100,000 = ₦4,900,000.
2. Finance cost.
   ₦4,900,000 × 6.75875% = ₦331,179.
3. Closing.
   ₦4,900,000 + ₦331,179 − ₦300,000 = ₦4,931,179.

How to answer in the exam

• Draw the amortised cost table. Opening, finance cost at the effective rate, cash paid, closing for every year, and check that the last year closes at the redemption amount.
• Use the effective rate, not the coupon, for the finance cost.
• Split a compound instrument. Liability first, equity as the balance.
• Derecognition. Say whether risks and rewards pass, then give the entries.

Common mistakes in the exam

• Charging only the coupon to profit or loss.
• Ignoring issue costs when calculating the carrying amount.
• Discounting a convertible loan at the coupon rate instead of the market rate for similar debt without the option.
• Remeasuring the equity component.
• Derecognising receivables factored with recourse.
• Forgetting to adjust the finance cost in the last year so the liability reaches the redemption amount.

Quick revision

• Liabilities: amortised cost; fair value through profit or loss for trading, derivatives, designated.
• Finance cost = opening × effective rate; closing = opening + cost − cash.
• Compound: liability = present value at the market rate without the option; equity = balance.
• Derecognise an asset when rights expire or risks and rewards pass; a liability when extinguished.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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