How Green Bonds and Sustainability-Linked Instruments Are Accounted for under IFRS 9/IAS 32 and US GAAP

Green bonds and sustainability-linked instruments channel financing toward environmental or KPI-based outcomes while preserving debt-like economics. From an accounting standpoint, the use of proceeds or ESG performance clauses rarely change the fact that these are financial liabilities; what changes is how cash-flow features are analyzed, whether any embedded derivatives exist, and which disclosures are required. Under IFRS (IFRS 9, IAS 32, IFRS 7, IAS 20) and US GAAP (ASC 470, ASC 815, ASC 835-30, ASC 480, ASC 450/958), the issuer focuses on classification and measurement of the liability, effective interest calculations, and transparent narrative of ESG covenants and KPI mechanics.

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How green bonds and sustainability-linked features arise.

Green bonds earmark proceeds for eligible projects (renewables, energy efficiency, clean transport). Sustainability-linked bonds (SLBs) retain general corporate use of funds but link coupons or redemption amounts to achieving predefined Sustainability Performance Targets (SPTs) measured by Key Performance Indicators (KPIs) (e.g., Scope 1–3 emissions intensity, renewable share, water usage).

These features create contingent cash-flow outcomes (step-ups/step-downs, one-off premia, or redemption adjustments) that must be evaluated under the host debt contract to determine whether they are closely related to the host or require bifurcation (under IFRS 9 and ASC 815) and how to compute the effective interest rate (EIR) if measured at amortized cost.

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Measurement of green bonds under IFRS.

Use-of-proceeds constraints do not alter liability classification. The bond is typically a financial liability at amortized cost under IFRS 9, with IAS 32 confirming liability presentation (unless equity-like terms exist, which is uncommon).

Initial recognition (issue at par): measured at fair value of consideration received net of transaction costs, with subsequent measurement at amortized cost using the effective interest method. The environmental earmarking is a contractual covenant that does not itself re-measure the liability unless failure triggers contractual changes in cash flows (e.g., coupon step-up).

Example (IFRS — green bond, par issue 10,000,000 at 4% coupon; costs 100,000):

• Debit: Cash 9,900,000

• Debit: Deferred Issue Costs (contra liability) 100,000

• Credit: Green Bond Liability 10,000,000

Amortize issue costs through EIR within Finance Costs over the term. The mapping of proceeds to projects is addressed through disclosures; if the issuer receives government incentives or grants tied to the green program, IAS 20 policies apply separately (recognize grant income systematically as related costs are incurred or deduct from asset cost, per policy).

Coupon step-ups for use-of-proceeds breaches: if the contract specifies a higher coupon until remediation, the liability remains at amortized cost with a revised EIR when the change becomes effective, unless analysis indicates an embedded derivative that is not closely related, requiring separation and fair value through profit or loss.

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Measurement of sustainability-linked bonds under IFRS.

SLBs embed non-financial performance clauses that can change the timing or amount of cash flows (e.g., +25 bps coupon if SPT missed; -10 bps if SPT achieved). Under IFRS 9 for issuers:

1. Identify the host (debt).

2. Assess embedded features. If a feature is not closely related to the host debt’s basic lending arrangement (e.g., cash flows vary with an ESG KPI that is not a typical credit-risk or time-value variable), bifurcate and measure the embedded derivative at fair value through P&L.

3. If the feature is considered closely related (e.g., a de minimis “penalty” meant to compensate for risk, transparently indexed and economically akin to a pricing adjustment), the whole instrument can remain at amortized cost, with the EIR updated when the step actually triggers.

Illustrative path (IFRS — SLB with SPT step-up at year 3):

• At issuance, management concludes the step-up is closely related (modest range, lending-like pricing). Entire liability at amortized cost.

• At the SPT test date, the KPI is missed, triggering +50 bps. Management revises the EIR prospectively and recognizes catch-up through the EIR recalculation (IFRS 9 B5.4.6 for changes in estimated cash flows).

If not closely related:

• Separate an embedded derivative liability at FVTPL on day 1.

• Subsequent changes in the derivative’s fair value go to profit or loss; the host debt remains at amortized cost.

Journal entries (IFRS — bifurcated case, at inception):

• Debit: Cash 10,000,000

• Credit: Host Debt (Amortized Cost) 9,850,000

• Credit: Embedded Derivative (FVTPL) 150,000

Subsequent period-end (derivative increases by 40,000):

• Debit: Loss on Embedded Derivative 40,000

• Credit: Embedded Derivative 40,000

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Measurement under US GAAP (green bonds and SLBs).

Under US GAAP, the issuer evaluates debt under ASC 470 and potential embedded derivatives under ASC 815. The liability is generally recorded at amortized cost unless (i) the issuer elects the fair value option (ASC 825) or (ii) an embedded derivative requires bifurcation and fair value measurement.

Use-of-proceeds covenants do not change the accounting for the debt; they are addressed via disclosures and potentially contingencies (ASC 450) for penalties. If government incentives are received, consider ASC 958-605 (for not-for-profit) or policy analogs (many for-profits present as other income or reduction of related costs in line with a consistent policy).

SLB step-ups/step-downs:

• Analyze under ASC 815-15 whether the coupon feature is an embedded derivative that is not clearly and closely related to the debt host. If so, bifurcate and measure at fair value through earnings.

• If clearly and closely related (e.g., a credit-risk indexed step-up), the entire instrument remains at amortized cost; coupon changes are handled through yield adjustments under ASC 835-30.

Journal entries (US GAAP — SLB, embedded derivative bifurcated):

• Debit: Cash 10,000,000

• Credit: Long-Term Debt (ASC 470) 9,860,000

• Credit: Embedded Derivative Liability (ASC 815) 140,000

At period-end, derivative fair value loss 35,000:

• Debit: Loss on Derivative (P&L) 35,000

• Credit: Embedded Derivative Liability 35,000

Convertible or put/call overlays: If the SLB also contains puts/calls or conversion features, evaluate ASC 470-20 (debt with conversion), ASC 815 (derivative scope), and ASC 480 (mandatorily redeemable or indexed to issuer’s stock) to determine classification and any separation.

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Comparative table: IFRS vs US GAAP.

Aspect	IFRS (IFRS 9 / IAS 32 / IFRS 7)	US GAAP (ASC 470 / ASC 815 / ASC 835-30)
Green bond base accounting	Financial liability at amortized cost; use-of-proceeds does not change classification.	Long-term debt at amortized cost; use-of-proceeds disclosed, not determinative.
SLB KPI step features	Assess embedded derivative; if not closely related, bifurcate at FVTPL; otherwise revise EIR when step triggers.	Assess embedded derivative; if not clearly and closely related, bifurcate at fair value; otherwise adjust yield prospectively.
Day-1 costs/fees	Offset against liability and amortize via EIR.	Debt issuance costs recorded as a contra-liability and amortized.
Government grants/incentives	IAS 20 policy: income over related costs or deduction from asset cost.	Policy choice (for-profits) typically other income or cost offset; NFPs use ASC 958-605.
Early modification	IFRS 9 modification guidance; assess 10% test; derecognize or adjust EIR.	ASC 470 modification/extinguishment model; quantitative and qualitative tests.
Disclosures	IFRS 7: risk, fair-value hierarchy, sensitivity, KPI mechanics, governance.	ASC 815/825/470: terms, fair value, derivative gains/losses, covenant effects.

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Presentation and disclosures.

Presentation (issuer): the liability is shown within non-current borrowings unless due within 12 months. When embedded derivatives are bifurcated, present a separate derivative liability (current/non-current based on maturity and settlement).

IFRS disclosures (IFRS 7):

• Nature of green/SLB frameworks, SPTs/KPIs, and testing dates.

• Methods/assumptions for fair value of embedded derivatives (if any).

• Sensitivity of cash flows to KPI outcomes and step ranges.

• Allocation of proceeds to eligible projects, unallocated cash balance at period-end.

• If applicable, IAS 20 grant policies and recognition patterns.

US GAAP disclosures:

• Debt terms, coupon step mechanics, maturity profile.

• Embedded derivative fair-value methods and P&L impacts (ASC 815).

• Debt issuance costs amortization and carrying amounts (ASC 835-30).

• Narrative on use-of-proceeds governance and any contingencies (ASC 450).

Example presentation (issuer):

Liabilities	Amount (USD)
Current Liabilities:
Current Portion of Long-Term Debt	1,200,000
Derivative Liabilities (current)	90,000
Non-Current Liabilities:
Green/SLB Liability (amortized cost)	9,650,000
Derivative Liabilities (non-current)	120,000

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Journal entries for common scenarios.

1) SLB coupon step-up becomes effective (IFRS, no bifurcation — revise EIR):At step date, recompute carrying amount using revised expected cash flows; recognize catch-up via P&L through the EIR mechanism (no separate entry beyond regular interest amortization). Narrative disclosure explains SPT miss and yield change.

2) Embedded derivative fair value change (both frameworks, bifurcated):

• Debit: Loss on Embedded Derivative xxx

• Credit: Embedded Derivative Liability xxx

3) Allocation of green proceeds to eligible project (no impact on liability):

• Debit: Construction in Progress / Eligible Asset xxx

• Credit: Cash xxx

If grants received for the same project (IFRS):

• Debit: Cash xxx

• Credit: Deferred Income (IAS 20) xxxSystematically recognize to Other Income as related depreciation/expenses are incurred.

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Impact on financial performance and ratios.

ESG-linked features affect interest expense via EIR changes or derivative fair-value gains/losses if bifurcated. Step-ups increase finance costs and reduce interest coverage; step-downs do the opposite. Fair-value accounting introduces earnings volatility, while amortized-cost instruments exhibit smoother expense recognition.

Leverage metrics can be affected by derivative liabilities recognized on the balance sheet. Covenant headroom may narrow if KPI triggers raise coupon or create make-whole payments. Analysts will reconcile statutory interest expense with ESG-related adjustments and monitor SPT probability to model forward interest cost.

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Operational considerations.

Management must hard-wire KPI definitions, baselines, calculation methodologies, and assurance processes (internal control plus potential external assurance) to avoid disputes at test dates. Treasury, sustainability, and accounting teams should align on scenario modelling for SPT outcomes to pre-assess EIR impacts or derivative fair-value ranges.

Documentation should include terms, test windows, fallback clauses, cure rights, and governance over use-of-proceeds tracking. Systems must capture step mechanics, indexation, and modification accounting for any refinancings or covenant resets.

Robust disclosure of frameworks, KPIs, and sensitivities helps readers understand how sustainability performance translates into cash-flow economics and reported finance costs.

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