How Inflation-Linked Bonds and Financial Liabilities Are Measured under IFRS 9 and ASC 825

Graziano Stefanelli
Nov 1
6 min read

Some debt instruments are indexed to inflation. Instead of paying a fixed principal and coupon, these liabilities adjust based on changes in a published inflation index (for example, CPI-linked notes, RPI-linked notes, inflation-indexed leases, or government inflation-linked debt). Under IFRS 9 and US GAAP (ASC 825, ASC 470), the challenge is whether these instruments qualify for amortized cost accounting or require fair value measurement, and how to separate any embedded inflation derivatives.

Both frameworks focus on two core questions:

Does the contractual cash flow profile still represent “principal and interest” in a basic lending arrangement
How should subsequent changes in carrying amount — from inflation, time value, and credit risk — be presented in profit or loss or OCI

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How inflation-linked debt works in practice

Inflation-linked instruments generally adjust either:

The principal, with coupons applied to the adjusted principal, or
The coupon cash flows directly, based on an inflation factor.

Example:A note is issued at 1,000,000 with a 2% real coupon, and principal is indexed to CPI.If cumulative inflation is 5%, the adjusted principal becomes 1,050,000, and the next coupon is 2% × 1,050,000 = 21,000.

This structure protects the lender from inflation erosion and exposes the borrower to inflation risk.

From the issuer’s point of view, that “extra” liability driven by inflation is economically similar to variable interest. The accounting question is whether that variability is still considered “interest on principal,” or whether it is an embedded derivative that must be separated.

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IFRS 9 classification and measurement

Under IFRS 9, a financial liability is generally measured at amortized cost unless:

It is held for trading, or
The entity elects the fair value option to eliminate an accounting mismatch.

For financial liabilities, unlike financial assets, IFRS 9 does not require an SPPI test to stay at amortized cost. Most plain debt is allowed at amortized cost. But there are two complications:

Embedded derivatives in financial liabilities are not separated — instead, the entire liability is measured at FVTPL if it contains certain non-closely-related features.
Changes in an issuer’s own credit risk for liabilities designated at FVTPL must be shown in OCI, not profit or loss.

Is inflation linkage “closely related” to the host debt

If the inflation index is relevant to the currency in which the instrument is denominated (example: a Euro-denominated bond linked to euro-area CPI), IFRS typically treats this as closely related, so the liability can remain at amortized cost.
If the linkage is to an index that is not economically related (example: USD debt linked to Brazilian CPI), that feature is generally not closely related, and the whole instrument may have to be measured at fair value through profit or loss (FVTPL).

Subsequent measurement at amortized cost (closely related inflation):Carrying amount is accreted using the effective interest method. The effective interest rate is applied to the inflation-adjusted principal, so increases in principal due to inflation become part of interest expense over time.

Example entry each period:

Debit: Interest Expense xx
Credit: Inflation-Linked Debt Liability xx

This captures both time value and the embedded inflation uplift.

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US GAAP classification and measurement

Under US GAAP (ASC 470 Debt and ASC 825-10):

Most standard inflation-indexed notes are accounted for at amortized cost, using the effective interest method, unless the issuer elects the fair value option.
The carrying amount is adjusted for accrued indexation. Those adjustments hit interest expense.

However, if the linkage is exotic — for example, leveraged inflation, caps/floors, or inflation tied to an unrelated economic environment — then there may be an embedded derivative under ASC 815.In that case:

The host debt stays at amortized cost,
The embedded derivative (inflation swap-style component) is bifurcated and measured at fair value through earnings.

This is a major difference from IFRS 9, which generally does not bifurcate embedded derivatives in liabilities.

Example (US GAAP, bifurcation):At issuance:

Debit: Cash 1,000,000
Credit: Debt Host Liability 980,000
Credit: Embedded Derivative Liability 20,000

End of period remeasurement:If inflation expectations change and derivative FV increases by 15,000:

Debit: Loss on Derivative (P&L) 15,000
Credit: Embedded Derivative Liability 15,000

Meanwhile, accretion of the host liability proceeds using effective interest, recorded as interest expense.

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Effective interest and carrying amount updates

In both frameworks, if accounted for at amortized cost, you build an amortization schedule that includes:

Opening carrying amount,
Interest/accretion using the effective rate,
Cash paid (coupon),
Closing carrying amount.

What’s different with inflation-linked debt is that the principal itself changes every period. That updated principal becomes the new base for future accretion.

Illustrative schedule (simplified):

Period	Opening Liability	Inflation Adjustment	Accrued Interest	Cash Paid	Closing Liability
Year 1	1,000,000	30,000	20,000	(20,000)	1,030,000
Year 2	1,030,000	25,000	20,600	(20,600)	1,055,000

The liability grows as inflation compounds. That growth flows through interest expense, not equity.

Entries (end of Year 1):

Debit: Interest Expense 50,000
Credit: Debt Liability 50,000
Debit: Debt Liability 20,000
Credit: Cash 20,000

Net increase in carrying amount = 30,000.

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Comparative framework — IFRS 9 vs US GAAP

Topic	IFRS (IFRS 9 / IAS 32)	US GAAP (ASC 470 / ASC 815 / ASC 825)
Default classification	Amortized cost unless FVTPL designation or non-closely-related feature	Amortized cost unless fair value option or derivative bifurcation
Embedded derivatives in liabilities	Generally no bifurcation — measure entire instrument at FVTPL if not closely related	Bifurcate embedded derivative and fair-value it separately
Inflation linkage to relevant local CPI	Usually “closely related,” stays at amortized cost	Generally allowed in host without bifurcation
Foreign / leveraged index link	Likely “not closely related,” entire liability at FVTPL	Often triggers bifurcation under ASC 815
P&L impact of inflation uplift	Interest expense (effective rate applied to indexed principal)	Interest expense for host + derivative remeasurement in P&L
OCI impact	Own-credit changes for liabilities designated FVTPL go to OCI	No comparable “own-credit to OCI” unless fair value option with certain presentation

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Disclosure requirements

Both IFRS and US GAAP demand enhanced disclosure when liabilities include material indexation or embedded inflation exposure. Typical disclosures include:

Nature and terms of inflation linkage (index used, lag, caps/floors).
Carrying amount and fair value of the liability.
Whether the liability is at amortized cost or measured at (or contains components measured at) fair value.
Sensitivity to changes in inflation assumptions.
For Level 3 inputs, description of valuation techniques (IFRS 13 / ASC 820).

Example disclosure summary:

Instrument	Carrying Amount (USD)	Measurement Basis	Fair Value Hierarchy
CPI-Linked Notes, due 2032	48,500,000	Amortized Cost	Level 2
BRL-CPI Linked Note (USD host)	12,800,000	FVTPL (IFRS) / Bifurcated (GAAP)	Level 3

These disclosures help users assess inflation risk embedded in debt and its earnings volatility.

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Journal entries summary

1) Issue an inflation-linked bond at par (amortized cost treatment):

Debit: Cash xx
Credit: Inflation-Linked Debt Liability xx

2) Periodic accretion and indexation (IFRS amortized cost or GAAP host debt):

Debit: Interest Expense xx
Credit: Inflation-Linked Debt Liability xx

3) Coupon payment:

Debit: Inflation-Linked Debt Liability xx
Credit: Cash xx

4) Embedded derivative remeasurement (US GAAP if bifurcated):

Debit: Loss on Derivative (P&L) xx
Credit: Derivative Liability xx

5) Electing FVTPL (IFRS liability fair value option):

Debit: Loss on Liability Fair Value (P&L) xx
Credit: Inflation-Linked Liability xx(Portion due to own credit risk → OCI, not P&L.)

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Impact on financial performance and ratios

Interest expense will generally rise in high-inflation environments because the liability is remeasured upward.
Leverage ratios (Debt / Equity) may spike over time without additional borrowing, as principal is indexed upward.
Interest coverage weakens because reported finance costs include both time value and inflation accretion.
Volatility:
- IFRS: If forced into FVTPL due to non-closely-related index, earnings can swing sharply each reporting period.
- GAAP: Derivative bifurcation isolates some of that volatility in a distinct line item.

Analysts should distinguish cash coupons actually paid from non-cash accretion caused by inflation. The latter affects profit and leverage but not immediate cash flow.

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Operational considerations

Treasury, accounting, and risk teams must align on whether the CPI linkage is considered “closely related” (IFRS) or requires bifurcation (US GAAP).
Systems must capture period-by-period indexation to recalculate carrying amounts and effective yields.
Entities should evaluate the fair value hierarchy (IFRS 13 / ASC 820) for disclosure, especially for bespoke, illiquid inflation-linked debt.
Forecasting covenants and interest coverage needs to incorporate non-cash accretion, or management risks breaching ratios when inflation spikes.
Hedging strategies (e.g. inflation swaps) must be monitored under IFRS 9 / ASC 815 hedge accounting to avoid unexpected P&L swings.

Properly classifying and measuring inflation-linked liabilities under IFRS 9 and US GAAP prevents understatement of leverage and clarifies how inflation risk flows through earnings, OCI, and cash obligations.

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DATA STUDIOS

.....[datastudios.org]