International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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that a credit loss occurs and the possibility that no credit loss occurs. Following
discussion at the ITG, this is understood to include a need to consider multiple
economic scenarios (see 5.6 below);
• the time value of money (see 5.7 below); and
• reasonable and supportable information that is available without undue cost or
effort at the reporting date about past events, current conditions and forecasts of
future economic conditions (see 5.9 below).
1.3
Key changes from the IAS 39 impairment requirements and the
implications
The new IFRS 9 impairment requirements eliminate the IAS 39 threshold for the
recognition of credit losses, i.e. it is no longer necessary for a credit event to have
occurred before credit losses are recognised. Instead, an entity always accounts for
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ECLs, and updates the loss allowance for changes in these ECLs at each reporting date
to reflect changes in credit risk since initial recognition. Consequently, the holder of the
financial asset needs to take into account more timely and forward-looking information.
The main implications for both financial and non-financial entities are as follows:
• The scope of the impairment requirements is now much broader. Previously,
under IAS 39, there were different impairment models for financial assets
measured at amortised cost and available-for-sale financial assets. Under IFRS 9,
there is a single impairment model for all debt instruments measured at amortised
cost and at fair value through other comprehensive income. Furthermore, loan
commitments and financial guarantee contracts that were previously in the scope
of IAS 37 – Provisions, Contingent Liabilities and Contingent Assets – are now in
the scope of the IFRS 9 impairment requirements (see 11 below).
• Previously, under IAS 39, loss allowances were only recorded for impaired
exposures. The new impairment requirements result in earlier recognition of credit
losses, by necessitating a 12-month ECL allowance for all credit exposures not
measured at fair value through profit or loss. In addition, there is a larger allowance
for all credit exposures that have significantly deteriorated (as compared to the
recognition of incurred losses under IAS 39). While credit exposures in stage 3, as
illustrated in Figure 47.2 above, are similar to those deemed by IAS 39 to have
suffered individual incurred losses, credit exposure in stages 1 and 2 essentially
replace those exposures measured under IAS 39’s collective approach.
• The ECL model is more forward-looking than the IAS 39 impairment model.
Holders of financial assets are not only required to consider historical information
that is adjusted to reflect the effects of current conditions and information that
provides objective evidence that financial assets are impaired in relation to incurred
losses. They are also required to consider reasonable and supportable information
that includes forecasts of future economic conditions including, where relevant,
multiple scenarios, when calculating ECLs, on an individual and collective basis.
• The application of the new IFRS 9 impairment requirements has led to an increase
in credit loss allowances (with a corresponding reduction in equity on first-time
adoption) of many entities, particularly banks and similar financial institutions.
However, the increase in the loss allowance has varied by entity, depending on its
portfolio and previous practices. Entities with shorter term and higher quality
financial instruments are less significantly affected. Similarly, financial institutions
with unsecured retail loans are generally affected to a greater extent than those
with collateralised loans such as mortgages.
• Moreover, the focus on expected losses will possibly result in higher volatility in the
ECL amounts charged to profit or loss, especially for financial institutions. The level of
loss allowances will increase as economic conditions are forecast to deteriorate and
will decrease as economic conditions are forecast to become more favourable. This
may be further compounded by the significant increase in the loss allowance when
financial instruments move between 12-month and lifetime ECLs and vice versa.
• The need to incorporate forward-looking information, including establishing
multiple macroeconomic scenarios, determining the probability of their
Financial instruments: Impairment 3733
occurrence and assessing how changes in macroeconomic factors will affect ECLs,
means that the application of the standard requires considerable judgement. Also,
the increased level of judgement required in making the ECL calculation and
assessing when significant deterioration has occurred may mean that it will be
difficult to compare the reported results of different entities. However, the more
detailed disclosure requirements, that require entities to explain their inputs,
assumptions and techniques used in estimating ECLs requirements, should provide
greater transparency over entities’ credit risk and provisioning processes. The
Enhanced Disclosures Task Force (EDTF), established in 2012 by the Financial
Stability Board to recommend best practice market risk disclosures, has also
published guidance to promote greater transparency and comparability about the
application of the ECL model (see Chapter 50 at 9.2).
• In financial institutions, finance and credit risk management systems and processes
now have to be better connected, because of the necessary alignment between risk
and accounting in the new model. Risk models and data are used more extensively
to make the assessments and calculations required for accounting purposes, which
are both a major change from IAS 39 and a key challenge.
• In addition, financial institutions need to fully understand the complex interactions
between the IFRS 9 and regulatory capital requirements in relation to credit losses.
The Basel Committee on Banking Supervision has now finalised what it calls an
‘interim’ approach and transitional arrangements, providing national jurisdictions with
a framework for any arrangement. This is contained in the BCBS document Standards
– Regulatory treatment of accounting provisions – interim approach and transitional
arrangements. However, the long-term regulatory treatment of ECL provisions
remains to be determined. In most cases, the new IFRS 9 ECL requirements have
resulted in a reduction in the regulatory capital of financial institutions.
• The IFRS impairment requirements have had a less significant impact on
corporates than on banks and similar financial institutions. To reflect this, we have
set out a summary of the main implications for corporates in a separate section
(see 4 below).Given that IFRS 16 – Leases – has retained the distinction for
accounting by lessors between finance leases and operating leases, the effect of
IFRS 9 is largely limited to finance leases. For these, there is a significant increase
in allowances, particularly if the lessor has opted to apply the simplified approach
and record lifetime allowances (see 3.2 below).
1.4
Key differences from the FASB’s standard
On 16 June 2016, the FASB issu
ed an Accounting Standard Update (ASU), Financial
Instruments – Credit Losses (Topic 326), that aims to address the same fundamental
issue that the IASB’s ECL model (in IFRS 9) addresses, namely the delayed recognition
of credit losses resulting from the incurred credit loss model. It is therefore also an ECL
model but it is not the same as the model in IFRS 9. The most significant differences
between the FASB’s and the IASB’s ECL models are, as follows:
• The FASB’s ECL model (known as the Current ECL or CECL model) will not be
applied to debt securities measured at fair value through other comprehensive
income (i.e. available for sale securities under US GAAP). Rather, for available for sale
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securities, an allowance is recognised to reflect estimated credit losses and is adjusted
over time to reflect both positive and adverse changes in expected cash flows.
• The FASB’s ECLs will be calculated based on the losses expected over the remaining
contractual life of an asset, considering the effect of prepayments and reasonably
expected troubled debt restructurings. An allowance for lifetime ECLs will be
required when the loan is initially recognised instead of 12-month ECLs. As a result,
the FASB’s model does not require an entity to assess whether there has been a
significant deterioration in credit quality, in contrast to the assessment required by
IFRS 9. This is similar to the IFRS 9 simplified approach (see 3.2 below).
• The FASB’s standard does not require, nor does it prohibit, an entity to use
probability weighted outcomes. However, entities are required to incorporate the
risk of loss, even if such a risk is remote, into their estimate. It is expected that an
allowance of zero will only be appropriate in very limited circumstances.
• For purchased credit-impaired assets defined as ‘acquired individual financial
assets (or acquired groups of financial assets with shared risk characteristics) that,
as of the date of acquisition, have experienced a more-than-insignificant
deterioration in credit quality since origination, as determined by an acquirer’s
assessment’ and that are measured at amortised cost, the FASB’s model will require
an entity to increase the purchase price by the allowance for ECLs upon
acquisition. In doing so, the FASB model will gross up the asset’s amortised cost
upon acquisition by the difference between the calculated ECLs and the purchase
discount (known as the non-credit discount), by establishing a liability which is
subsequently amortised to income over the asset’s life (see 3.3 below for the
accounting treatment of credit-impaired assets under IFRS 9).
• Unlike IFRS 9, there is no exception for revolving credit facilities (e.g. commitments
connected with overdrafts and credit cards) under the FASB’s model (see 12 below for
the IFRS 9 treatment) and therefore, no impairment allowance is required if the
commitment is unconditionally cancellable or legally revocable without any conditions.
The FASB standard has tiered effective dates, starting in 2020 for calendar-year
reporting public business entities that meet the definition of a U.S. Securities and
Exchange Commission (SEC) filer. Early adoption is permitted for all entities but this
cannot be before 2019 for calendar-year entities.
1.5
The IFRS Transition Resource Group for Impairment of Financial
Instruments (ITG) and IASB webcasts
The IASB has set up an ITG that aims to:
• provide a public discussion forum to support stakeholders on implementation issues
arising from the new impairment requirements that could create diversity in practice;
and
• inform the IASB about the implementation issues, which will help the IASB
determine what action, if any, will be needed to address them.5
However, the ITG does not issue any guidance.
Members of the ITG include financial statement preparers and auditors from various
geographical locations with expertise, skills or practical knowledge on credit risk
Financial instruments: Impairment 3735
management and accounting for impairment. Board members and observers from the
Basel Committee on Banking Supervision and the International Organisation of
Securities Commissions also attend the meetings.
The ITG agenda papers are prepared by the IASB staff and are made public before the
meetings. The staff also provides ITG meeting summaries which are not authoritative.
Both the staff papers and the meeting summaries represent educational reading on the
issues submitted.
Following its inaugural meeting in December 2014 to discuss its operating procedures, the
ITG met three times, on 22 April 2015, on 16 September 2015, and on 11 December 2015.
Although no further meetings have been planned, the group has not been disbanded and
stakeholders may continue to submit potential implementation issues following the
submission guidelines. Further meetings will be convened if warranted.
On 22 April 2015, the ITG discussed eight implementation issues raised by stakeholders.
These included:6
• when applying the impairment requirements at the reporting date, whether and
how to incorporate events and forecasts that occur after economic forecasts have
been made, but before the reporting date, and between the reporting period end
and the date of signing the financial statements (see 5.9.4 below);
• whether the impairment requirements in IFRS 9 must also be applied to other
commitments to extend credit, in particular, a commitment (on inception of a finance
lease) to commence a finance lease at a date in the future and a commitment by a
retailer through the issue of a store account to provide a customer with credit when
the customer buys goods or services from the retailer in the future (see 11 below);
• whether there is a requirement to measure ECLs at dates other than the reporting date,
namely the date of derecognition and the date of initial recognition (see 7.3.1 below);
• whether an entity should consider the ability to recover cash flows through an
integral financial guarantee contract when assessing whether there has been a
significant increase in the credit risk of the guaranteed debt instrument since initial
recognition (see 6.1.1 below);
• the maximum period to consider when measuring ECLs on a portfolio of mortgage
loans that have a stated maturity of 6 months, but contain a contractual feature
whereby the term is automatically extended every 6 months subject to the lender’s
non-objection (see 5.5 below);
• the maximum period to consider when measuring ECLs for revolving credit
facilities and the determination of the date of initial recognition of the revolving
facilities for the purposes of assessing them for significant increases in credit risk
(see 12.2.2 and 12.2.4 below);
• whether the measurement of ECLs for financial guarantee contracts issued should
consider future premium receipts due from the holder and, if so, how (see 11
below); and
• the measurement of ECLs in respect of a modified financial asset, the calculation of the
modification gain or loss and subsequent requirement to measure ECLs on the modified
financial asset as well
as the appropriate presentation and disclosure (see 8.2 below).
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On 16 September 2015, the ITG held its third meeting to discuss six implementation
issues raised by stakeholders. These included:7
• how to identify a significant increase in credit risk for a portfolio of retail loans
when identical pricing and contractual terms are applied to customers across broad
credit quality bands (see 6.2.1 below);
• the possibility of using behavioural indicators of credit risk for the purpose of the
assessment of significant increases in credit risk since initial recognition
(see 6.2.4 below);
• when assessing significant increases in credit risk, whether an entity would be
required to perform an annual review to determine whether circumstances still
support the use of the 12-month risk of a default occurring as an approximation of
changes in the lifetime risk of a default occurring (see 6.4.3 below);
• when measuring ECLs for revolving credit facilities, how an entity should estimate
future drawdowns on undrawn lines of credit when an entity has a history of
allowing customers to exceed their contractually set credit limits on overdrafts and
other revolving credit facilities (see 12.3 below);
• at what level should forward-looking information be incorporated – at the level of
the entity or on a portfolio-by-portfolio basis (see 5.9.5 below); and
• how to determine what is reasonable and supportable forward-looking
information and how to treat shock events with material, but uncertain, economic
consequences (see 5.9.5 below).
On 11 December 2015, the ITG held its fourth meeting to discuss eleven implementation
issues raised by stakeholders. These included:8
• what was meant by the ‘current EIR’ when an entity recognises interest revenue in
each period based on the actual floating-rate applicable to that period (see 5.7 below);
• what was meant by ‘part of the contractual terms’, specifically whether a credit
enhancement must be an explicit term of the related asset’s contract in order for it
to be taken into account in the measurement of ECLs, or whether other credit
enhancements that are not recognised separately can also be taken into account
(see 5.8.1.A below);