International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  only one way of applying the requirements of IFRS 9. Measuring a 12-month expected

  loss using point in time, forward-looking information, every time that a foreign currency

  exposure is first recognised would not be feasible. Given that there was no consensus

  on this issue, we expect that there may be diversity in practice.

  7.3.2

  Trade date and settlement date accounting

  For financial assets measured at amortised cost or at fair value through other

  comprehensive income, IFRS 9 requires entities to use the trade date as the date of

  initial recognition for the purposes of applying the impairment requirements.

  [IFRS 9.5.7.4]. This means that entities that use settlement date accounting for regular way

  purchases of debt securities may have to recognise a loss allowance for securities which

  they have purchased but not yet recognised and, correspondingly, no loss allowance for

  securities that they have sold but not yet derecognised. (See Chapter 45 at 2.2 for further

  details on trade date accounting and settlement date accounting).

  Irrespective of the accounting policy choice for trade date accounting versus settlement

  date accounting, the recognition of the loss allowance on the trade date ensures that

  entities recognise the loss allowance at the same time; otherwise entities could choose

  settlement date accounting to delay recognising the loss allowance until the settlement

  date. The effect of this is similar to accounting for fair value changes on financial assets

  measured at fair value through other comprehensive income and those measured at fair

  value through profit or loss when settlement date accounting is applied (i.e. a

  measurement change needs to be recognised in profit or loss and the statement of

  financial position even if the related assets that are being measured are only recognised

  slightly later). It is also consistent with the treatment of ECLs in loans, where an ECL is

  calculated in respect of a loan commitment between the date that the commitment is

  made and the loan is drawn down.

  For settlement date accounting, the recognition of a loss allowance for an asset that has

  not yet been recognised raises the question of how that loss allowance should be

  presented in the statement of financial position. The time between the trade date and

  the settlement date is somewhat similar to a loan commitment in that the accounting is

  off balance sheet, which suggests presentation of the loss allowance as a provision.

  In practice, some entities tend to opt for settlement date accounting for regular way

  securities recorded at amortised cost, because they do not need the additional systems

  capabilities to account for the securities on trade date (i.e. they do not need to account for

  them until settlement date). The change from the IAS 39 incurred loss model to the IFRS 9

  ECL model means that the settlement date accounting simplification for financial assets

  measured at amortised cost would lose much of its benefit from an operational perspective.

  7.4

  Interaction between the initial measurement of debt instruments

  acquired in a business combination and the impairment model

  of IFRS 9

  Consistent with IFRS 9 and IFRS 13 – Fair Value Measurement, IFRS 3 requires

  financial assets acquired in a business combination to be measured by the acquirer

  on initial recognition at their fair value (see Chapter 45 at 3.3.4 and Chapter 9

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  at 5.5.5). [IFRS 3.18, IFRS 3.36]. IFRS 3 contains application guidance explaining that an

  acquirer should not recognise a separate valuation allowance (i.e. loss allowance for

  ECLs) in respect of loans and receivables acquired in a business combination for

  contractual cash flows that are deemed to be uncollectible at the acquisition date.

  This is because the effects of uncertainty about future cash flows are included in the

  fair value measure. [IFRS 3.B41].

  Consequently, the accounting for impairment of debt instruments measured at

  amortised cost or fair value through other comprehensive income under IFRS 9 does

  not affect the accounting for the business combination. At the acquisition date, the

  acquired debt instruments are measured at their acquisition-date fair value in

  accordance with IFRS 3. No loss allowance is recognised as part of the initial

  measurement of debt instruments that are acquired in a business combination.

  In contrast, after their original recognition, the subsequent accounting for debt

  instruments acquired in a business combination is in the scope of IFRS 9.

  [IFRS 9.5.5, 9.5.2.1, 9.5.2.2]. At the first reporting date after the business combination,

  following the guidance in IFRS 9, a loss allowance is recognised. [IFRS 9.5.5.3, 9.5.5.5]. This

  will result in an impairment loss that is recognised in profit or loss (rather than an

  adjustment to goodwill), just as would be the case if the entity were to originate those

  assets or acquire them as a portfolio, rather than acquire them through a business

  combination. [IFRS 9.5.5.8].

  Despite the colloquial reference to a ‘day one’ loss that results from the ECL impairment

  model in IFRS 9, it is important to understand that the recognition of a loss allowance

  for newly acquired (whether purchased or originated) debt instruments that are in the

  scope of the impairment requirements of IFRS 9 is a matter of subsequent measurement

  of those financial instruments. This means that the acquirer recognises the loss

  allowance for all debt instruments acquired in a business combination (that are subject

  to impairment accounting) in the reporting period that includes the business

  combination but not as part of that business combination, and with a corresponding

  impairment loss in profit or loss.

  The only exception to this is the specific accounting for purchased or originated

  credit-impaired financial assets which applies to the extent that the portfolio includes

  financial assets which are credit-impaired at the acquisition date (i.e. the EIR is

  determined using a cash flow estimate that includes all ECLs and no allowance is made

  for ECLs). A financial asset is credit-impaired when one or more events that have a

  detrimental impact on the estimated future cash flows of that financial asset have

  occurred (see 3.1 above).

  It follows that, on a business combination, the acquirer needs to classify the acquired

  debt instruments that will be recorded at amortised cost or at fair value through OCI,

  according to whether or not they are purchased credit-impaired. If not, they will be

  regarded as stage 1 assets and be subject to a 12-month ECL. If they are purchased

  credit-impaired then there will be no need for an additional ECL unless there is a

  subsequent change in estimated lifetime ECL. None of the assets will be classified as

  stage 2 at the date of initial recognition.

  Financial instruments: Impairment 3827

  7.5

  Interaction between expected credit losses calculations and fair

  value hedge accounting

  Previously, the implementation guidance of IAS 39 made it clear that a fair value hedge

  adjustment would be included in the carrying amount of a financial asset that is subject

  to the impairment requirements. Otherwise, a part of its carrying amount would not

  have a loss
allowance or the loss allowance would be overstated (in case of a negative

  fair value hedge adjustment). This guidance stated that the effect of fair value hedge

  accounting is to adjust the EIR, which affects the rate used to discount expected future

  cash flows. [IAS 39.E.4.4]. The rationale given in the example is that the original interest

  rate before the hedge becomes irrelevant once the carrying amount of the loan is

  adjusted for any changes in its fair value attributable to interest rate movements.

  Similarly, for a financial asset that becomes credit-impaired, IFRS 9 requires impairment

  to be measured by reference to the gross carrying amount of the asset, which would include

  the fair value hedge adjustment. Therefore, for a credit-impaired financial asset in stage 3,

  the EIR would be adjusted to reflect any fair value hedge adjustment. [IFRS 9.B5.5.33].

  However, whereas under IAS 39, most assets that are impaired would not generally be

  those for which fair value hedge accounting has been undertaken, under the new ECL

  impairment model an allowance is required for assets in stages 1 and 2, in addition to

  assets in stage 3. Hence, if the discount rate were to be adjusted whenever fair value

  hedge is applied, then all fair value hedge adjustments would need to be taken into

  account in calculating ECLs. This would give rise to significant operational challenges.

  IFRS 9 is not explicit on this matter, but two points in the standard would seem to be

  relevant. First, unlike IAS 39, except for credit-impaired assets, the ECL requirements

  are not based on an asset’s ‘carrying amount’ but on the contractual cash flows that are

  expected to be lost. Second, implementation guidance E4.4 in IAS 39, which stated that

  a fair value hedge adjusts the EIR, was not carried forward into the new standard. We

  understand that removing this guidance was not intended to change the accounting

  treatment in this respect. However another requirement of IAS 39, carried forward into

  IFRS 9, is that a fair value hedge adjustment is only required to be amortised when the

  hedged item ceases to be adjusted for changes in fair value attributable to the risk being

  hedged, which can be read to imply that until then there is no need to adjust the EIR,

  and hence the rate used to discount ECLs. [IFRS 9.6.5.10].

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  We believe the requirement is not clear and, so at least until it is clarified, there is an

  accounting policy choice on the matter. One approach would be to adjust the EIR

  whenever a fair value hedge adjustment is made and hence change the interest rate used

  to discount expected losses. The other would not take into account the fair value hedge

  adjustment until the EIR is adjusted to amortise the fair value hedge adjustment.

  [IFRS 9.6.5.8]. Such an adjustment to the EIR is permitted to commence at any time but

  would, at the latest, be required when hedge accounting ceases or when the financial

  asset becomes credit impaired, i.e. moved to stage 3.

  8

  MODIFIED FINANCIAL ASSETS

  If the contractual cash flows on a financial asset are renegotiated or modified, the holder

  needs to assess whether the financial asset should be derecognised (see Chapter 48

  at 3.4 and 6.2 and Chapter 46 at 3.8 for further details on modification and

  derecognition). In summary, an entity should derecognise a financial asset if the cash

  flows are extinguished or if the terms of the instrument have substantially changed.

  8.1

  Accounting treatment if modified financial assets are

  derecognised

  In some circumstances, the renegotiation or modification of the contractual cash

  flows of a financial asset can lead to the derecognition of the existing financial asset

  and subsequently, the recognition of a new financial asset. [IFRS 9.B5.5.25]. This means

  that the entity is starting afresh and the date of the modification will also be the date

  of initial recognition of the new financial asset at its fair value. Typically, the entity

  will recognise a loss allowance based on 12-month ECLs at each reporting date until

  the requirements for the recognition of lifetime ECLs are met. However, in what the

  standard describes as ‘some unusual circumstances’ following a modification that

  results in derecognition of the original financial asset, there may be evidence that

  the new financial asset is credit-impaired on initial recognition (see 3.3 above).

  Thus, the financial asset should be recognised as an originated credit-impaired

  financial asset. In practice, we believe that more restructured financial assets will be

  treated as originated credit-impaired than the Board seems to have envisaged.

  [IFRS 9.B5.5.26].

  Financial instruments: Impairment 3829

  8.2

  Accounting treatment if modified financial assets are not

  derecognised

  In other circumstances, the renegotiation or modification of the contractual cash flows

  of a financial asset does not lead to the derecognition of the existing financial asset as

  per IFRS 9. In such situations, the entity will:

  • continue with its current accounting treatment for the existing asset that has been

  modified;

  • recognise a modification gain or loss in profit or loss by recalculating the gross

  carrying amount of the financial asset as the present value of the renegotiated or

  modified contractual cash flows, discounted at the financial asset’s original EIR (or

  the credit-adjusted EIR for purchased or originated credit-impaired financial

  assets). Any costs or fees incurred adjust the carrying amount of the modified

  financial asset and are amortised over the remaining term of the modified financial

  asset (see 3.1 above); [IFRS 9.5.4.3, Appendix A, IAS 1.82(a)]

  • assess whether there has been a significant increase in the credit risk of the

  financial instrument, by comparing the risk of a default occurring at the reporting

  date (based on the modified contractual terms) and the risk of a default occurring

  at initial recognition (based on the original, unmodified contractual terms). A

  financial asset that has been renegotiated or modified is not automatically

  considered to have lower credit risk. The assessment should consider the credit

  risk over the expected life of the asset based on historical and forward-looking

  information, including information about the circumstances that led to the

  modification. Evidence that the criteria for the recognition of lifetime ECLs are

  subsequently no longer met may include a history of up-to-date and timely

  payment in subsequent periods. This means a minimum period of observation will

  often be necessary before a financial asset may qualify to return to stage 1;

  [IFRS 9.5.5.12, B5.5.27] and

  • make the appropriate quantitative and qualitative disclosures required for

  renegotiated or modified assets to enable users of financial statements to

  understand the nature and effect of such modifications (including the effect on the

  measurement of ECLs) and how the entity monitors its assets that have been

  modified (see 15 below and Chapter 50 at 5.3). [IFRS 7.35F(f), B8B, 35J].

  The following example has been adapted from Example 11 of the Implementation

  Guidance in the standard to illustrate the accounting treatment of a loan that is modified.

>   It should be noted that it does not consider whether any of the contractual cash flows

  should be written off, as a partial derecognition. [IFRS 9 IG Example 11 IE66-IE73].

  Example 47.18: Modification of contractual cash flows

  Bank A originates a five-year loan that requires the repayment of the outstanding contractual amount in full

  at maturity. Its contractual par amount is €1,000 with an interest rate of 5 per cent, payable annually. The EIR

  is 5 per cent. At the end of the first reporting period in Year 1, Bank A recognises a loss allowance at an

  amount equal to 12-month ECLs because there has not been a significant increase in credit risk since initial

  recognition. A loss allowance balance of €20 is recognised. In Year 2, Bank A determines that the credit risk

  on the loan has increased significantly since initial recognition. As a result, Bank A recognises lifetime ECLs

  on the loan. The loss allowance balance is €150.

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  At the end of Year 3, following significant financial difficulty of the borrower, Bank A modifies the

  contractual cash flows on the loan. It forgoes interest payments beyond year 3 until maturity and extends the

  contractual term of the loan by one year so that the remaining term at the date of the modification is three

  years. The modification does not result in the derecognition of the loan by Bank A.

  As a result of that modification, Bank A recalculates the gross carrying amount of the financial asset as the

  present value of the modified contractual cash flows discounted at the loan’s original EIR of 5 per cent. The

  difference between this recalculated gross carrying amount and the gross carrying amount before the

  modification is recognised as a modification gain or loss. Bank A recognises the modification loss (calculated

  as €136) against the gross carrying amount of the loan, reducing it to €864, and a modification loss of €136

  in profit or loss.

  Bank A also remeasures the loss allowance, taking into account the modified contractual cash flows and

  evaluates whether the loss allowance for the loan should continue to be measured at an amount equal to

  lifetime ECLs. Bank A compares the current credit risk (taking into consideration the modified cash flows)

  to the credit risk (on the original unmodified cash flows) at initial recognition. Bank A determines that the