discussed the interaction of IFRS 9 and IAS 28 – Investments in Associates and Joint
Ventures, when a loan is regarded as part of ‘long-term interests that, in substance, form part
of the entity’s net investment’ as set out in paragraph 38 of IAS 28, which gives as an
example, ‘an item for which settlement is neither planned nor likely to occur in the
foreseeable future’. The IFRIC concluded that although a loan is considered as ‘in substance
part of the investment’, for the purposes of allocating losses in IAS 28, it is still in the scope
of IFRS 9 as it is not ‘an investment’ as mentioned in scope paragraph 2.1 (a) of IFRS 9 and,
except for the allocation of losses, is not accounted for using the equity method. Since then,
in October 2017, the IASB amended IAS 28 to clarify that IFRS 9 should be applied to long
term interests in associates and joint ventures.
The IFRIC discussion on long-term interests in associates was in the context of IAS 28
and not IAS 27. It is perhaps relevant that IFRS 9 in its scope paragraph refers to ‘interests’
in subsidiaries, rather than ‘investments’, although IAS 27 itself uses ‘investments’. IAS 27
also allows investments to be at cost, rather than accounted for using the equity method.
However, it would probably be difficult to sustain an argument that ‘investments’ as used
in IAS 27, encompasses loans which are, in substance, part of the net investment, when
the IFRIC has concluded that the same term in IAS 28 does not.
Having said that, an undocumented interest free loan to a subsidiary, when there is no
expectation of repayment, may, in substance, be more like a capital contribution. If this
is the case, then it will be helpful to document it as such (with the features of equity)
and then it may be measured at cost and subject to the impairment requirements of
IAS 36 – Impairment of Assets – rather than those of IFRS 9. The amendment of a loan
(if previously documented as such) to a capital contribution would be similar to a
forgiveness of the debt and so, as already mentioned above, may have implications for
(or be constrained by) tax and may only in future be capable of being repaid if there are
adequate distributable profits.
Another example of where it may be helpful to restructure (and so amend the
documented terms of) loans is where a subsidiary is only financed by loan capital and
there is little or no equity capital, a situation that tax experts refer to as ‘thinly
capitalised’. Interest paid on a portion of the loan may be disallowed for tax purposes,
reflecting that a portion of the loan is, in substance, the subsidiary’s capital. The
requirements of IFRS 9 may make it worthwhile for such loans to be restructured (and
the new terms documented), so that a portion becomes an investment in the subsidiary,
which is outside the scope of the standard. This has the additional benefit that the
probability of default on the remaining portion of the loan will be lower if the company
has loss absorbing equity. Before restructuring loan arrangements, any possible tax
consequences or the need for future distributable profits in order to repay investments
should be considered.
Most intercompany loans will qualify to be measured at amortised cost (see Chapter 44),
since they are held in a business model to collect the cash flows rather than to sell the
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loan and they normally have features which represent solely payments of principal and
interest. Loans which may provide greater challenges include:
a)
Some loans pay no interest, even though they are not expected to be repaid for a
number of years. If they are not repayable on demand then these will normally be
recognised initially at fair value and so at less than par. The discount will then be
accreted to par as part of the EIR. Consequently they are deemed to pay interest
and so may satisfy the SPPI criterion.
(b) Loans that are ‘non-recourse’ as described in Chapter 44 at 6.5, in which
repayment of the loan is either contractually or implicitly dependent on the
performance of an asset or assets held by the subsidiary. This is most likely to be
an issue for loans to SPEs or other related parties such as joint ventures, where
there is insufficient equity capital to absorb the likely variability of cash flows of
the underlying asset(s). This problem is equivalent to the ‘thin capitalisation’ issue,
described above. Such non-recourse loans are required to be measured at fair
value through profit or loss.
All financial assets within the scope of IFRS 9 must be measured on initial recognition
at fair value (see Chapter 45 at 3). This means that an interest free loan, or a loan at
below a market rate of interest, will need to be recognised initially at less than its
nominal value unless it is repayable on demand. This criterion would require both that
the lender may legally call the loan and that it is expected that the subsidiary would be
able to repay the loan if called. The fair value of the loan on initial recognition will
normally reflect the economics of the arrangement. The loan will then accrete in value
over its expected life, and so will compensate the lender for the time value of money
and credit risk, and so qualify to be recorded at amortised cost.
If the fair value of the loan when first recorded is less than the par value, the accounting
for the difference will depend on whether the loan is to a subsidiary, a fellow subsidiary
or to a parent. If the loan is to a subsidiary, the difference will normally be recorded as
a capital contribution, which will be outside the scope of IFRS 9 and is in the scope of
IAS 27. If the loan is to a fellow subsidiary or to a parent it will normally be recorded as
a distribution of capital to the parent.
It should be stressed that any ECLs measured on a loan to a group company will require
a charge to profit or loss; the expense cannot be capitalised as part of the investment in
a subsidiary.
Compared to most loans to third parties, a lender within a group is likely to have access
to much more qualitative and quantitative information about the credit risk of the
borrower. Consequently the staging assessment is likely to be much better informed than
for a third party loan and will be, primarily, a qualitative exercise. In many cases, it will be
reasonably clear whether there has been a significant increase in credit risk since the
inception of the loan, although judgement will still be required to determine whether it is
‘significant’. Circumstances that indicate a significant increase in credit risk may include a
significant change in the business, financial or economic conditions, or regulatory,
economic or technological environment in which the borrower operates, declining
revenues and margins, or capital deficiencies. Any of these changes are likely to have a
significant impact on the entity’s ability to meet its debt obligations. [IFRS 9.B5.5.17 (f), (g), (i)].
Financial instruments: Impairment 3861
Also, the credit risk on a loan depends in part on the level of loss absorbing equity of
the borrowing entity. If the parent of a group company commits to support a distressed
subsidiary (in advance of becoming distressed) by injecting new equity, this
may mean
that there is no significant increase in the credit risk of the loan.
Moreover, if a subsidiary is guaranteed by its parent, it will often be appropriate to
assume that the parent will not let the subsidiary default. Therefore, for a guaranteed
loan it may be the parent’s credit standing that will determine whether the loan should
be in stage 1 (and accordingly the entity would recognise 12-month ECLs) or in stage 2
(and accordingly the entity would recognise lifetime ECLs).
a)
It is probably fair to say that much less attention has been paid to how to calculate
ECLs on intercompany loans than on other aspects of IFRS 9. Some other key
considerations when analysing intercompany loans are, but not limited to, the
following: If a loan is repayable on demand, the period over which losses should
be calculated would normally be no more than 24 hours and therefore, the PD may
be very small, since ECLs are only measured over the period in which the entity is
exposed to credit risk. However, this treatment would not be appropriate for loans
that may be documented as on demand, but in substance provide long term
finance. Such loans cannot be repaid if called because the borrowing group entity
does not have access to the means to repay or to other sources of financing. Should
the loan repayment be demanded, the probability of default would be 100% if the
entity could not repay it. However, even though the PD may be 100%, the LGD
may be much lower if the lender can expect in due course to recover most or all
of the amount of the loan once the underlying assets are realised. To avoid this,
entities may wish to consider renegotiating the contractual terms of such loans in
order to better reflect the substance of the arrangement. This could mean
restructuring and re-documenting a demand loan as an equity contribution (that is
not in the scope of IFRS 9), or as a term loan and the ECL would then be calculated
on that basis.
b) For those stage 1 intercompany loans that are term loans with a maturity greater
than 12 months, it will be necessary to determine the PD over 12 months and the
LGD. This will often be difficult given that there will be no statistical basis to do
so. It will be easier to assess a PD and for it to be reasonably low if the borrower is
adequately capitalised relative to the risks it faces, so that it could raise funding
from a third party.
c) For those intercompany loans between fellow subsidiaries that are explicitly
guaranteed by a parent, the ECLs may be much lower. Also, if the parent is listed and
the guarantee is considered to be integral to the loan (see 5.8.1.A above)), the ECL
will normally be equal to the parent’s PD multiplied by its LGD. That is because, the
parent will usually ensure, if it can do so, that its subsidiary will not default (and the
subsidiary is also likely to default if the parent does). It will often be much easier to
calculate an ECL based on a parent PD and LGD, since there may be bond spreads,
credit default swap (CDS) spreads and credit ratings to draw upon. Therefore, it may
be advisable to document guarantee arrangements when this is already the implicit
basis on which the loan was given. However, it may be that the parent has no other
activities other than acting as a holding entity, in which case its PD will be closely
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aligned with that of its subsidiaries. There could also be situations where the
subsidiary can be expected to survive even if the parent defaults.
d) To the extent that the lender is the parent, it cannot of course for its own
accounting purposes rely on guarantees given to itself. Meanwhile, any entity that
does provide a guarantee will need to measure its exposure to the guarantee, hence
the existence of a guarantee does not remove the challenge of calculating the PD
and LGD of the subsidiary. In general, the fact that a group intends to ensure that
a subsidiary will never default does not eliminate the risk posed by that subsidiary’s
activities or remove the need for an ECL allowance.
e) In some cases it may be possible to derive a PD for a loan to a group entity based
on the cost of loans provided to that, or similar entities, by external lenders.
14
PRESENTATION OF EXPECTED CREDIT LOSSES IN THE
STATEMENT OF FINANCIAL POSITION
IFRS 9 uses the term ‘loss allowance’ throughout the standard as an umbrella term for
ECLs that are recognised in the statement of financial position. However, that umbrella
term leaves open the question of how those ECLs should be presented in that statement.
Their presentation differs by the type of the credit risk exposures that are in scope of
the impairment requirements. [IFRS 9 Appendix A]. This section explains how presentation
applies in the different situations.
Any adjustment to the loss allowance balance due to an increase or decrease of the
amount of ECLs recognised in accordance with IFRS 9, is reflected in profit or loss in a
separate line as an impairment gain or loss. [IAS 1.82(ba), IFRS 9.5.5.8, Appendix A].
14.1 Allowance for financial assets measured at amortised cost,
contract assets and lease receivables
ECLs on financial assets measured at amortised cost, lease receivables (see Chapter 23
and 24) and contract assets (see Chapter 28) are presented as an allowance, i.e. as an
integral part of the measurement of those assets in the statement of financial position.
Unlike the requirement to show impairment losses as a separate line item in the
statement of profit or loss, there is no similar consequential amendment to IAS 1 to
present the loss allowance as a separate line item in the statement of financial position.
[IAS 1.82(ba)].
It is clear from the standard that the definition of amortised cost of a financial asset is
after adjusting for any loss allowance and hence, the loss allowance would reduce the
gross carrying amount in the statement of financial position (which is why an allowance
is sometimes referred to as a contra asset account). [IFRS 9 Appendix A]. Accordingly,
financial assets measured at amortised cost, contract assets and lease receivables should
be presented net of the loss allowance at their amortised cost in the statement of
financial position.
This was confirmed at the ITG meeting in December 2015, when the ITG discussed
whether an entity is required to present the loss allowance for financial assets measured
at amortised cost (or trade receivables, contract assets or lease receivables) separately
Financial instruments: Impairment 3863
in the statement of financial position. The ITG members first noted that irrespective of
how the loss allowance is presented or how it is included in the measurement of the
financial instrument, IFRS 7 contains disclosure requirements pertaining to the loss
allowance for all financial instruments within the scope of the IFRS 9 impairment
requirements. The ITG members also noted that, in contrast to the case of financial
assets measured at fair value through other comprehensive income, neither IFRS 9 nor
IFRS 7 contains any specific requirements regarding the presentation of the loss
allowance for financial assets measured at amortised cost (or trade receivables, contra
ct
assets or lease receivables) on the face of the statement of financial position. In
accordance with the general requirements of IAS 1, the financial statements should fairly
present the financial position of an entity. However, the ITG members noted that
paragraph 54 of IAS 1 does not list the loss allowance as an amount that is required to
be separately presented on the face of the statement of financial position.
14.1.1 Write-off
IFRS 9 provides guidance on when the allowance should be used, i.e. when it should be
applied against the gross carrying amount of a financial asset. This occurs when there is
a write-off on a financial asset, which happens when the entity has no reasonable
expectations of recovering the contractual cash flows on a financial asset in its entirety
or a portion thereof. A write-off is considered a derecognition event.
[IFRS 9.5.4.4, B3.2.16(r)]. No similar guidance was provided previously in IAS 39 and its
derecognition guidance does not refer to write-offs.
For example, a lender plans to enforce the collateral on a loan and expects to recover
no more than 30 per cent of the value of the loan from selling the collateral. If the lender
has no reasonable prospects of recovering any further cash flows from the loan, it should
write off the remaining 70 per cent. [IFRS 9.B5.4.9]. The example given in the standard
demonstrates that write-offs can be for only a partial amount instead of the entire gross
carrying amount.
If the amount of loss on write-off is greater than the accumulated loss allowance, the
difference will be an additional impairment loss. In situations where a further
impairment loss occurs, the question has arisen as to how it should be presented: simply
as a loss in profit or loss with a credit directly to the gross carrying amount; or first, as
an addition to the allowance that is then applied against the gross carrying amount. The
difference between those alternatives is whether the additional impairment loss flows
through the allowance, showing up in a reconciliation of the allowance as an addition
and a use (i.e. a write-off), or whether such additional impairment amounts bypass the
allowance. The IASB’s original 2009 Exposure Draft (see 1.1 above) explicitly mandated
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