New IFRS For Impairment Of Financial Instruments
After the financial crisis of 2007-8, it became glaringly obvious that amendments were necessary to the existing accounting rules for financial instruments. The International Accounting Standards Board (IASB) issued IFRS 9, Financial Instruments on July 24, 2014. The following is a summary of the new impairment rules.
Overview of expected credit loss model
The following financial instruments fall within the scope of the expected credit loss (ECL) model:
Financial assets measured at amortized cost; Financial assets mandatorily measured at fair value through other comprehensive income (FVOCI); Loan commitments that are not measured at fair value through profit and loss (FVPL) when there is a present obligation to extend credit; Financial guarantee contracts that are within the scope of IFRS 9 and that are not measured at FVPL; and Lease and trade receivables. The current loss model under IAS 39 only allows impairment provisions for losses occurring at the reporting date. The new impairment rules are forward-looking, which will have major implications for preparers of financial statements.
A 12-month ECL allowance is recognized at each reporting period for financial instruments that have not seen a significant increase in credit risk. The 12-month ECL is a portion of the lifetime ECL and represents the amount of expected credit losses resulting from a default in the 12 months following the reporting date.
For all financial instruments undergoing a significant increase in credit risk, a lifetime ECL is recognized. If afterwards, the credit risks decreases, so that the criteria for recognizing a lifetime ECL is no longer met, then the entity measures the loss allowance as the 12-month ECL.
The ECL is the present value of the expected cash shortfalls over the life of the financial instrument. Measurement should take into account an unbiased and probability weighted estimate of cash flows under a range of possible outcomes. The degree to which judgment is exercised will depend on the availability of information.
In assessing credit risk, only the risk of default over the remaining term of the financial instrument is considered. The exercise can be performed for a portfolio of instruments with shared credit risk. Although the standard does not prescribe the method to use, the objective is to use all reasonable and supportable information including forward-looking information, which is available without undue cost or effort.
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