Financial Instruments: Recognition and Measurement
Amortised cost - an expected cash flow approach
The staff introduced the session with a brief overview of the key features of an expected cash flow approach to recognising impairment for assets measured at amortised cost. In particular they reminded Board members that this approach would remove the requirement to identify a trigger event before recognising credit losses.
Board members discussed the worked examples provided by the staff in their agenda paper. Initial discussions concentrated on Example 3 which illustrates a scenario where the amortised cost is calculated to be higher than original cost. Some Board members were uncomfortable with this if the objective of the expected loss model is to measure impairment, as a carrying value exceeding cost would seem counter-intuitive (ie indicating negative impairment). Other Board members were happy with the example as they believed it was a consequence of effective interest rate methodology and simply represented the present value of future interest and principal cash flows.
Discussion moved on to how the expected cash flows used to calculate the effective interest rate would be defined. Board members requested clarification on whether the expected cash flows would be the entity's own expectation of cash flows or the entity's estimate of a market participant's expectation of cash flows. Board members also requested further clarity on which risks should be included in the expected cash flow and which risks should be included in the effective interest rate.
One Board member questioned whether the expected loss model actually reduced complexity and the burden on preparers because of the need to reassess expected cash flows on a continuous basis even where there have been no impairment triggers. Other Board members felt that the removal of impairment triggers in the current incurred loss model would reduce complexity overall.
The staff informed the Board that they are in the early stages of exploring with some banks the systems impact of an expected loss approach.
Board members requested the staff to give more detail on how collective and individual impairment would work under an expected cash flow approach. The staff informed the Board that the interaction between individual and collective impairment would be another topic covered in their discussion with banks to gain an understanding of the practical impacts.
Some Board members expressed concern that an expected loss model may obscure the reporting of credit losses as in cases where expected losses are correctly estimated at inception, no bad debts would subsequently be recorded.
Amortised cost - objective of an impairment test and implications for financial assets
The staff presented their paper setting out the differing complexities for measuring impairment of financial assets versus non-financial assets.
It was explained that the general approach for measuring impairment for non-financial assets is based on current values due to the nature of such instruments. However, for financial assets, alternatives are available as cash flows associated with such instruments are contractual.
The Board expressed an understanding of the different characteristics of financial and non-financial assets and the consequential different impairment approaches available.