Financial instruments – Amortised cost and impairment

Date recorded:

The Board continued its discussions on the amortised cost and impairment project, specifically with regard to the recognition of subsequent changes in expected losses. At the 5 October 2010 Board meeting, the staff presented the Board with information about two possible alternatives for recognising subsequent changes in expected losses that could be operational in the context of open portfolios (the full catch up method proposed in the ED was criticised as not operational for open portfolios).

The first alternative is the time proportionate (or partial catch-up) approach which allocates a constantly updated estimate of expected losses over the total life of the portfolio with the amount recognised in the current period representing those expected losses that would have been recognised to date had they been included in the initial estimate. The second alternative is the single period allocation (or no catch-up) approach which would spread the subsequent changes in expected losses proportionately over the current and future periods.

During today's meeting, the staff provided information on what the amounts within the statement of financial position and within profit and loss represent under IAS 39, the full catch up approach in the ED, and the partial and no catch up approach alternatives. Amortised cost under the proposal in the ED represents the present value of all future expected cash flows. However, by addressing the operational limitations of the ED proposal, usage of either the partial catch up or the no catch up approach makes understanding the amount recognised in the statement of financial position more difficult (particularly for the no catch up method which also introduces a ceiling/floor concept for the loss allowance).

The Board generally struggled with the no-catch up approach primarily because of the difficulty in explaining what the amount recognised within the statement of financial position represented. The Board reaffirmed their support of the conceptual basis for amortised cost measurement in the ED but acknowledged that to address the operational issues for open portfolios, the partial catch-up approach would be the only alternative that somewhat maintained the principles within the ED.

The topic shifted to scope with one Board member expressing concern as to whether even the partial catch-up method could be applied by non-financial institutions. The staff responded that they are currently developing a model that would be operational for open portfolios (and therefore for closed portfolios as well). The Board could later consider whether the standard would impose further scope limitations to certain financial instruments (e.g., short term trade receivables) or certain types of entities (e.g., non-financial entities).

Some Board members raised the question of whether they should be considering two separate models, the partial catch-up approach for open portfolios and the full catch-up model (as proposed in the ED) for closed portfolios or individually significant items (e.g., leveraged buy-out loans). Another Board member mentioned that another alternative would be to retain the fundamental concepts contained within the ED and perhaps permit practical expedients for open portfolios by using a partial catch-up approach.

The Board made no definitive decisions, but did provide the staff with direction by eliminating the no-catch up approach from further consideration and concentrating their efforts between further development of the partial catch-up approach and reconsideration of the full catch-up approach from the exposure draft.

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