IASB proposes new impairment model

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07 Mar 2013

The International Accounting Standards Board (IASB) has published its long-awaited proposal for a new accounting model for impairments of financial assets. In the Exposure Draft (ED) the Board proposes a model according to which credit losses are no longer recognised if incurred; rather, entities would recognise expected credit losses on financial assets and on commitments to extend credit based upon current estimates of expected shortfalls in contractual cash flows as at the reporting date. Comments are due 5 July 2013.


Exposure Draft ED/2013/3 Financial Instruments: Expected Credit Losses contains a revised approach as regards the impairment of financial assets. Since 2009 the Board has been developing a new approach for recognising impairments. During the global financial crisis, the IASB came under pressure to change its requirements, which were perceived as being complex and inconsistent, and to provide for a more timely recognition of dawning credit losses. Under the current rule set in IAS 39 Financial Instruments: Recognition and Measurement, a financial instrument is impaired and impairment losses are incurred if a loss event occurred and this loss event had a reliably measurable impact on the future cash flows (so-called Incurred Loss Model, ILM).

In November 2009 the IASB published its first proposal in which it suggested measuring expected credit losses through adjusting the effective interest rate of a financial instrument (ED/2009/12 Amortised Cost and Impairment). This approach was based on the fact that expected credit losses of a financial asset are usually priced into the interested rate to be charged. Hence, expected credit losses should ideally be reflected in the yield on the financial asset, whereas changes in credit loss expectations should be recognised when incurred as those changes are not priced into the asset. This original approach was hailed as being conceptually sound, however, it was also deemed impracticable given that the tracking that is needed to follow changes in credit for the individual instrument is seldom done.

In January 2011, the IASB and the U.S. Financial Accounting Standards Board (FASB) issued a supplement in which they proposed to de-couple interest recognition from the recognition of impairments (ED/2011/1 Supplementary Document). Financial instruments would have been allocated to a ‘good book’ and a ‘bad book’, whereby the former would comprise those financial assets for which there had been no loss as at the reporting date. All other instruments would be allocated to the ‘bad book’. While for financial assets in the ‘bad book’ an allowance equal to the credit losses expected over the remaining life of the instruments would be recognised —which is not that different to what used to be done for instruments under the ILM—, the allowance booked for assets allocated to the ‘good book’ would be a time-proportionate allocation of credit losses expected over their life. If an entity expected a higher amount for the foreseeable future, it would then book that higher amount instead of the time-proportionate amount.

Since 2011 the IASB and FASB have worked on fine-tuning this approach, which is still the basis of the current proposal. Two questions were of special concern to the Boards: (1) What amount should be recognised for assets in the ’good book’? (2) When and how should assets move between ‘good book’ and ‘bad book’ if their credit significantly deteriorated or improved? Although the FASB had decided in July 2012 not to pursue the jointly developed approach any further and to issue its own impairment model instead, the IASB continued the work.

If finalised the proposals now published in the ED would be integrated into IFRS 9 Financial Instruments as a separate section.


Summary of key proposals

Objective. The objective is to recognise expected credit losses for all financial instruments within the scope of the requirements. Expected credit losses are defined as the expected shortfall in contractual cash flows. An entity should estimate expected credit losses considering past events, current conditions and reasonable and supportable forecasts.

Scope. The following instruments are within the scope of the proposed requirements:

  • all financial assets measured at amortised cost;
  • all debt instruments measured at fair value through other comprehensive income under the new proposal issued in December 2012;
  • all trade and lease receivables; and
  • other financial instruments subject to credit risk, such as written loan commitments and written financial guarantee contracts as long as they are not measured at fair value through profit or loss.

Impairment – Amount. The impairment amount to be recognised on these financial instruments depends on whether or not they have significantly deteriorated since their initial recognition. Three stages are being distinguished:

  • Stage 1: Financial instruments whose credit quality has not significantly deteriorated since their initial recognition;
  • Stage 2: Financial instruments whose credit quality has significantly deteriorated since their initial recognition; and
  • Stage 3: Financial instruments for which there is objective evidence of an impairment as at the reporting date.

For stage 1 financial instruments, the present value of 12-month expected credit losses are recognised which are the expected shortfalls in contractual cash flows over the life of a financial instrument that will result if a default occurs in the 12 months after the reporting date (12 months expected credit losses); in contrast, an impairment is recognised for financial instruments classified as stage 2 or 3 at the present value of expected credit shortfalls over their remaining life (lifetime expected credit loss).

Impairment – Recognition. For financial assets entities would recognise a loss allowance whereas for commitments to extend credit a provision would be set up to recognise expected credit losses.

Interest. For stage 1 and 2 instruments interest revenue would be calculated on their gross carrying amounts, whereas interest revenue for stage 3 financial instruments would be recognised on a net basis (i.e. after deducting expected credit losses from their carrying amount).

Purchased or originated credit-impaired financial assets. Rather than apply the two-stage approach, changes in lifetime expected credit losses in the estimate of lifetime losses since initial recognition are recognised directly in profit or loss.

Simplified approach for trade and lease receivables. Entities will have an accounting policy choice to always measure the impairment at the present value of expected cash shortfalls over the remaining life of the receivables instead of applying the two-class model.

New disclosures. The proposed approach comes with new disclosure requirements, including a reconciliation, a description of inputs and assumptions used to measure expected credit losses, and information about the effects of the deterioration and improvement in the credit risk of financial instruments.

Effective date. The IASB will decide on the effective date only upon completion of its redeliberations.


Comparison with FASB proposal

In December 2012 the FASB published its proposed model on Current Expected Credit Losses (CECL). The key difference between the IASB’s proposals above and the FASB’s approach is that the FASB would not distinguish between instruments that have deteriorated since their initial recognition and those that have not. Instead, the FASB would require a single measurement model for all financial instruments when determining the impairment allowance: At initial recognition entities would recognise a charge equalling the present value of lifetime expected credit losses.

Comments on the IASB’s proposal are due 5 July; the comment period for the FASB’s ED will already end 30 April.


Additional information

The ED will be discussed in the upcoming Dbriefs webcast — IFRS: Important developments on 27 March.

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