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FRC calls for responses to its draft comment letter on the IASB’s impairment proposals

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17 May 2013

The Financial Reporting Council (FRC) has prepared a draft comment letter giving its preliminary views on the International Accounting Standard Board's (IASBs) Exposure Draft ED/2013/3 'Financial Instruments: Expected Credit Losses'. The draft comment letter seeking responses provides a clear indication that the FRC are satisfied with the majority of the proposals in the Exposure Draft (ED) and feel that they are likely to meet users’ needs to provide expected credit losses.

The ED proposes a model under which credit losses would no longer be recognised if incurred. Instead 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.  The draft comment letter states:  

We believe that the ED’s proposals strike a reasonable balance between costs of implementation and underlying economics and are likely to meet users’ need to provide expected credit losses. 

Although satisfied with the majority of the proposals the FRC draft comment letter makes a number of suggestions, not least, in their view, to ensure consistency of application in practice, on specific aspects of the proposals that the FRC feel will need to be clarified by the IASB.  Such suggested areas for improvement include: 

  • Clarification of the concepts of ‘significant deterioration’ and ‘undue cost and effort’, the second of which may be interpreted differently by different constituents depending upon who they are.
  • Clarification of the interest rates that can be used in the approach, ensuring that interest revenue and the credit losses are calculated using the same rate. 
  • Clarification of how the model applies in the case of financial assets where a financial institution is applying forbearance and the modification does not result in a new asset. 

The FRC draft comment letter is consistent with the comments expressed by the European Financial Reporting Advisory Group (EFRAG) in their draft comment letter on 16 April 2013.  Both commented that the recognition of a portion of expected credit losses at initial recognition is not conceptually sound but is a pragmatic solution in the absence of a better model.  Both the FRC and EFRAG also acknowledge that the proposals in the ED overcome a number of operational challenges highlighted by constituents commenting on the 2009 ED. For example having to estimate the full expected cash flows for all financial instruments and the subjectivity in calculating expected losses in the “good book”.  The FRC comment that such simplifications will make application of the model easier to apply to all types of entities.  They note:   

We agree with the IASB that these operational simplifications would result in an improvement in financial reporting as they would ensure earlier recognition of expected credit losses, lead to a reduction in systematic overstatement of interest revenue, and provide useful information on credit deterioration. 

Additionally the draft comment letter goes on to explain that because of the extensive IT requirements which would be required , the FRC would expect to see a mandatory date set three years from the effective date of the standard to allow entities to make the necessary changes.  But the FRC also say that entities that have transitioned systems earlier should not be precluded from adopting the new standard before the mandatory effective date. 

Constituents are invited to send comments direct to the FRC by 14 June 2013.

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