Impairment of Financial Assets as per IFRS 9 is based on ‘Expected Losses‘, UNLIKE IAS 36 which operates an Incurred Loss Model (i.e. Impairment is recognized only when an event has occurred which has caused a fall in the recoverable amount as compared to carrying amount of an asset).
Anticipating credit losses is a PRUDENT approach, it is LESS likely that assets will be over-stated. Users of the ‘Financial Statements’ are also provided with timely information because they are warned about potential impairment issues before actual defaults have occurred.
Table of Contents
Impairment of Financial Assets (As Per IFRS 9)
1. Overview of the New Impairment Model
IFRS 9 establishes a ‘three-stage impairment model‘, based on whether there has been a significant increase in the credit risk of a financial asset since its initial recognition.
These THREE stages then determine the amount of impairment to be recognized as expected credit losses (ECL) at each reporting date as well as the amount of interest revenue to be recorded in future periods:
| Stage 1: Credit risk has not increased significantly since initial recognition – Recognize 12 Months ECL, and recognize interest on a gross basis. |
| Stage 2: Credit risk has increased significantly since initial recognition – Recognize Lifetime ECL, and recognize interest on a gross basis. |
| Stage 3: Financial asset is credit impaired [The Financial Asset is written down to its estimated recoverable amount] – Recognize Lifetime ECL, and recognize interest on a net basis (i.e. on the gross carrying amount less credit allowance). |
Impairment of Financial Assets – Scope
The following ‘Financial Instruments‘ are INCLUDED within the scope of the IFRS 9:
- Debt Instruments Measured at Amortized Cost;
- Debt instruments measured at (FVOCI) Fair Value through Other Comprehensive Income;
- Issued loan commitments (Except those measured at FVPL);
- Issued financial guarantee contracts (Except those measured at FVPL);
- Lease receivables within the scope of IFRS 16; AND
- Contract assets within the scope of IFRS 15.
Key Definitions
1. Credit Loss
The DIFFERENCE between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. all cash shortfalls), discounted at the Original Effective Interest Rate.
2. Expected Credit Losses (ECL)
The weighted average of credit losses with the respective risks of a default occurring as the weights.
3. Lifetime Expected Credit Losses
The expected credit losses that result from all possible default events over the expected life of a financial instrument.
4. 12-Month Expected Credit Losses
The portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date.
IFRS 9 Impairment of Financial Assets – Expected Loss Model (ECL)
1. Simplified Approach
1.1 Compulsory Application
- Trade Receivable without ‘Significant Financing Component‘
- Contract Assets without ‘Significant Financing Component’
1.2 Optional Application
For following financial assets, an entity has to choose an accounting policy to be applied consistently EITHER the ‘General Approach‘ or ‘Simplified Approach‘ for recognizing expected credit losses:
- Trade Receivable with ‘Significant Financing Component’
- Contract Assets with ‘Significant Financing Component’
- Lease Receivables
1.3 Measurement
IFRS 9 requires a loss allowance measured as the lifetime expected credit losses to be recognized. Because the maturities will typically be 12 months or less, the credit loss for 12 Month and Lifetime ECL would be the same.
Expected credit losses on trade receivables can be calculated using ‘Provision Matrix‘.
2. General Approach
2.1 Compulsory Application
- Debt Instruments measured at Amortized Cost
- Debt Instruments measured at ‘Fair Value through Other Comprehensive Income‘ (FVOCI)
2.2 Optional Application
For following financial assets, an entity has to choose an accounting policy to be applied consistently EITHER the ‘General Approach‘ or ‘Simplified Approach‘ for recognizing expected credit losses:
- Trade Receivable with ‘Significant Financing Component’
- Contract Assets with ‘Significant Financing Component’
- Lease Receivables
2.3 Measurement at Initial Recognition
IFRS 9 requires a loss allowance measured as the 12 Month Expected Credit Losses (ECL) to be recognized at initial recognition.
2.4 Measurement at Subsequent Recognition
The expected credit losses associated with the financial asset is then reviewed at each subsequent reporting date. The amount of expected credit loss recognized as a loss allowance depends on the extent of credit deterioration since initial recognition.
- If there is No Significant Increase in Credit Risk, the loss allowance for that asset is remeasured to the 12 Month Expected Credit Loss as at that date.
- If there is a Significant Increase in Credit Risk, the loss allowance for that asset is Re-Measured to the Lifetime Expected Credit Loss as at that date. [This does NOT mean that the financial asset is impaired]. ‘The entity still hope to collect amounts due but the possibility of a loss event has increased.’
| A Significant Increase in Credit Risk can Include: |
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| – Changes in general economic and/or market conditions (e.g, Expected increase in unemployment rates, interest rates); – Significant changes in the operating results or financial position of the borrower; – Changes in the amount of financial support available to an entity (e.g, from it’s Parent); – Expected or potential breaches of covenants; Expected delay in payment (Rebut-table presumption that credit risk has increased significantly when contractual payments are more than 30 days past due). |
- If there is Credit Impairment, the financial asset is written down to its estimated recoverable amount. The entity accepts that NOT all contractual cash flows will be collected and the asset is impaired.
‘Credit Impairment’
A ‘Financial Asset’ is credit impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred.
Evidence that a financial asset is credit impaired include but NOT limited to observable data about the following events:
- Significant financial difficulty of the issuer or the borrower;
- Actual breach of contract (e.g, default or delinquency in payments);
- Granting of a concession to the borrower due to the borrower’s financial difficulty;
- Probable that the borrower will enter bankruptcy or other financial reorganization;
- Disappearance of an active market for that financial asset because of financial difficulties; OR
- Purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.
If an entity REVISES its estimates of receipts it must adjust the gross carrying amount of the financial asset to reflect actual and revised estimated contractual cash flows.
It must be Re-Measured to the present value of estimated future cash flows from the asset discounted at the Original Effective Rate.
| Future Revenue Recognition |
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| Interest is recognized in the future by applying the effective rate to the new amortized cost (after the recognition of the impairment loss). |
| Reversal of Impairment |
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| Subsequently, if the credit risk of the financial instrument improves so that the financial asset is no longer credit impaired and the improvement can be related objectively to an event since the ‘Net Method’ was applied, the calculation of interest revenue reverts to the ‘Gross Method’ from the beginning of the next reporting period. |
2.5 Loss Allowance
| Loss Allowance for Financial Assets Carried at Amortized Cost | Loss Allowance for Financial Assets Carried at FVOCI |
|---|---|
| Movement on the loss allowance is recognized in Profit or loss. The loss allowance balance is netted against the financial asset to which it relates on the face of the statement of financial position. This is just for PRESENTATION only; the loss allowance does not reduce the carrying amount of financial asset in the double entry system. | Movement on the loss allowance is recognized in Profit or loss but the loss allowance balance is not netted against the financial asset to which it relates as this is carried at fair value. The loss allowance is RECOGNIZED in other comprehensive income (OCI). |
3. Purchased or Originated Credit-Impaired Financial Assets
If a Financial Asset is Credit Impaired when Purchased, then interest income is calculated using a credit adjusted effective interest rate.
This incorporates expected lifetime credit losses at the inception date and therefore the allowance recorded against such assets should only be the change in the lifetime expected credit losses since inception.
Synopsis
Impairment of Financial Assets as per IFRS 9 requires entities to assess ‘Expected Credit Losses’ based on historical information, current conditions, and future expectations.
The three-stage approach categorizes ‘Financial Assets’ into different groups based on credit risk. Initially, assets are subject to a 12-month expected credit loss, and if there is a SIGNIFICANT increase in credit risk, a lifetime expected credit loss is recognized.
Chartered Accountant – ICAP
Bachelor of Accounting (Honours) – AeU, Malaysia