In March 2013, the IASB issued an exposure draft (ED), ‘Financial instruments: Expected credit losses’. This is a result of several years of discussions and follows two previously published impairment proposals. The ED outlines an expected loss model that will replace the current incurred loss model of IAS 39, ‘Financial instruments: Recognition and measurement’. It seeks to address the criticisms of the incurred loss model and, in particular, that it caused impairment losses to be recognized ‘too little and too late’. It is expected that impairment losses will not only be larger but will also be recognized earlier.
Under the ED, an entity should measure the expected credit losses for a financial instrument at an amount equal to 12-month expected credit losses if the credit risk of the financial instrument has not increased significantly since initial recognition. However, lifetime expected credit losses are required to be provided for if, at the reporting date, the credit risk of the financial instrument has increased significantly since initial recognition.
Twelve-month expected credit losses do not represent the cash shortfalls only expected to occur in the 12-month period after the reporting date. Rather, they equate to the present value of all cash shortfalls expected to occur over the remaining life of the instrument resulting from default events on the financial instrument that are possible within the 12-month period after the reporting date.
Interest revenue is calculated under the ED using the effective interest method on an asset’s gross carrying amount. Similar to today, it should be presented as a separate line item in the statement of profit or loss and other comprehensive income. But, once there is objective evidence of impairment (that is, the asset is impaired under the current rules of IAS 39), interest is calculated on the carrying amount, net of the expected credit loss allowance.
Comments are due to the IASB on the ED by 5 July 2013. All constituents are encouraged to provide feedback to the board, particularly those in the banking and insurance industries, who will be most significantly affected by the proposals. The IASB expects to finalize the impairment requirements by the end of 2013.
The proposal does not specify its effective date, but is seeking comments on the appropriate mandatory effective date for all phases of IFRS 9.