Financial instruments – impairment

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In February 2014, the IASB finalized the tentative impairment model for financial instruments that incorporates the proposals in the “2013 Exposure Draft, Expected Credit Losses”, published in May 2013 and the decisions made during the deliberation process. It is expected that the new impairment requirements will be incorporated into IFRS 9, Financial Instruments, during the second quarter of 2014.

The tentative expected credit loss (ECL) impairment model 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’. Under the ECL model, expected losses are recognized throughout the life of a financial asset measured at amortized cost, not just after a loss event has been identified. The expected credit loss is measured as the present value of the expected cash shortfalls over the life of the financial instrument. It is expected that impairment losses will not only be larger but will also be recognized earlier.

For all financial instruments in scope of the tentative ECL model, an entity should measure the expected credit losses at an amount equal to 12-month expected credit losses if the financial instrument was not credit-impaired on initial recognition and 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. The Board tentatively confirmed the proposed rebuttable presumption that there is a significant increase in credit risk when contractual payments are more than 30 days past due.

The twelve-month ELC are a portion of the lifetime ECL and represent the amount of expected credit losses that would result from a default in the 12 months after the reporting date. Therefore, they do not represent:

  1. lifetime ECL that an entity will incur on financial instruments that it predicts will default in the next 12 months; or
  2. the cash shortfalls only expected to occur in the 12-months period after the reporting date.

Under the tentative ECL model, interest revenue is calculated 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. 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.

The IASB tentatively decided to require an entity to apply IFRS 9 for annual periods beginning on or after January 1, 2018. When effective, the new impairment model would be applied retrospectively, with certain practical expedients.

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