Following several years of discussions and two previously published proposals, the IASB has issued an exposure draft, Financial Instruments: Expected Credit Losses. The proposed guidance introduces an expected loss impairment model that will replace the incurred loss model used today.
Under the proposed model, an entity will recognize an impairment loss at an amount equal to the 12-month expected credit loss. If the credit risk on the financial instrument has increased significantly since initial recognition, it should recognize an impairment loss at an amount equal to the lifetime expected credit loss.
The 12-month expected credit loss measurement represents all cash flows not expected to be received (“cash shortfalls”) over the life of the financial instrument that result from those default events that are possible within 12 months after the reporting date. Lifetime expected credit loss represents cash shortfalls that result from all possible default events over the life of the financial instrument.
The proposed guidance will apply to: (a) financial assets measured at amortized cost under IFRS 9, Financial instruments; (b) financial assets measured at fair value through other comprehensive income under the exposure draft, Classification and Measurement: Limited amendments to IFRS 9; (c) loan commitments when there is a present legal obligation to extend credit (except for loan commitments accounted for at fair value through profit or loss (FVPL) under IFRS 9); (d) financial guarantee contracts within the scope of IFRS 9 that are not accounted for at FVPL; and (e) lease receivables within the scope of IAS 17, Leases.
Calculation of the impairment
Expected credit losses are determined using an unbiased and probability-weighted approach and should reflect the time value of money. The calculation is not a best-case or worst-case estimate. Rather, it should incorporate at least the probability that a credit loss occurs and the probability that no credit loss occurs.
Assessment of credit deterioration
When determining whether lifetime expected losses should be recognized, an entity should consider the best information available, including actual and expected changes in external market indicators, internal factors, and borrower-specific information. Where more forward-looking information is not available, delinquency data can be used as a basis for the assessment.
Under the proposed model, there is a rebuttable presumption that lifetime expected losses should be provided for if contractual cash flows are 30 days past due. An entity does not recognize lifetime expected credit losses for financial instruments that are equivalent to “investment grade.”
Interest income is calculated using the effective interest method on the gross carrying amount of the asset. When there is objective evidence of impairment (that is, the asset is impaired under the current rules of IAS 39, Financial instruments: Recognition and Measurement), interest is calculated on the net carrying amount after impairment.
Purchased or originated credit impaired assets
Impairment is determined based on full lifetime expected credit losses for assets where there is objective evidence of impairment on initial recognition. Lifetime expected credit losses are included in the estimated cash flows when calculating the asset’s effective interest rate (“credit-adjusted effective interest rate”), rather than being recognized in profit or loss. Any later changes in lifetime expected credit losses will be recognized immediately in profit or loss.
Trade and lease receivables
The exposure draft includes a simplified approach for trade and lease receivables. An entity should measure impairment losses at an amount equal to lifetime expected losses for short-term trade receivables resulting from transactions within the scope of IAS 18, Revenue. For long-term trade receivables and for lease receivables under IAS 17, an entity has an accounting policy choice between the general model and the model applicable for short-term trade receivables. The use of a provision matrix is allowed, if appropriately adjusted to reflect current events and forecast future conditions.
Extensive disclosures are proposed, including reconciliations of opening to closing amounts and disclosure of assumptions and inputs.
Convergence is not yet achieved as the IASB and FASB are proposing different impairment models. The FASB issued an exposure draft on credit losses in December 20121. The major difference between the IASB’s proposed model and the FASB’s “current expected credit loss” model is that, under the FASB’s proposal, a full lifetime expected loss is recorded on initial recognition, whereas the IASB requires a significant increase in credit risk before recognizing full lifetime expected losses.
All entities that hold financial assets subject to credit losses will be affected by the IASB's proposed model. Therefore, the model is expected to impact the majority of constituents.
The proposal does not specify its effective date, but it refers to IFRS 9 that currently sets its effective date as January 1, 2015. The IASB is seeking comments on the appropriate mandatory effective date for all phases of IFRS 9.
Comments on the IASB proposal are due July 5, 2013. The IASB expects to finalize its impairment model by the end of 2013.
PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams that have questions should contact the financial instruments team in the National Professional Services Group (1-973-236-7803).
In Brief is designed to provide a timely, high-level overview of significant financial reporting developments. It is issued by the National Professional Services Group of PwC. This publication is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. To access additional content on financial reporting issues, register for CFOdirect Network (www.cfodirect.pwc.com), PwC’s online resource for financial executives.
1 Refer to Dataline 2013-01, Credit losses on financial assets – An overview of the FASB’s current expected credit loss model.