IFRS9: Expected Credit Losses (ECL) for Fair Value through Other Comprehensive Income (FVOCI) Instruments

[lexignot]

Hello the community,

I found this illustration on Expected Credit Losses (ECL) for Fair Value through Other Comprehensive Income (FVOCI) instruments from a PwC doc (photos below or link – p21). I am not sure I understand all the accounting treatments, so could you please help me with the following:

1. I understand the CU30 ECL is recognized when the instrument is acquired on Dec 15 (and NOT on Dec 31), is that correct?

2. When ECL is recognized, the accumulated impairment loss account, which is a contra asset account, is credited (decreased) by CU30, with no impact on the Financial asset – FVOCI account which remains at faire value (FV) on the balance sheet, correct?

3. On Dec 31, when the FV of the instrument has decreased to CU950, I don’t understand why the ECL is recognized in the P&L. I understood ECL for FVOCI instruments has no impact on the P&L? The contra asset account “accumulated impairment loss account” is debited (increase in value) by the same amount at the same time correct?

4. On Dec 31, why is a new ECL of CU50 not created? And instead the existing ECL (CU30) is recognized, and the remaining portion (CU20) is recognized as a loss in OCI? Why isn’t the entire amount (CU50) recognized as a loss in OCI?

5. Let’s consider the reverse scenario: the purchase of CU1,000 debt instrument with a value of CU1,050 at Dec 31. What would be the impact on ECL and the financial statements?

Thanks in advance for your help!

[JakobLavrod]

A short mention about the rationale for the FVOCI treatment is that we handle it in the PnL as if it was amortized cost, and in the balance sheet as if FVPL. The idea is to not "pollute" the PnL with volatility that does not give interesting information, but still reflect the correct value in the balance sheet. A good example is a liqudity portfolio to be used in stressed situation. Since you rarley plan to liqudiate it, any fair value market changes will not really matter, so they will not be reflected in the PnL, however IF you had to sell it, the fair value is really what will matter, so then it is good that the balance sheet has the right position.

For something at amortized cost, you have to include effects of changes in credit risk though impairment in the PnL, hence you have to do the same also for FVOCI, and in order to get the balance sheet to align with Fair value, you use OCI as a "residual item" to balance it.

1. I can only speak from experience here. From a practical point, you typically only compute impairment at each month end, in this case, 31 december, so an asset could be on the balance sheet "impairment free" until you reach an end of the month point at which the impairment gets computed. I think this is what PwC are trying to show.

2. Agree

3. The ECL goes in the PnL since it has not been recognized before. Any changes in ECL goes fully to PnL for FVOCI, it is all other market effects that goes into OCI.

4. The amount 50 is due to the change in fair value. Of that, since the ECL is 30 (so the amortized cost value is 970), one need to put 20 in OCI in order for the sum to line up to 950. From an explanation perspective, it would have been more clear to buy the asset at 31 December and then show the change next month, since now it is confusing to look at both value changes and initial ECL at the same time.

5. If the fair value was 1050, you would still put 30 in PnL (from ECL) and then you need to put -80 in OCI for it to line up to 1050.

[lexignot]

Thank you very much @JakobLavrod for your very detailed and clear explanation, it is much appreciated!

Just a few follow up questions:

1. The ECL is created in the accumulated impairment loss account (contra asset account) at month end or immediately after acquiring the asset?

2. When the ECL is recognized and goes in the P&L, the contra asset account “accumulated impairment loss account” is debited (increase in value) by the same amount at the same time, correct?

3. How often do you re-evaluate the ECL of an asset, at the end of each month, at the same time as you re-evaluate the Faire Value?

Thanks!

[JakobLavrod]

1. The requirement is that ECL is created at reporting period. In practice however for internal management accounting, it is standard (at least in all three banks I have worked) to create the ECL at each month end. In theory, if you measured the balance sheet even more often, you would create it even more frequently. I once meet representatives for a bank that made daily balance sheets, and then they created the ECL daily as well.

2. Yes I think so (however the more accounting practical matters are not my strong suite, I work with the ECL calculation itself)

3. As in question 1, as often as you update the balance sheet, so typically monthly.

[Marek Muc]

re. 2, the asset account is credited rather than debited, i.e. CR Accumulated impairment losses / DR Impairment expense in P/L

[JakobLavrod]

Thank you Marek for the assist on the debits and credits

[lexignot]

Thank you very much both for the clarifications, very helpful and much appreciated!