IFRS 9 requires recognition of impairment losses on a forward-looking basis, which means that impairment loss is recognised before the occurrence of any credit event. These impairment losses are referred to as expected credit losses (‘ECL’).
In general, impairment losses are recognised on receivables, loan commitments and financial guarantee contracts (see detailed list).
Three approaches to impairment
Overview of the three approaches to impairment
IFRS 9 sets out three approaches to impairment:
- general approach,
- simplified approach for certain trade receivables, contract assets and lease receivables,
- specific approach for purchased or originated credit-impaired financial assets.
General approach
The general IFRS 9 approach to impairment follows a three stage model (sometimes referred to as three-bucket model):
As we can see, under the general approach, an entity recognises expected credit losses for all financial assets. ECL can be 12-month ECL or lifetime ECL depending on whether there was a significant increase in credit risk (IFRS 9.5.5.3).
Changes in the loss allowance are recognised in P/L as impairment gains/losses (IFRS 9.5.5.8).
Simplified approach
To assist entities that have less sophisticated credit risk management systems, IFRS 9 introduced a simplified approach under which entities do not have to track changes in credit risk of financial assets (IFRS 9.BC5.104). Instead, lifetime ECL are recognised from the date of initial recognition of a financial asset (IFRS 9.5.5.15).
The simplified approach is required for trade receivables or contract assets that result from transactions that are within the scope of IFRS 15 and do not contain a significant financing component (or are accounted for under the one-year practical expedient as per IFRS 15.63). For trade receivables or contract assets that do contain a significant financing component, it is the entity’s choice to apply simplified approach. Similarly, the entity can choose to apply simplified approach to lease receivables accounted for under IFRS 16 (IFRS 9.5.5.15). See also the practical approach to simplified loss rate approach (provision matrix).
Specific approach for purchased or originated credit-impaired financial assets
IFRS 9 sets out a specific approach for purchased or originated credit-impaired financial assets (often abbreviated to ‘POCI’ assets). For these assets, entity recognises only the cumulative changes in lifetime ECL since initial recognition of such an asset (IFRS 9.5.5.13-14). Purchased or originated credit-impaired financial asset is an asset that is credit-impaired on initial recognition (IFRS 9.Appendix A).
It is important to note that an asset is not credit impaired merely because it has high credit risk at initial recognition (IFRS 9.B5.4.7).
See the section on measurement of ECL below that expands points mentioned above.
Measurement of expected credit losses (ECL)
Definition of credit losses
Credit loss is 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, discounted at the original effective interest rate (EIR) or credit-adjusted EIR (IFRS 9.Appendix A).
Cash flows used in ECL measurement
When estimating cash flows for ECL measurement, the entity takes into account (IFRS 9.Appendix A):
- expected life of a financial instrument,
- all contractual terms of the financial instrument (e.g. prepayment, extension, call and similar options),
- collaterals held,
- other credit enhancements integral to the contractual terms.
Lifetime expected credit losses (ECL)
Lifetime ECL are ECL that result from all possible default events over the expected life of a financial instrument (IFRS 9.Appendix A). Lifetime ECL are therefore the present value of the difference between (IFRS 9.B5.5.29):
- the contractual cash flows that are due to an entity under the contract; and
- the cash flows that the entity expects to receive.
See this example.
12-month expected credit losses (ECL)
12-month ECL are a portion of lifetime ECL and represent the lifetime ECL resulting from a default occurring in the 12 months after the reporting date weighted by the probability of that default occurring. Obviously, a shorter period should be used for financial assets if their expected life is less than 12 months (IFRS 9.B5.5.43).
IFRS 9 clarifies that 12-month ECL are neither the lifetime ECL that an entity will incur on financial instruments that it predicts will default in the next 12 months nor the cash shortfalls that are predicted over the next 12 months (IFRS 9.B5.5.43). This results from the fact that that 12-month ECL are weighted by the probability of default (‘PD’). For example, 12-month ECL will be recognised even if PD is minuscule.
The example below illustrates calculation of lifetime ECL and 12-month ECL for a loan.
Example: Illustrative calculation of lifetime ECL and 12-month ECL for a loan
On 31 December 20X1, Entity A lends Entity B $100,000. Entity B will repay the loan in 5 annual instalments amounting to $25,000 (i.e. $125,000 in total). Calculation of ECL will be based on PD/LGD/EAD model:
PD – probability of default (assessed by Entity A)
EAD – expected exposure at the time of default
LGD – loss given default (i.e. what % of EAD will not be recovered at default, this should take into account any collaterals held)
Calculations of 12-month ECL and lifetime ECL are shown below. You can access all calculations presented in this example in an excel file.
Note: you can scroll the table horizontally if it doesn’t fit your screen
| reporting date | EAD | PD (marginal) | PD (cumulative) | LGD | EIR | Marginal ECL |
|---|---|---|---|---|---|---|
| 20X1-12-31 | 100,000 | 3% | 3% | 80% | 7.9% | 2,224 |
| 20X2-12-31 | 82,926 | 3% | 6% | 80% | 7.9% | 1,709 |
| 20X3-12-31 | 64,500 | 3% | 9% | 80% | 7.9% | 1,231 |
| 20X4-12-31 | 44,627 | 4% | 13% | 80% | 7.9% | 1,053 |
| 20X5-12-31 | 23,164 | 4% | 17% | 80% | 7.9% | 506 |
| total | 6,722 |
As we can see from the table above, 12-month ECL at 31 December 20X1 amount to $2,224 whereas lifetime ECL amount to $6,722.
Measurement methodology
IFRS 9 does not give specific methodology requirements for measuring ECL, instead it provides general guidance stating that the measurement of ECL should reflect (IFRS 9.5.5.17):
- an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes,
- the time value of money, and
- reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions.
There are two common approaches to ECL measurement applied in practice:
Significant increase in credit risk
Overview of the concept of significant increase in credit risk
Under the general approach to ECL calculation, a significant increase in credit risk (‘SICR’) since initial recognition moves a financial asset out of Stage 1 and 12-month ECL to lifetime ECL. Therefore, SICR plays crucial role in ECL measurement. In assessing significant increase in credit risk, an entity uses the change in the risk of a default occurring over the expected life of the financial instrument (and not the change in the amount of ECL). To achieve this, an entity compares the risk of a default occurring on the financial instrument at the reporting date with the risk of a default occurring on the financial instrument at the date of initial recognition (IFRS 9.5.5.9).
What is ‘significant’
IFRS 9 does not specify what ‘significant’ means and the reasons for that are given in basis for conclusions paragraph IFRS 9.BC5.171. Therefore, entities need to exercise judgement and develop their own criteria. It is clarified that a significant increase in credit risk is an event that happens before a financial asset becomes credit-impaired or an actual default occurs (IFRS 9.B5.5.7). Paragraph IFRS 9. B5.5.17 provides a list of information that may be relevant in assessing changes in credit risk.
Definition of default
Default is not defined in IFRS 9. Instead, the standard requires an entity to apply a default definition that is consistent with the definition used for internal credit risk management purposes for the relevant financial instrument and consider qualitative indicators (for example, financial covenants) when appropriate. However, IFRS 9 introduces a rebuttable presumption that default does not occur later than when a financial asset is 90 days past due, unless an entity has reasonable and supportable information to demonstrate that a more lagging default criterion is more appropriate. The definition of default should be the same for all financial instruments unless an entity can demonstrate that another default definition is more appropriate for a particular financial instrument (IFRS 9.B5.5.37). The 90-day threshold is also consistent with Basel regulatory capital calculations for banks.
Past due information
Many entities rely on past due information when assessing changes in credit risk, i.e. information on payments that were not made when contractually due. IFRS 9 notes that entities should use more forward-looking information where available without undue cost or effort, but otherwise past due information is also acceptable. IFRS 9 introduces also a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due and that this is the latest point at which lifetime ECL should be recognised, even when adjusting for forward-looking information (IFRS 9.5.5.11; B5.5.19-20).
Collective and individual assessment basis
IFRS 9 notes that information on individual asset level may not be available and a collective assessment for groups of financial assets may be necessary to ensure that significant increase in credit risk is recognised on a timely manner and not only after the instrument becomes past due (IFRS 9.B5.5.1-6). Collective assessment is widely used in practice for homogeneous, individually insignificant, financial assets. This is often the only possible way to apply forward-looking ECL model. Paragraph IFRS 9.B5.5.5 provides examples of grouping of financial assets for the purpose of impairment assessment on a collective basis.
See also Illustrative Example 5 accompanying IFRS 9 (section ‘Collective assessment’).
Practical expedient for assets with low credit risk
An entity may assume that the credit risk on a financial instrument has not increased significantly since initial recognition if the financial instrument is determined to have low credit risk at the reporting date (IFRS 9.5.5.10). Paragraphs IFRS 9.B5.5.22‒24 elaborate on when an asset can be considered to have low credit risk.
Credit-impaired financial assets
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. Examples of such events are given in Appendix A to IFRS 9 in the definition of credit-impaired financial assets and include significant financial difficulty of the borrower and breach of contract terms (e.g. past-due event or default).
Measurement of interest income on credit-impaired financial assets is covered in a separate section.
Simplified loss rate approach to lifetime ECL suitable for non-financial entities (provision matrix)
Loss rate approach is most suitable for non-financial entities as it does not require sophisticated credit risk management systems in place. Under a loss rate approach, lifetime ECL are calculated using a provision matrix which can be constructed using the following steps:
- receivables are segmented based on different credit loss patterns (e.g. based on customer type, product type, geographical region, collateral etc.),
- ageing of receivables is prepared (e.g. not past due, past due 1-30 days, 31-60 days, 90+ days)
- historical loss patterns are calculated and treated as a starting point is estimating loss rate,
- historical data is adjusted to take into account reasonable and supportable information that is available without undue cost or effort at the reporting date about current conditions and forecasts of future economic conditions.
Provision matrix is specifically referred to in paragraph IFRS 9.B5.5.35 and Example 12 (IFRS 9.IE74-77) as an example of a simplified approach to ECL measurement for trade receivables, contract assets and lease receivables. See also basis for conclusions in paragraph IFRS 9.BC5.225.
Example: Lifetime ECL for trade receivables using a provision matrix
Entity A is a service provider and has 2 types of customers: individual customers (B2C) and business customers (B2B). Entity A believes that B2C / B2B segmentation best reflects credit loss patterns. Sales are usually made on credit, therefore Entity A has a significant balance of trade receivables outstanding at each reporting date. As there is no significant financing component, Entity A recognises lifetime ECL for all its trade receivables.
For the purpose of this example, loss rate is calculated based on sales made in January of a given year. In real life, the loss rate should be based on data from several months, but it cannot be too old as it may yield outdated results. The illustrative calculation of loss rate for B2C customers is presented below.
You can access all calculations presented in this example in an excel file. Scroll tables presented below horizontally if they don’t fit your screen.
| payments | receivables outstanding | receivables ageing | loss rate | |
|---|---|---|---|---|
| sales in January | 100,000 | not overdue | 2% | |
| paid on time | 50,000 | 50,000 | overdue 1-30 days | 4% |
| paid 1-30 days after due date | 27,000 | 23,000 | overdue 31-60 days | 9% |
| paid 31-60 days after due date | 15,000 | 8,000 | overdue 61-90 days | 25% |
| paid 61-90 days after due date | 6,000 | 2,000 | overdue 91+ days (not paid at all) | 100% |
Additionally, Entity A analysed forward-looking information (e.g. GDP forecasts, changes in unemployment rate, changes in law) and concluded that there is no indication that the above historical loss rate should be adjusted (see IFRS 9.B5.5.52-53).
As at the reporting date, Entity A prepared ageing of its trade receivables from B2C customers and calculated lifetime ECL as presented in the following table.
| amount | ageing | loss rate | ECL allowance |
|---|---|---|---|
| 300,000 | not overdue | 2% | 6,000 |
| 140,000 | overdue 1-30 days | 4% | 5,600 |
| 60,000 | overdue 31-60 days | 9% | 5,217 |
| 23,000 | overdue 61-90 days | 25% | 5,750 |
| 5,000 | overdue 91+ days | 100% | 5,000 |
| total ECL allowance | 27,567 | ||
Adjusted Basel PD/LGD/EAD approach
Financial institutions often use Basel PD/LGD/EAD approach as a starting point in ECL calculation, which is then adjusted to meet IFRS 9 requirements. A simplified illustration is presented in this example.
Reasonable and supportable information
Discussion on what is meant by reasonable and supportable information, and how historical information can be used, is contained in paragraphs IFRS 9.B5.5.49-54.
Probability-weighted amount
As noted earlier, ECL should reflect an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes (IFRS 9.5.5.17). This means that the ECL allowance will be recognised for a financial asset even if the most likely scenario is that there will be no actual credit loss (IFRS 9.B5.5.41). IFRS 9 helpfully clarifies that, in practice, ‘this exercise may not need to be a complex analysis. In some cases, relatively simple modelling may be sufficient, without the need for a large number of detailed simulations of scenarios. For example, the average credit losses of a large group of financial instruments with shared risk characteristics may be a reasonable estimate of the probability-weighted amount. In other situations, the identification of scenarios that specify the amount and timing of the cash flows for particular outcomes and the estimated probability of those outcomes will probably be needed. In those situations, the expected credit losses should reflect at least two outcomes in accordance with paragraph IFRS 9.5.5.18’ (IFRS 9.B5.5.42).
The clarification cited above helps to keep things simple because strict reading of paragraph IFRS 9.5.5.17 could have led to developing multiple scenarios. For example, a bank with mortgage credit exposures could start predicting doomsday scenarios, e.g. economic downturn when people lose jobs and house prices go down. More discussion on this subject can be found in Meeting Summary (11 December 2015) of Transition Resource Group for Impairment of Financial Instruments (agenda item ‘Incorporation of forward-looking scenarios’).
For trade receivables, contract assets and lease receivables accounted for using a simplified approach, it is generally accepted that a simple provision matrix is enough.
Time horizon
The maximum period to consider when measuring ECL is the maximum contractual period (including extension options) over which the entity is exposed to credit risk and not a longer period, even if that longer period is consistent with business practice (IFRS 9.5.5.19). This means that the measurement horizon of ECL should not go beyond the point where further extension options are at the discretion of the lender, but should take into account extension and prepayment options at the discretion of the borrower.
See also this discussion on ECL on bank accounts.
Time value of money
ECL should be discounted to the reporting date (IFRS 9.B5.5.44). ECL take into account the amount and timing of payments, therefore a credit loss arises even if the entity expects to be paid in full but later than when contractually due (IFRS 9.B5.5.28).
The following discount rate should be used in calculating ECL (IFRS 9.B5.5.44):
- effective interest rate (EIR) determined at initial recognition or an approximation thereof – for fixed rate assets, or
- current EIR – for variable interest rate assets.
The ‘approximation’ of EIR above is most likely intended to be a practical relief for banks that makes it easier for them to reconcile IFRS 9 with Basel models, which cover only the time value of money between default event and subsequent recoveries (e.g. sale of collateral).
For trade receivables, contract assets and lease receivables accounted for using a simplified approach, it is accepted that a simple provision matrix is enough.
Collateral and credit enhancements
Collateral and credit enhancements should be taken into account when measuring ECL (IFRS 9.B5.5.55). IFRS 9 does not specify how to measure the proceeds from collateral, but fair value seems the only reasonable option.
Revolving credit facilities
IFRS 9 includes a specific exception regarding time horizon for ECL measurement for revolving credit facilities that do not have a fixed term or repayment structure and usually have a short contractual cancellation period. For such financial instruments, ECL are measured over the period that the entity is exposed to credit risk even if that period extends beyond the maximum contractual period (IFRS 9.5.5.20;B5.5.39-40). See also Example 10 accompanying IFRS 9.
Cash flows expected from sale of a defaulted receivable
Cash flows expected from sale of a defaulted receivable can and should be taken into account when measuring ECL. This matter is not specifically addressed in IFRS 9, but it was discussed at the December 2015 meeting of Transition Resource Group for Impairment of Financial Instruments (agenda item ‘Inclusion of cash flows expected from the sale on default of a loan in the measurement of expected credit losses’). ITG noted that cash flows expected from the sale on default of a loan should be included in the measurement of expected credit losses if:
- selling the loan is one of the recovery methods that the entity expected to pursue in a default scenario;
- the entity is neither legally nor practically prevented from realising the loan using that recovery method; and
- the entity has reasonable and supportable information upon which to base its expectations and assumptions.
The inclusion of recovery sales proceeds in the measurement of ECL is appropriate for assets in all three stages of the ECL model.
The Basel Committee
In 2015 the Basel Committee issued Guidance on Credit Risk and Accounting for Expected Credit Losses which is aimed and supplementing and expanding ECL IFRS 9 model for largest banks. This guidance focuses on systems and control environment, but contains also additional guidance on ECL models for banks.
Impact of expected credit losses on interest calculation
Overview of the impact of ECL on interest calculation
IFRS 9 follows a ‘decoupled’ approach to ECL and interest revenue under which interest is recognised on the gross carrying amount, i.e. without taking ECL into account. An exception to this rule relates to assets that become credit-impaired or are credit-impaired on initial recognition (IFRS 9.5.4.1; BC5.72).
Purchased or originated credit-impaired financial asset and credit adjusted EIR
For purchased or originated credit-impaired financial assets, interest is calculated using credit-adjusted effective interest rate (EIR). This means that initial ECL are included in the estimated cash flows when calculating EIR (IFRS 9.5.4.1(a); B5.4.7).
It may happen that after a modification of contractual terms resulting in derecognition of the original financial asset, there may be evidence that the modified financial asset is credit-impaired at initial recognition. This might occur, for example, in a situation in which there was a substantial modification of a distressed asset that resulted in derecognition of the original financial asset. (IFRS 9.B5.5.26).
Example: Purchased credit-impaired financial asset and credit adjusted EIR
On 1 January 20X1, Entity X issues a bond with a face value of $10,000 and a fixed annual coupon of $600 (i.e. 6%) payable on 31 December each year until maturity date, which is 31 December 20X6. In 20X2, Entity X run into financial difficulties and did not pay the coupon due on 31 December 20X2 which resulted in significant reduction in market prices of this bond. On 1 January 20X3, Entity A acquires this bond for $5,000 as it believes that Entity X will be able to partially repay the face value on redemption date. Entity A expects to receive $8,000 on 31 December 20X6, but it does not expect to receive any coupon payments.
You can access all the calculations presented in this example in an excel file. Scroll the tables presented below horizontally if they don’t fit your screen.
On 1 January 20X3, Entity A calculates credit adjusted EIR based on expected cash flows that include initial ECL:
| Date | Cash flow |
|---|---|
| 20X3-01-01 | (5,000) |
| 20X3-12-31 | - |
| 20X4-12-31 | - |
| 20X5-12-31 | - |
| 20X6-12-31 | 8,000 |
| credit adjusted EIR | 12.5% |
Note that EIR based on contractual cash flows would amount to 33.3%:
| Date | Cash flow |
|---|---|
| 20X3-01-01 | (5,000) |
| 20X3-01-01 | 600* |
| 20X3-12-31 | 600 |
| 20X4-12-31 | 600 |
| 20X5-12-31 | 600 |
| 20X6-12-31 | 10,600 |
| contractual EIR | 33.3% |
* past due coupon
The accounting scheme for the bond using the credit adjusted EIR is as follows:
| year | opening balance 1 Jan | interest in P/L | cash flow | closing balance 31 Dec |
|---|---|---|---|---|
| 20X3 | 5,000 | 623 | - | 5,623 |
| 20X4 | 5,623 | 701 | - | 6,325 |
| 20X5 | 6,325 | 789 | - | 7,113 |
| 20X6 | 7,113 | 887 | (8,000) | - |
Let’s now assume that on 1 January 20X6 Entity A revises its estimates and expects to receive $8,500, which it finally receives on 31 December 20X6. On 1 January 20X6, $8,500 to be received on 31 December 20X6 and discounted using the original credit-adjusted EIR has a present value of $7,558. Under the original accounting schedule presented above, the bond has a carrying value of $7,113 on 1 January 20X6. Therefore, Entity A recognises an impairment gain amounting to $445. The accounting schedule for this bond is updated as follows:
| year | opening balance 1 Jan | impairment gain | interest in P/L | cash flow | closing balance 31 Dec |
|---|---|---|---|---|---|
| 20X3 | 5,000 | - | 623 | - | 5,623 |
| 20X4 | 5,623 | - | 701 | - | 6,325 |
| 20X5 | 6,325 | - | 789 | - | 7,113 |
| 20X6 | 7,113 | 445 | 942 | (8,500) | - |
Financial assets that have become credit-impaired after initial recognition
For financial assets that are not purchased or originated credit-impaired financial assets, but subsequently have become credit-impaired financial assets (stage 3 in the general ECL model), interest is recognised by application of original EIR to amortised cost of the asset, i.e. after deducting ECL from the gross amount. See the example below:
Example: Asset that has become credit-impaired after initial recognition
On 1 January 20X1, Entity A lends $1 million to Entity B and Entity B needs to repay the loan on 31 December 20X4 by paying $1.5 million. There are no payments required between these dates, which results in the effective interest rate (EIR) at 10.7%. Entity A estimates the 12-month ECL at initial recognition at $20,000.
On 1 January 20X2, the financial situation of Entity B deteriorates significantly and Entity A considers its loan to Entity B as credit-impaired (stage 3). It now expects to receive only $0.5 million on 31 December 20X4 (the same repayment date). The estimated credit loss (ECL) at repayment date is therefore $1 million which, discounted using the original EIR of 10.7%, gives a present value of ECL at $737,788 as of 1 January 20X2. The accounting schedule for this bond is presented below.
All calculations presented in this example are available for download in excel file. You can scroll the table horizontally if it doesn’t fit your screen.
| 1 January | 1 January | 1 January | Interest in P/L | Interest in P/L | Interest in P/L | Impairment in P/L (expense) | Cash flow | 31 December | 31 December | 31 December | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| year | Gross carrying amount | ECL allowance | Amortised cost | Interest on loan | Unwinding of ECL discount | Total interest in P/L | Gross carrying amount | ECL allowance | Amortised cost | ||
| 20X1 | 1,000,000 | (20,000) | 980,000 | 106,682 | (2,134) | 104,548 | (20,000) | - | 1,106,682 | (22,134) | 1,084,548 |
| 20X2 | 1,106,682 | (737,788) | 368,894 | 118,063 | (78,709) | 39,354 | (715,654) | - | 1,224,745 | (816,497) | 408,248 |
| 20X3 | 1,224,745 | (816,497) | 408,248 | 130,658 | (87,105) | 43,553 | - | - | 1,355,403 | (903,602) | 451,801 |
| 20X4 | 1,355,403 | (903,602) | 451,801 | 144,597 | (96,398) | 48,199 | - | (500,000) | - | - | - |
| total | 235,654 | (735,654) |
As a result, Entity A recognised $235,654 of interest income in total and $735,654 of credit losses in P/L, which gives a net loss of $500,000.
Credit-impaired financial asset that is subsequently cured
When a financial asset is paid in full or no longer credit-impaired (‘cured’), the difference between:
- the interest that would be calculated by applying the effective interest rate to the gross carrying amount of the credit-impaired financial asset and
- the interest recognised by applying the effective interest rate to amortised cost of the asset, i.e. after deducting ECL from the gross amount
is recognised as a reversal of impairment loss. This approach may result in net reversal if impairment losses recognised on a given asset to date. See relevant IFRIC agenda decision.
Loan commitments and financial guarantee contracts
Overview of impairment requirements for loan commitments and financial guarantee contracts
As a rule, ECL should be recognised for loan commitments and financial guarantee contracts that are not measured at FVTPL. The date that the entity becomes a party to the irrevocable commitment should be considered to be the date of initial recognition for the purposes of applying the IFRS 9 impairment requirements (IFRS 9.5.5.6).
Cash shortfalls
For a financial guarantee contract, the entity is required to make payments only in the event of a default by the debtor in accordance with the terms of the instrument that is guaranteed. Accordingly, cash shortfalls for the purpose of ECL measurement are the expected payments to reimburse the holder for a credit loss that it incurs less any amounts that the entity expects to receive from the holder, the debtor or any other party. If the asset is fully guaranteed, the estimation of cash shortfalls for a financial guarantee contract would be consistent with the estimations of cash shortfalls for the asset subject to the guarantee (IFRS 9.B5.5.32).
Discount rate
ECL on loan commitments should be discounted using the effective interest rate (EIR), or its approximation, that will be applied when recognising the financial asset resulting from the loan commitment. ECL on financial guarantee contracts, or on loan commitments for which the EIR cannot be determined, are discounted by applying a discount rate that reflects the current market assessment of the time value of money and the risks that are specific to the cash flows but only if, and to the extent that, the risks are taken into account by adjusting the discount rate instead of adjusting the cash shortfalls being discounted (IFRS 9.B5.5.47-48).
Initial recognition of financial assets following a draw down on a loan commitment
For the purpose of applying the impairment requirements of IFRS 9, a financial asset that is recognised following a draw down on a loan commitment should be treated as a continuation of that commitment instead of as a new financial instrument. The ECL on the financial asset should therefore be measured considering the initial credit risk of the loan commitment from the date that the entity became a party to the irrevocable commitment (IFRS 9.B5.5.47).
Presentation and use of loss allowance
Assets at amortised cost
Loss allowance reduces amortised cost of an asset, it is therefore not presented as a liability.
Assets at FVOCI with recycling
ECL are recognised also for assets carried at FVOCI, but the loss allowance does not reduce the carrying amount of the asset below its fair value in the statement of financial position. Instead, recognition of ECL impacts P/L and the change in fair value recognised through OCI is recognised after taking ECL into account (IFRS 9.5.5.2). An example of relevant journal entries is provided in Example 13 accompanying IFRS 9.
Loan commitments and financial guarantees
The part of loss allowance that relates to undrawn loan commitments, or to financial guarantees, is presented as a provision as there is no asset that the loss allowance could be credited against. However, if a financial instrument includes both a financial asset and an undrawn commitment component and the entity cannot identify the ECL on those components separately, ECL on the loan commitment should be recognised together with the loss allowance for the financial asset. To the extent that the combined ECL exceed the gross carrying amount of the financial asset, they should be presented as a provision (IFRS 7.B8E).
Use of loss allowance
IFRS 9 exposure draft included a requirement that all write-offs must go through the use of loss allowance and therefore direct write-offs against the contractual amount of financial assets without using an allowance account were prohibited (IFRS 9 ED 2009/12 par.B29). Final version of IFRS 9 does not contain any such requirement but it seems that the approach set out in exposure draft makes the most sense. The significance of this distinction is that impairment losses are required to be presented in a separate line in P/L (IAS 1.82(ba)) and IFRS 7 requires a reconciliation from the opening balance to the closing balance of the loss allowance (IFRS 7.35H).
Scope of IFRS 9 impairment requirements
Impairment requirements of IFRS 9 apply to (IFRS 9.5.5.1):
- assets measured at amortised cost,
- assets measured at FVOCI with recycling,
- loan commitments (not at FVTPL),
- financial guarantee contracts (not at FVTPL),
- lease receivables (IFRS 16),
- contract assets (IFRS 15).
In contrast, impairment requirements of IFRS 9 do not apply to (IFRS 9.5.5.1):
- assets measured at FVTPL,
- assets measured at FVOCI no recycling,
- loan commitments at FVTPL,
- financial guarantee contracts at FVTPL.
See classification of financial assets and financial liabilities.
Disclosure
Disclosure requirements relating to impairment and credit risk in general are contained in paragraphs IFRS 7.35A-38.
More about financial instruments
See other pages relating to financial instruments:
Scope of IAS 32
Financial Instruments: Definitions
Derivatives and Embedded Derivatives: Definitions and Characteristics
Classification of Financial Assets and Financial Liabilities
Measurement of Financial Instruments
Amortised Cost and Effective Interest Rate
Impairment of Financial Assets
Derecognition of Financial Assets
Derecognition of Financial Liabilities
Factoring
Interest-free loans or loans at below-market interest rate
Offsetting of Financial Instruments
Hedge Accounting
Financial Liabilities vs Equity
IFRS 7 Financial Instruments: Disclosures