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  • Quarter 2 2013

    Our second edition of 2013 starts with adetailed look at the IASBs new proposalson accounting for the impairment offinancial instruments before consideringother items in the IASBs pipeline.

    We then go on to IFRS-related newsat Grant Thornton before turning to amore general round-up of financialreporting developments relevant to IFRSpreparers. We finish with theimplementation dates of newer Standardsthat are not yet mandatory and a list ofIASB publications that are out forcomment.

    Welcome to IFRS News a quarterly update fromthe Grant ThorntonInternational IFRS team.IFRS News offers asummary of the moresignificant developments in International FinancialReporting Standards (IFRS)along with insights intotopical issues and commentsand views from the GrantThornton InternationalIFRS team.

    IFRS News

  • IASB unveils new proposals forimpairment of financial assets

    2 IFRS News Quarter 2

    Long-awaited proposals vie foracceptance with alternative USapproachThe IASB has issued the Exposure DraftFinancial Instruments: Expected CreditLosses. It contains proposals aimed atrectifying what was perceived to be amajor weakness in accounting during thefinancial crisis of 2007/8, namely therecognition of credit losses at too late astage.

    The proposals follow on from twoearlier exposure documents, aNovember 2009 Exposure Draft and aSupplementary Document published inJanuary 2011. Should these latestproposals be finalised, they will beincorporated as a chapter in IFRS 9Financial Instruments the Standardthat will eventually replace IAS 39Financial Instruments: Recognition andMeasurement. The proposals will affectall entities that hold debt-type financialassets or issue commitments to extendcredit that are not accounted for at fairvalue through profit or loss.

    Background to the proposalsDuring the financial crisis, the delayedrecognition of credit losses on loans (andsome other financial assets) wasidentified as a major weakness in theperformance of IAS 39. This was becausethe incurred loss model used under thatStandard delays the recognition of creditlosses until there is evidence that a creditloss event has occurred. In addition, IAS 39 was criticised for the complexityarising from the use of different ways ofmeasuring impairment for differentcategories of asset.

    The main proposalsThe Exposure Draft proposes analternative to the incurred loss modelthat would use more forward-lookinginformation. The perceived complexityof IAS 39 would also be addressed byapplying the same impairment model toall financial instruments that are subjectto impairment accounting.

    Under the proposals, recognition ofcredit losses would no longer bedependent on the entity first identifyinga credit loss event. An entity wouldinstead consider a broader range ofinformation when assessing credit riskand measuring expected credit losses,including: past events, such as experience of

    historical losses for similar financialinstruments

    current conditions reasonable and supportable forecasts

    that affect the expected collectabilityof the future cash flows of thefinancial instrument.

    In applying this more forward-lookingapproach, a distinction is made between: financial instruments that have not

    deteriorated significantly in creditquality since initial recognition orthat have low credit risk and

    financial instruments that havedeteriorated significantly in creditquality since initial recognition andwhose credit risk is not low.

    12-month expected credit losses arerecognised for the first of these twocategories while lifetime expected creditlosses are recognised for the secondcategory.

    Instruments that will be within the scope of the proposals: loans and other debt-type financial assets measured at amortised cost

    loans and other debt-type financial assets measured at fair value through other

    comprehensive income*

    trade receivables

    lease receivables

    loan commitments (for the issuer)

    financial guarantee contracts (for the guarantor)

    * the IASB has proposed the introduction of this measurement category in its November 2012 Exposure DraftClassification and Measurement: Limited Amendments to IFRS 9 (Proposed amendments to IFRS 9 (2010).

  • IFRS News Quarter 2 3

    As noted above, an asset moves from12-month expected credit losses tolifetime expected credit losses when therehas been a significant deterioration incredit quality since initial recognition andthe credit risk is more than low. Hencethe boundary between 12-month andlifetime losses is based both on thechange in credit risk and the absolutelevel of risk at the reporting date.

    There is also a third stage in themodel. For assets for which there isobjective evidence of impairment,interest is calculated based on theamortised cost net of the lossprovision.

    It is envisaged that entities will be able to use their current riskmanagement systems as a basis forimplementing these proposals.

    The three-stage processThe three-stage process proposed in theExposure Draft as a means of reflectingthe general pattern of deterioration ofcredit quality of a financial instrumentcan be illustrated below.

    This three-stage model issymmetrical in other words financialassets are reclassified back from stages 2or 3 (lifetime expected losses) to stage 1(12-months expected losses) if an earliersignificant deterioration in credit qualitysubsequently reverses, or the absolutelevel of credit risk becomes low.

    What are 12-month expected credit losses?

    What are lifetime expected creditlosses?Lifetime expected credit losses are the

    expected shortfalls in contractual cash flows,

    taking into account the potential for default

    at any point during the life of the financial

    instrument.

    12-month expected credit losses are calculated

    by multiplying the probability of a default

    occurring on the instrument in the next 12

    months by the total (lifetime) expected credit

    losses that would result from that default.

    They are not the expected cash shortfallsover the next 12 months. They are also notthe credit losses on financial instruments that

    are forecast to actually default in the next 12

    months.

    Stage 1 financial instruments that have not

    deteriorated significantly in credit quality

    since initial recognition or that have low

    credit risk at the reporting date

    12-month expected credit losses are

    recognised

    interest revenue is calculated on the

    gross carrying amount of the asset (ie

    without reduction for expected credit

    losses).

    Stage 2 financial instruments that have

    deteriorated significantly in credit quality

    since initial recognition (unless they have

    low credit risk at the reporting date) but

    that do not have objective evidence of a

    credit loss event

    lifetime expected credit losses are

    recognised

    but interest revenue is still calculated

    on the assets gross carrying amount.

    Stage 3 financial assets that have objective

    evidence of impairment at the reporting

    date

    lifetime expected credit losses are

    recognised

    interest revenue is calculated on the

    net carrying amount (ie reduced for

    expected credit losses).

    Deterioration in credit quality

    Credit risk = low Credit risk > low

  • 4 IFRS News Quarter 2

    A simplified approach for certainassetsIn developing the proposals, there wasconcern that the process of determiningwhether to recognise 12-month orlifetime expected credit losses was notjustifiable for instruments such as tradereceivables and lease receivables.

    As a result, the IASB has includedtwo simplifications in its proposals: 1) for short term trade receivables, an

    entity should always recognise a lossallowance at an amount equal tolifetime expected credit losses.Practical expedients, such as use of aprovisioning matrix, are permitted.

    2) for long-term trade receivables(ones which constitute financingtransactions under IAS 18 Revenue)and lease receivables, entities wouldbe allowed to choose an accountingpolicy to always recognise a lossallowance at an amount equal tolifetime expected credit losses.

    Convergence with US GAAPLike the IASBs current standard IAS 39,US GAAP also uses an incurred lossimpairment model at the moment. Thetwo Boards have therefore been workingtogether to develop a more forward-looking model based on expected creditlosses and in December 2012, the USFinancial Accounting Standards Board(FASB) issued its proposals for acurrent expected credit loss (CECL)model.

    Unlike the IASB Exposure Draft,however, the FASB proposals make nodistinction between those financialinstruments that have deteriorated incredit quality since initial recognition andthose that have not. Instead expectedcredit losses are always recognised atwhat the IASB describes in its proposalsas lifetime expected credit losses.

    Accordingly, the FASB proposal wouldgenerally result in larger loan lossprovisions. Both proposals would result in so-called day-1 losses (lossesarising immediately on originating orpurchasing debt assets) an outcomethat some commentators considercounter-intuitive but the day-1 losswould be higher under the FASBproposal. While some of the informationthat is used to estimate and measureexpected credit losses is consistent underboth the IASB and FASB models, this isa significant difference.

    Grant Thornton International commentGiven that the comment periods on the IASB Exposure Draft and on the FASBs CECL

    Exposure Draft overlap, we can expect respondents to compare and contrast the two

    expected credit loss models and to express a preference for one over the other. Loan loss

    p

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