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IFRS 9 Basic Concepts
IFRS 9 For Dummies
What is IFRS 9
International Financial Reporting Standard (IFRS) - 9 is a key component of the International Accounting Standards Board (IASB)’s reform package that followed the global financial crisis. It determines how banks should classify and measure financial assets and liabilities for accounting purposes. Crucially, the rules mark a fundamental shift in credit impairment rules.
How New Impairment Rules in IFRS 9 Affect You
New impairment rules in IFRS 9 will cause a lot of headaches for mainly financial institutions.
They will have a hard time to adjust or upgrade their own information systems in order to provide just the right information and calculate loss provision in line with the new requirements.
But – even if you’re not working in a financial institution, don’t celebrate that much.
Do you have some trade receivables? In such a case, you ARE affected as well. How????
Expected Credit Loss Model – the basics
IFRS 9 introduces so-called “general model” of recognizing impairment loss. This model requires recognizing impairment losses in line with the stage in which the financial asset currently is. There are 3 stages:
Stage 1: Performing Financial Assets
Here, we have financially healthy financial assets that are expected to perform normally in line with their contractual terms and there are no signs of increased credit risk.
IFRS 9 requires recognizing impairment loss amounting to 12-month expected credit losses immediately at initial recognition of these assets.
What is 12-month expected credit loss????
It is the expected credit loss resulting from default events on a financial instrument that are possible within 12 months after the reporting date.
In this case, the interest revenue is recognized based on effective interest rate method on gross carrying amount, so no loss allowance is taken into account.
Stage 2: Financial assets with significantly increased credit risk
When the credit risk of certain financial asset significantly increased and the resulting credit quality is NOT low risk, then an entity needs to recognize full lifetime expected credit losses.
What are they????
They are present value of losses that arise if a borrower defaults on their obligations throughout the life of the financial instrument.
In fact, 12-month expected credit losses are just the portion of the life time expected credit losses.
Now, please be careful, because expected credit losses are in fact a difference between:
The present value of cash flows based on the contract of a financial instrument; and
The present value of cash flows that an entity really expects to obtain from the financial instrument.
As a result, the timing of payments from the financial instrument directly affects their present value and thus the amount of an impairment loss.
In practice, if you expect that debtor will pay you in full, but later than in line with the contract, there IS an impairment loss!
Interest revenue for stage 2 assets is calculated exactly in the same way as in stage 1 (on gross carrying amount).
Stage 3: Credit-impaired financial assets
When your financial asset has already become credit impaired (meaning that certain default events have occurred), then an entity still recognizes lifetime expected credit losses.
However, this time, interest revenue is calculated and recognized based on the amortized cost(that is gross carrying amount less loss allowance).
In this stage, financial assets might need to be individually assessed.