ACCA SBR INT Syllabus C. Reporting The Financial Performance Of A Range Of Entities - Impairment of Financial Instruments - Notes 12 / 14
Impairment of Financial Instruments
Expected Credit Loss model
This applies to:
Amortised cost items
FVTOCI items
How it works
Initially you show 12m expected losses
Dr Expense
Cr Loss Allowance (This gets shown next to the financial asset - it reduces it)
Then you look to see if there's been a significant increase in credit risk? If so switch from 12m to lifetime expected credit losses
No significant increase in credit risk? Show 12-month expected losses only
How do you calculate the Expected Credit Loss?
Use:
a probability-weighted outcome
the time value of money
the best available forward-looking information.
Notice the use of forward-looking info - this means judgement is needed - so it will be difficult to compare companies
Stage 1 - Assets with no significant increase in credit risk
For these assets:
12-month expected credit losses (‘ECL’) are recognised and
Interest revenue is calculated on the gross carrying amount of the asset (that is, without deduction for credit allowance)
12-month ECL are based on the asset’s entire credit loss but weighted by the probability that the loss will occur within 12 months of the Y/E
Stage 2 - Assets with a significant increase in credit risk (but no evidence of impairment)
For these assets:
Lifetime ECL are recognised
Interest revenue is still calculated on the gross carrying amount of the asset.
Lifetime ECL come from all possible default events over its expected life
Expected credit losses are the weighted average credit losses with the probability of default (‘PD’) as the weight.
Stage 3 - Assets with evidence of impairment
For these assets:
Lifetime ECL are recognised and
Interest revenue is calculated on the net carrying amount (that is, net of credit allowance
In subsequent reporting periods, if the credit quality improves so there’s no longer a significant increase in credit risk since initial recognition, then the entity reverts to recognising a 12-month ECL allowance
Where does the impairment go?
The changes in the loss allowance balance are recognised in profit or loss as an impairment gain or loss
Collective Basis
If the asset is small it’s just not practical to see if there’s been a significant increase in credit risk
So, you can assess ECLs on a collective basis, to approximate the result of using comprehensive credit risk information that incorporates forward-looking information at an individual instrument level
Simplified Approach
This means no tracking changes in credit risk!
Instead just recognise a loss allowance based on lifetime ECLs at each reporting date, right from origination.
The simplified approach is for trade receivables, contract assets with no significant financing component, or for contracts with a maturity of one year or less
12-month expected credit losses
These are a portion of the lifetime ECLs that are possible within 12 months
The portion is weighted by the probability of a default occurring
It is not the predicted (probable) defaults in the next 12 months. For instance, the probability of default might be only 25%, in which case, this should be used to calculate 12-month ECLs, even though it is not probable that the asset will default.
Also, the 12-month expected losses are not the cash shortfalls that are predicted over only the next 12 months. For a defaulting asset, the lifetime ECLs will normally be significantly greater than just the cash flows that were contractually due in the next 12 months.
Lifetime expected credit losses
These are from all possible default events over the expected life
Estimate them based on the present value of all cash shortfalls
So, basically, it’s the difference between:
The contractual cash flows And
The cash flows now expected to receive
As PV is used, even late (but the same) cashflows create an ECL
For a financial guarantee contract, the ECLs would be the PV of what it expects to pay as guarantor less any amounts from the holder