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IFRS 9

Financial Instruments
Part III: Impairment

IFRS Foundation

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IFRS Foundation

Agenda

Scope of the impairment requirements


Overview of the impairment requirements
Determining significant increases in credit risk
Measurement of expected credit losses
Interest revenue and credit-impaired financial assets
Reclassified financial assets
Estimates and other judgements
Disclosures (IFRS 7)
Summary
Effective date and transition
IFRS Foundation

Scope of the impairment


requirements

IFRS Foundation

Scope of the impairment requirements

Financial
assets
measured at
amortised cost

Loan
commitments
and financial
guarantee
contracts not
measured at
FVTPL

Financial
assets
measured at
FVOCI
Lease
receivables

Scope
Trade
receivables
and contract
assets

IFRS Foundation

Overview of the
impairment requirements

IFRS Foundation

Overview of the impairment requirements

7 7

Change in credit risk since initial recognition


Stage 1

Stage 2

Stage 3

Impairment recognition
12-month
expected credit losses

Lifetime
expected credit losses

Lifetime
expected credit losses

When significant increase in credit risk occurs


Interest revenue
Gross basis

Gross basis

Net basis

Performing

Under-performing

Non-performing

IFRS Foundation

12-month & lifetime expected credit losses


Definitions

Credit loss - 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 (ie
all cash shortfalls), discounted at the original effective interest rate (or credit-adjusted
effective interest rate for purchased or originated credit-impaired financial assets)
Expected credit losses (ECL) - weighted average of credit losses with the respective
risks of a default occurring as the weights

What are 12-month ECL?

What are lifetime ECL?

Portion of lifetime ECL representing


lifetime cash shortfalls that will result if a
default occurs in 12 months weighted by
probability of that default occurring

ECL that result from all possible default


events over the expected life of a
financial instrument

IFRS Foundation

12-month vs lifetime expected credit losses


When to recognise

When to recognise 12-month expected credit


losses?
No significant increase in credit risk since initial recognition; or
Low credit risk (for example, investment grade)

When to recognise lifetime expected credit losses?


Underperforming assets, ie a significant increase in credit risk
since initial recognition
Non-performing assets, ie asset is credit-impaired

Expected credit losses will be recognised for all financial


instruments in scope at all times
IFRS Foundation

Determining significant
increases in credit risk

IFRS Foundation

Determining significant increases in credit


risk

11

Change in credit risk over the life of the instrument - ie risk of a default
occurring (not changes in expected credit losses)
No definition of default, but rebuttable presumption that no later than 90 days past due
Maturity matters

Compare to credit risk at initial recognition


consider reasonable and supportable information, that is available without undue
cost or effort, that is indicative of significant increases in credit risk

Financial instruments that have low credit risk at the reporting date (eg
investment grade) may assume credit risk has not increased significantly
More than 30 days past due rebuttable presumption that credit risk has
increased significantly since initial consideration
Where default patterns are not concentrated at a specific point, changes in
risk of default over the next 12 months may be used if they are a reasonable
approximation of the changes in the lifetime risk of a default occurring
Expected credit losses are updated at each reporting date for new information
and changes in expectations even if deterioration is not significant
IFRS Foundation

Examples of factors to consider when


assessing for a significant increase in risk

1212

Significant change in what would charge for credit risk now


because of changes in credit risk since initial recognition
Changes in external market indicators of credit risk eg CDS
levels for obligor
Actual or expected change in internal or external credit rating
Actual or expected increase in the risk of default on another
facility with the same obligor
An actual or expected significant change in the operating results
of a borrower
Changes in how the bank manages the credit risk on the
instrument
Past due information

Example 1:* assessing significant increases in credit risk since


initial recognition
Significant increase in credit risk

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Bank X provides a tranche of a senior secured loan facility to Company Y.

At the time of origination of the loan:


It was expected that Company Y would be able to meet the covenants for the life of
the instrument.
Generation of revenue and cash flow was expected to be stable in Company Ys
industry over the term of the senior facility. However, there was some business risk
related to the ability to grow gross margins within its existing businesses.
At initial recognition, Bank X considers that the loan is not an originated credit-impaired
loan.
Subsequent to initial recognition:
Company Y has underperformed on its business plan for revenue generation and net cash flow
generation due to macroeconomic changes.
Company Y has increased its leverage ratio
Company Y is now close to breaching its covenants
Trading prices for Company Ys bonds have decreased, market spreads have increased, not
explained by changes in the market environment
Bank X expects a further deterioration in the macroeconomic environment
Refer to Example 1 in paragraph IE7-IE11 of IFRS
9 Financial Instruments
*

IFRS Foundation

Example 2:* assessing significant increases in credit risk


since initial recognition
No significant increase in credit risk

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Company C, is the holding company of a group that operates in a cyclical production industry.
The group structure is complex and has been subject to change, making it difficult for investors to analyse
the expected performance of the group and to forecast cash available at holding company level.

Bank B provided a loan to Company C when prospects for the industry were positive.
However, a potential decrease in sales was anticipated due to the point in the cycle.
At the time that Bank B originates the loan:
Creditors are concerned about Company Cs ability to refinance its debt.
Company Cs leverage was in line with that of other customers with similar credit risk.
Headroom on its coverage ratios before triggering a default is high.

On initial recognition, Bank B determines that the loan is subject to considerable credit risk, has
speculative elements and uncertainties affecting Company C including the groups uncertain
prospects for cash generation which could lead to default.
Loan not considered by Bank B to be originated credit-impaired.
Subsequent to initial recognition, Company C has announced that three of its five key subsidiaries
had a significant reduction in sales volume but were expected to improve in following months.
Sales of the other two subsidiaries were stable.

Company C announced a corporate restructure, which will increase the flexibility to refinance
existing debt and the ability of the operating subsidiaries to pay dividends to Company C.
Refer to Example 2 in paragraph IE12-IE17 of IFRS
9 Financial Instruments
*

IFRS Foundation

Example 3:* assessing significant increases in credit risk


since initial recognition (low credit risk)
Highly collateralised financial asset

15

Company H owns real estate assets financed by a five-year loan from Bank Z.
Loan-to-value (LTV) ratio = 50%.
secured by a first-ranking security over the real estate assets.
At initial recognition, the loan is not considered to be originated credit-impaired.

Subsequent to initial recognition:


Revenues and operating profits of Company H have decreased due to an economic
recession.
Expected increases in regulations have the potential to further negatively affect revenue and
operating profit.
These negative effects could be significant and ongoing.

As a result, Company Hs free cash flow is expected to be reduced to the point that the
coverage of scheduled loan payments could become tight. Bank Z estimates that a
further deterioration in cash flows may result in Company H missing a contractual
payment on the loan and becoming past due.
Recent third party appraisals have indicated a decrease in the value of the real estate
properties, resulting in a current LTV ratio of 70%.

Refer to Example 3 in paragraph IE18-IE23 of IFRS


9 Financial Instruments
*

IFRS Foundation

Determining significant increases in credit risk


Collective and individual assessment basis
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Assessment of significant increases in credit risk since initial recognition may
be performed on a collective basis eg retail loans
Use relevant, reasonable and supportable forward-looking information (if
available without undue cost or effort) to assess changes in credit risk
If no reasonable and supportable information available without undue cost or
effort to measure lifetime expected credit losses on an individual instrument
basis measure on a collective basis
Grouping financial instruments for collective assessment examples of
shared credit risk characteristics:
instrument type, credit risk ratings, collateral type, date of initial
recognition, remaining term to maturity, industry, geographical location of
the borrower, the value of collateral relative to the financial asset if it has
an impact on the probability of a default occurring (for example, non
recourse loans in some jurisdictions or loan-to-value ratios).

IFRS Foundation

Example 4:* assessing significant increase in


credit risk on a collective basis
Bank ABC provides
mortgages to finance
residential real estate in a
specific area

The area includes a mining


community - largely
dependent on the export of
coal and related products

Significant decline in coal


exports occurs and the
closure of several coal
mines is expected

The risk of a default


occurring on mortgage
loans to borrowers who are
employed by the coal mines
is determined to have
increased significantly

17

Bank ABC segments its mortgage portfolio on the basis of industries of borrowers employment
ie a shared credit risk characteristic
Refer to Example 5 in paragraph IE38 of IFRS 9
Financial Instruments
*

IFRS Foundation

Modified financial assets

18

Contractual cash flow renegotiated or modified and not


derecognised

Assess whether there has been a significant increase in credit


risk

Compare:
Risk of default at reporting date
(based on modified contractual
terms)

and

IFRS Foundation

Risk of default at initial recognition


(based on original, unmodified
contractual terms)

Exceptions to the general model

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Simplified approach for trade receivables, contract assets and lease receivables
Do not
contain
significant
financing
component

Contain
significant
financing
component

Trade
receivables

Trade receivables
and lease
receivables

Contract assets
within the scope
of IFRS 15

Loss allowance
= lifetime
expected credit
losses
(simplified
approach)

Contract assets
within the scope
of IFRS 15

Accounting policy
choice: simplified
approach or
monitor
significant
increase in credit
risk

Assets credit-impaired on initial recognition


Use credit-adjusted effective interest rate
Allowance balance represents changes in lifetime losses since initial recognition
IFRS Foundation

Measurement of
expected credit losses

IFRS Foundation

Measurement of expected credit losses (ECL)

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ECL are a probability-weighted estimate of credit losses (ie the present value of all cash
shortfalls) over the expected life of the financial instrument:
Maximum period is the maximum contractual period of exposure to credit risk
o Include cash flows expected from collateral and other credit enhancements that are part of contractual terms

ECL shall be measured in a way that reflects:


Unbiased and probability-weighted outcome: must consider possibility that credit loss
will/will not occur
Time value of money discount at effective interest rate or an approximation thereof
Reasonable and supportable information: available without undue cost or effort at the
reporting date, reflecting:
Past events

Current conditions

+ Future economic conditions

Particular measurement methods are not prescribed


IFRS Foundation

Loan commitments and financial guarantees

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Undrawn loan commitments: credit loss = present value of difference between


contractual cash flows due to the entity if loan commitment drawn and
cash flows expected if the loan is drawn down

For loan commitments & financial guarantee contracts - maximum period to


consider = contractual period over which an entity has a present contractual
obligation to extend credit
But, if financial instrument has both a loan and an undrawn commitment
component and contractual ability to demand repayment and cancel undrawn
commitment (ie revolving credit facilities, such as credit cards and overdraft
facilities)
measure expected credit losses beyond contractual period during which exposed
to credit risk and would not be mitigated by credit risk management actions

Financial guarantee contract


cash shortfalls = expected payments to reimburse the holder for a credit loss that it
incurs less any amounts that the entity expects to receive
If the asset is fully guaranteed - estimation of cash shortfalls would be consistent
with the estimations of cash shortfalls for the asset subject to the guarantee
IFRS Foundation

Reasonable and supportable information

2323

Include information about past events, current conditions and


forecasts of future economic conditions.
Borrower-specific factors:
changes in operating results of borrower, technological advances that
affect future operations, changes in collateral supporting obligation

Macroeconomic factors:
house price indexes, GDP, household debt ratios

The data sources could be:


Internal data - credit loss experience and ratings
External data - ratings, statistics or reports

Historical information can be used as a base but must be


updated to reflect current conditions and future forecasts

Example 5:* recognition and measurement of expected credit losses


12-month expected credit loss measurement using an explicit
probability of default approach

24

Assume recognition of lifetime expected credit losses appropriate


Entity B acquires a portfolio of 1,000 five-year bullet loans for CU1,000 each
(ie CU1million in total).
average 12-month PD = 0.5% for the portfolio.
Entity B uses changes in the lifetime PD to determine whether the
credit risk of the portfolio has increased significantly since initial
recognition because the loans have significant payment obligations
beyond the next 12 months.
Entity B determines no significant increase in credit risk since initial
recognition and estimates that the portfolio has an average LGD of 25%.
The 12-month PD remains at 0.5% at the reporting date.
Entity B measures the loss allowance on a collective basis at an amount
equal to 12-month expected credit losses based on the average 0.5% 12
month PD.
Refer to Example 8 in paragraph IE51-IE52 of IFRS
9 Financial Instruments
*

IFRS Foundation

Example 6:* Practical expedient


Provision matrix

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Company M, a manufacturer, has a portfolio of trade receivables of CU30


million in 20X1 and operates only in one geographical region.
The customer base consists of a large number of small clients.
Trade receivables are categorised by common risk characteristics reflecting
customers abilities to pay all amounts due in accordance with the contractual
terms.
The trade receivables do not have a significant financing component.
Loss allowance = lifetime time expected credit losses.
A provision matrix is used to determine the expected credit losses for the
portfolio, based on its historical observed default rates over the expected life of
the trade receivables and is adjusted for forward-looking estimates.
In this case, it is forecast that economic conditions will deteriorate over the next
year.

Refer to Example 12 in paragraph IE74-IE77 of


IFRS 9 Financial Instruments
*

IFRS Foundation

Example 6:* Practical expedient


Provision matrix (continued)

26

Company M estimates the following provision matrix:


Current

130 days
past due

3160 days
past due

6190 days
past due

More than 90 days


past due

Default rate

0.3%

1.6%

Refer to Example 12 in paragraph IE74 of IFRS 9


Financial Instruments

3.6%

IFRS Foundation

6.6%

10.6%

Interest revenue and


credit-impaired financial
assets

IFRS Foundation

Interest revenue and credit-impaired


financial assets

Change to net basis (ie


Interest calculated on the amortised cost amount adjusted
for any loss allowance) for
gross carrying amount
financial assets that
(ie before adjusting for
subsequently become creditany loss allowance)
impaired
(Stages 1 and 2)
(Stage 3)

28

Interest on gross
carrying amount if
financial assets no
longer creditimpaired
(Stages 1 and 2)

Financial assets are credit-impaired when one or more events


that have a detrimental impact on estimated future cash flows
have occurred
IFRS Foundation

Credit-impaired financial assets


Evidence

29

Significant financial difficulty of the issuer or the borrower

Breach of contract, eg default or past due event


Borrower granted a concession that the lender(s) would not otherwise
consider
Probable that the borrower will enter bankruptcy or other financial
reorganisation
Disappearance of an active market for that financial asset because of financial
difficulties
Purchase or origination of a financial asset at a deep discount that reflects the
incurred credit losses

Single event or combined effect of several events


IFRS Foundation

Reclassified financial
assets

IFRS Foundation

Reclassified financial assets


Measurement of expected credit losses (ECL)

31

Reclassification to
Fair value through
profit or loss

Fair value through OCI

Fair value
through
profit or loss

Re
cla
ssi
fic
ati
on
fro
m

Amortised cost

Consider only changes in credit risk since date of reclassification

Fair value
through OCI

Amortised
cost

Not applicable
financial assets
measured at
FVTPL do not
carry a loss
allowance

Use same effective interest rate


Measurement of ECL
unchanged
Derecognise loss allowance
Any adjustment to the gross
carrying amount recognise
as an accumulated impairment
in OCI and disclose at
reclassification date

IFRS Foundation

Use same effective interest rate


Measurement of ECL unchanged
Loss allowance = adjustment to
gross carrying amount

Example 7:* reclassification of financial assets


from FVTPL to amortised cost

32

Entity A purchases a portfolio of bonds: FV (gross carrying amount) = CU500,000.


Business model for managing the bonds changes Entity A reclassifies into the amortised
cost measurement category
FV of the portfolio of bonds at the reclassification date = CU490,000.
12-month expected credit losses at reclassification date = CU4,000.
Debit
Bonds (gross carrying amount of the amortised cost
assets)

Credit

CU490,000

Bonds (FVPL assets)

CU490,000

Impairment loss (P&L)

CU4,000

Loss allowance

CU4,000

The impairment requirements apply to the bond from the reclassification date.

Refer to Example 15 in paragraph IE104-IE107,


IE110 of IFRS 9 Financial Instruments
*

IFRS Foundation

Estimates and other


judgements

IFRS Foundation

Main judgements and estimates in applying


IFRS 9

34

Impairment
Determining whether there is a significant increase in credit risk
since initial recognition
Measurement of expected credit losses (ECL)
Determining whether loans will be paid as due and, if not, how much
might be recovered and when
Probability-weighting different scenarios

Appropriately incorporating forward-looking information into the


assessment of changes in credit risk and measurement of ECL
Determining whether a collective or individual and collective
assessment is needed for portfolios of shared risk characteristics

Determining the appropriate period over which to measure ECL


for revolving credit facilities
IFRS Foundation

Disclosures

IFRS Foundation

Disclosures (IFRS 7)

36

Objective: enable users of financial statements to understand the effect of credit risk on the amount,
timing and uncertainty of future cash flows
Quantitative

Qualitative

Reconciliation of allowance accounts showing


key drivers for change

Explanation of gross carrying amounts


showing key drivers for change

How forward-looking information has been


incorporated

Gross carrying amount by credit risk rating


grades

Changes in estimation techniques or significant


assumptions made and reasons for changes

Maximum exposure to credit risk (net of


collateral) and collateral for credit impaired
financial assets

Basis for grouping if expected credit losses were


measured on a collective basis

Modification to contractual cash flows

Entitys default definition and reasons for selecting


those definitions

Contractual amount outstanding for assets


written off but still subject to enforcement
activity

Write off policies, modification policies, collateral

Credit risk disclosures refer to IFRS 7 Financial


Instruments: Disclosures paragraphs 35F35N.

Basis of inputs, assumptions and estimation


techniques used to:
o Measure 12-month and lifetime expected credit
losses
o determine significant increase in credit risk
o determine credit-impaired

IFRS Foundation

Summary

IFRS Foundation

Application of the impairment requirements on a


reporting date
Summary
Is the financial instrument a purchased or
originated credit-impaired financial asset?

Yes

No

Is the simplified approach for trade


receivables, contract assets and lease
receivables applicable?

38

Calculate a
credit-adjusted effective
interest rate and always
recognise a loss
allowance for changes
in lifetime expected
credit losses

No

Does the financial instrument have low credit


risk at the reporting date?

Yes

No

Has there been a significant increase in


credit risk since initial recognition?

Yes

No
No

Yes

Calculate
interest
revenue on
the gross
carrying
amount

Recognise lifetime expected credit losses

Is the low credit risk


simplification applied?
Yes

Recognise 12-month
expected credit losses
and calculate interest
revenue on gross
carrying amount

And
No

Is the financial instrument a credit-impaired


financial asset?
IFRS Foundation

Yes

Calculate interest
revenue on amortised
cost

Effective date and


transition

IFRS Foundation

Effective date and transition

40

Annual periods beginning on or after 1 January 2018


(early application of completed (whole) version permitted)
Retrospective application required but transition reliefs provided
On transition determine if instruments are at stages 1,2 or 3 unless not
possible to determine initial credit risk without undue cost or effort
If initial credit risk not used, recognise lifetime expected credit losses unless
low credit risk

Permit but not require restatement of comparatives


Restate if, and only if, it is possible without the use of hindsight

Disclose information that would permit the reconciliation of the ending


impairment allowances in accordance with IAS 39 and the provisions in
accordance with IAS 37 to the opening loss allowances determined in
accordance with IFRS 9
Impracticable exemption for interim periods
IFRS Foundation

Transition Resource Group for Impairment


of Financial Instruments (ITG)

41

New expected credit loss model = a fundamental change


Significant implementation implications
ITG provides a public forum for stakeholders to learn about the new impairment
requirements from others involved with implementation
ITG discusses questions from stakeholders about the new impairment
requirements
Members = financial statement preparers & auditors
ITG informs the IASB about implementation issues
Help the IASB determine what, if any, action will be needed to address those issues

ITG does NOT issue guidance


ITG was established in 2014 and will have a limited life during the
implementation period
See: http://
www.ifrs.org/About-us/IASB/Advisory-bodies/ITG-Impairment-Financial-Instrument/Pages/H
ome.aspx
IFRS Foundation

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