CFM21890 - IFRS 9: measurement of financial assets: impairment

For those entities applying IFRS or FRS 101 with a period of account beginning before 1 January 2018 refer to IAS 39 for the recognition and measurement of financial instruments at CFM21520+

Financial assets classified as amortised cost or FVTOCI must be tested for impairment at the end of each period of account. Impairment losses are recognised in profit or loss for financial assets classified at both amortised cost and FVTOCI.

The impairment approach of IFRS 9 is that a company shall recognise a loss allowance for the expected credit losses of a financial asset. Credit loss is the difference between the cash flows expected per the contract and the cash flows the company expects to receive (ie all cash shortfalls).

The amount of the expected credit losses to be recognised depends on the level of credit risk attached to the financial asset:

For financial assets where the credit risk has not increased significantly since initial recognition, a company shall recognise a loss allowance equal to 12 month expected credit losses.

For financial assets where the credit risk has increased significantly since initial recognition, a company shall recognise a loss allowance equal to the lifetime expected credit losses.

For trade receivables, contract assets and lease receivables a simplified approach may be applied. This approach allows a company to always recognise a loss allowance equal to the lifetime expected credit losses.

Credit risk

Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.

A company shall assess at each reporting date whether the credit risk associated to a financial asset has increased significantly since initial recognition.

An increase in credit risk is reflected by a change in the risk of a default occurring over the expected life of the financial asset. When making the assessment the company must consider reasonable and supportable information, that is available without undue cost or effort that is indicative of significant increases in credit risk since initial recognition.

Application guidance to IFRS 9 at paragraph B5.5.17 sets out a lengthy, non-exhaustive list of information that may be relevant in assessing changes to credit risk.

A company 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.

Low credit risk is based on a company’s internal credit risk ratings, or other methodologies that are consistent with a globally understood definition of low credit risk. An example of low credit risk is a financial instrument with an external rating of ‘investment grade’.

12 month expected credit losses

12 month expected credit losses refers to the lifetime expected credit losses of financial assets that are possible to have a default event within the 12 months after the reporting date.

Lifetime expected credit losses

Lifetime expected credit losses refers to the expected credit losses that result from all possible default events over the expected life of the financial asset.

Calculation of credit losses

The credit loss shall be calculated as the difference between all contractual cash flows that are due to a company in accordance with the contract and all the cash flows that the company expects to receive (i.e. all cash shortfalls), discounted at the original effective interest rate.

The cash flows that are considered shall include cash flows from the sale of collateral held or other credit enhancements that are integral to the contractual terms.

A company shall measure expected credit losses of a financial asset in a way that reflects:

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.

Example - 12 month expected credit loss measurement

Company A advances a 10 year £1m loan. Taking into consideration the expectations for instruments with similar credit risk (using reasonable and supportable information that is available without undue cost or effort), the credit risk of the borrower, and the economic outlook for the next 12 months, Company A estimates that at inception of the loan the probability of default is 0.5% over the next 12 months.

At the end of Company A’s next period of account the company determines the probability of default has not increased and that there was no significant increase in credit risk. Company A determines that 25% of the gross carrying amount will be lost if the loan defaults. Company A measures the loss allowance at an amount equal to 12 month expected credit losses using the 12 month probability of default of 0.5%. Therefore at the reporting date the loss allowance is £1,250 (0.5% x 25% x £1,000,000)