Curing Of A Credit-impaired Financial Asset – FAQ | IFRS

Curing of a credit-impaired financial asset

Curing of a credit-impaired financial asset presents the explanation of what a credit-impaired financial asset is, how to account for a credit-impaired asset as long as it is credit-impaired and how to account for a credit-impaired asset that is no longer credit-impaired (i.e. curing of a credit-impaired financial asset which means the borrower has, for example, restructured its business and cash flow recovered sufficiently to return paying all interest and principal as per the original contract). Curing of a credit-impaired financial asset

Credit-impaired assets

A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include observable data about the following events:

  1. the significant financial difficulty of the issuer or the borrower; Curing of a credit-impaired financial asset
  2. a breach of contract, such as a default or past due event; Curing of a credit-impaired financial asset
  3. the lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider;
  4. it is becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
  5. the disappearance of an active market for that financial asset because of financial difficulties; or
  6. the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.

It may not be possible to identify a single discrete event—instead, the combined effect of several events may have caused financial assets to become credit-impaired. Curing of a credit-impaired financial asset

Accounting for interest revenue while credit-impaired

When a financial asset becomes credit-impaired, IFRS 9 5.4.1(b) requires an entity to calculate interest revenue by applying the effective interest rate to the amortised cost of the financial asset, i.e. the (original) gross amount less expected credit losses. This results in a difference between (a) the interest that would be calculated by applying the effective interest rate to the gross carrying amount of the credit-impaired financial asset, and (b) the interest revenue recognised for that asset. Curing of a credit-impaired financial asset

Curing of a credit-impaired financial asset

If a financial asset ‘cures’, so that it is transferred back to stage 2 or stage 1, interest revenue would once again be recognised based on the gross carrying amount. As a result, an entity recognises the adjustment required to bring the loss allowance to the amount required to be recognised in accordance with IFRS 9 as a reversal of expected credit losses ECLs in profit or loss [IFRS 9 5.5.8].

Reversal loss allowance

The allowance would be reversed to zero if the asset is recovered in full. The amount of this adjustment includes the effect of the unwinding of the discount on the loss allowance during the period that the financial asset was credit impaired. Ultimately, the reversal of impairment losses may exceed the impairment losses recognised in profit or loss over the life of the asset if amounts collected exceed the expected cash flow losses. Curing of a credit-impaired financial asset

Curing of a credit-impaired financial assetThe case of curing a credit-impaired financial asset

An existing loan with an effective interest rate of 10% has become credit-impaired. Lifetime expected credit losses have been recognised on the loan as of 1 January Year 20×1.

The expected shortfall in cash flows is shown in Table 1 and remain unchanged until 31 December N+3. Discounted at the effective interest rate (EIR) this gives an expected credit loss (ECL) as at 1 January of CU59,000, as shown in Table 1.

Table 1: Contractual & expected cash flows

Cash flows as at 31 Dec

in CU ‘000

20×1

20×2

20×3

20×4

Total

Contractual cash flows

10

10

10

110

140

Expected cash flows

0

0

0

60

60

Expected shortfall in cash flows

10

10

10

50

80

ECL as at 1 January N (shortfall discounted at EIR)

-91

-8

-8

-34

-592


Curing of a credit-impaired financial asset

For illustrative purposes, assume that the contractual cash flows (principal + accrued interest) are fully recovered, unexpectedly, on 31 December 20×4.

For simplification purposes, interest is not accrued on unpaid interest.


Table 2: Stage 3 accounting  – Loan and ECL allowance movements

CU ‘000

31 December,

Cumulative P&L effect

20×1

20×2

20×3

20×4

Gross loan and interest

Opening balance

100

110

120

130

Interest calculated based on the gross carrying amount

10

10

10

10

Settlement

0

0

0

-140

Closing balance

110

120

130

0

ECL allowance

Opening balance

-59

-65

-70

-75

-59

Initial allowance3

Unwinding of discount

-6

-5

-5

-5

Reversal of ECL allowance

0

0

0

80

80

Reversal of unused allowance

Closing balance

-65

-70

-75

0

21

PNL Impairment expense

Loan and interest net of ECL allowance at amortised cost

Opening balance

41

45

50

55

Interest revenue based on the amortised cost

4

5

5

5

19

Interest on the amortised cost4

Settlement

0

0

0

-60

Closing balance

45

50

55

0

19

PNL Interest revenue

Interest revenue accounting

As the loan is credit impaired, interest revenue is restricted to the amount derived from applying the EIR to the amortised cost of the loan. The Interpretations Committee’s decision clarifies that the reversal of the ECL allowance is recognised in full in the impairment expense line. The impact of this on a cumulative basis is that some of the effective interest on the gross carrying amount of the loan (CU40,000) is not presented as interest revenue, but rather, as a reversal of impairment. This is the portion (CU21,000) which represents the unwinding of discount on the ECL provision while the loan was credit impaired.

As a result the settlement in 20×4 is regularly recorded as follows:

Settlement accounting in CU ‘000

BS

Cash

140

BS

\ Gross loan and interest

140

BS

ECL Allowance

80

PNL

\ Impairment expense5

80

See also: The IFRS Foundation

Curing of a credit-impaired financial asset

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