Fixed Income Accounting For Expected Credit Losses – FAQ | IFRS

Fixed income Accounting for expected credit losses

The ability to delay the recognition of credit losses on loans until there is evidence of a trigger event has been identified as one of the weaknesses in the incurred loss model outlined in Fixed income Accounting for expected credit lossesIAS 39 for Fixed income Accounting for expected credit losses. To tighten up the credit loss rules, a forward-looking impairment model has been built into IFRS 9 that is applicable for bonds classified as amortized cost or FVOCI. Reporting entities are required to make Expected Credit Losses (ECL) calculations for these bonds.

Generally, the loss allowance shall be calculated at an amount equal to the 12-month ECL unless there has been a significant increase in credit risk since the purchase date of the bond, at which time the loss allowance will be measured at an amount equal to the lifetime ECL. Since the ECL calculation is designed to reflect the changes in ECL relative to the initial recognition of a bond, the same bond purchased at a different point in time may have a different ECL allowance. An entity shall recognize in the P&L statement, as an impairment gain or loss, changes in the amount of ECL. See ‘Measurement of expected credit losses‘ for a more detailed explanation of the ECL calculation.

Any change in an entity’s ECL calculation is likely to lead to significant balance sheet and P&L volatility, especially when the loss allowance calculation changes between the 12-month and the lifetime ECL pools. Insurers with less tolerance for accounting volatility may, therefore, want to perform much more detailed credit analysis, especially for volatile asset classes like high yield bonds, in order to fully assess the long-term creditworthiness of bond issuers before they make an investment decision.

The worked examples provide a simplified set of accounting entries to compare the differences in accounting entries under IAS 39 and IFRS 9 when accounting for debt instruments.

ACCOUNTING STANDARDS FOR DEBT INSTRUMENTS: IAS 39 VS. IFRS 9 CASE STUDY

The examples in this case study have been simplified and are intended only to illustrate how ECL calculations can affect accounting entries at the first reporting date after a bond purchase.

An entity purchases a bond at par for $1,000 very shortly before its financial reporting date (we assume that there is no coupon payment between the purchase date and the first financial reporting date). On the reporting date, the market value of the bond decreases to $950.

Here it is presented how the bond would be accounted for under IAS 39, while further down below the accounting treatment under IFRS 9 is presented. The main difference is that, under IFRS 9, the reporting entity is required to register an impairment gain or loss in its P&L statement equal to the changes in ECL since the last reporting date.

In this example, the entity determines that there has not been a significant increase in credit risk since the initial recognition of the bond and thus reports a loss allowance equals to the 12-month ECL, which amounts to $30.

ACCOUNTING TREATMENT UNDER IAS 39

At initial recognition (purchase date)

Held-to-Maturity, Available-for-Sale, Held-for-Trading

Bond

€1,000

Cash

€1,000

At reporting date

Held-to-Maturity

No new accounting entry, initial entry is valid for reporting

Note: The Held-to-Maturity classification is similar to Loans and Receivables in respect to its effect on balance sheet and P&L volatility.

Available-for-Sale

Unrealized loss (in OCI)

€50

Bond

€50

Held-for-Trading

Loss (in P&L)

€50

Bond

€50

Held-to-maturity

Available-for-sale

Held-for-trading

Potential balance sheet volatility

χ

Ѵ

Ѵ

Potential P&L volatility

χ

χ

Ѵ

ACCOUNTING TREATMENT UNDER IFRS 9 Fixed income Accounting for expected credit losses

At initial recognition (purchase date)

Amortised cost, FVOCI, FVPL

Bond Fixed income: Accounting for expected credit losses

€1,000

Cash Fixed income: Accounting for expected credit losses

€1,000

At reporting date

Amortised cost

Impairment loss (in P&L)

€30

Bond Fixed income: Accounting for expected credit losses

€30

FVOCI

Unrealized loss (in OCI)

€50

Bond Fixed income: Accounting for expected credit losses

€50

Impairment loss (in P&L)

€30

Loss allowance (in OCI)

€30

FVPL

Loss (in P&L)

€50

Bond Fixed income: Accounting for expected credit losses

€50

Amortised cost

FVOCI

FVPL

Potential balance sheet volatility

Ѵ

Ѵ

Ѵ

Potential P&L volatility Fixed income: Accounting for expected credit losses

Ѵ

Ѵ

Ѵ

See also the IFRS Foundation

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