Purchased And Originated Credit-impaired Financial Assets – FAQ | IFRS

Purchased and originated credit-impaired financial assets

Credit-impaired financial assets are those for which one or more events that have a detrimental impact on the estimated future cash flows have already occurred. If these financial assets had been originated or purchased before becoming credit impaired, they would be in Stage 3 and lifetime expected losses would be recognised.

Indicators that an asset is credit-impaired would include observable data about the following events: Purchased and originated credit-impaired financial assets

Significant financial difficulty of the issuer or the borrower

  • Breach of contract, Purchased and originated credit-impaired financial assets
  • The lender has granted concessions as a result of the borrower’s financial difficulty which the lender would not otherwise consider,
  • It is becoming probable that the borrower will enter bankruptcy or other financial reorganisation,
  • The disappearance of an active market for that financial asset because of financial difficulties,
  • The financial asset is purchased or originated at a deep discount that reflects the incurred credit losses.

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

For purchased and originated credit-impaired financial assets, a ‘day 1 loss’ is not recognised. Instead: Purchased and originated credit-impaired financial assets

  • Lifetime expected credit losses would be included in the estimated cash flows for the purposes of calculating the effective interest rate – resulting in a credit-adjusted effective interest rate,
  • Interest revenue would be calculated on the net carrying amount at the credit-adjusted effective interest rate i.e. including expected credit losses,
  • Expected credit losses would be discounted using the credit-adjusted effective interest rate,
  • Any subsequent changes (favourable or unfavourable) from the initial expected credit losses would be recognised immediately in profit or loss.

Purchased credit-impaired financial assets are recorded on initial recognition at the transaction price without presentation of an allowance for expected contractual cash shortfalls that are implicit in the purchase price, but disclosures are required of contractual cash shortfalls that are implicit in the purchase price.

It is only in unusual circumstances that originated financial assets would be regarded as being credit impaired. Simply because originated assets might be of high credit risk does not mean that they are credit impaired. Purchased and originated credit-impaired financial assets

Example: purchased credit-impaired financial asset and credit adjusted EIR

On 1 January 20X1, Entity X issues a bond with a face value of $10,000 and a fixed annual coupon of $600 (i.e. 6%) payable on 31 December each year until maturity date, which is 31 December 20X6. In 20X2, Entity X run into financial difficulties and did not pay the coupon due on 31 December 20X2 which resulted in significant reduction in market prices of this bond. On 1 January 20X3, Entity A acquires this bond for $5,000 as it believes that Entity X will be able to partially repay the face value on redemption date. Entity A expects to receive $8,000 on 31 December 20X6, but it does not expect to receive any coupon payments.

On 1 January 20X3, Entity A calculates credit adjusted EIR based on expected cash flows that include initial ECL:

A

B

1

20×3-01-01 purchase of credit-impaired bond of $10,000

-$5,000

2

20×3-12-31 no coupon of interest

3

20×4-12-31 no coupon of interest

4

20×5-12-31 no coupon of interest

5

20×6-12-31 redemption of credit-impaired bond of $10,000

$8,000

6

Adjusted Effective interest rate

12.5%

(put the numbers in a spreadsheet, use the function =IRR(B1:B5) in cell B6).

The purchase, interest recognition and redemption accounting for this credit-impaired bond of $10,000 are as follows:

Year

Opening 01 – 01

Interest recognition

Cash flow (out (in))

Closing 31 – 12

20×3

6231

-5,000

5,623

20×4

5,623

701

6,325

20×5

6,325

789

7,113

20×6

7,113

887

8,000

On 1 January 20X6 Entity A revises its estimates and expects to receive $8,500 which it finally receives on 31 December 20X6. On 1 January 20X6, $8,500 to be received on 31 December 20X6 and discounted using the original credit-adjusted EIR has a present value of $7,558. Under the original accounting schedule presented above, the bond has a carrying value of $7,113 on 1 January 20X6. Therefore, Entity A recognises an impairment gain amounting to $445. The accounting schedule for this bond is updated as follows:

Year

Opening 01 – 01

Impairment gain

Interest recognition

Cash flow (out (in))

Closing 31 – 12

20×3

623

-5,000

5,623

20×4

5,623

701

6,325

20×5

6,325

789

7,113

20×6

7,113

445

942

8,500

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