IFRS vs US GAAP Financial assets

Last update

IFRS vs US GAAP Financial assets – Both the FASB and the IASB have finalized major projects in the area of financial instruments. With the publication of IFRS 9, Financial Instruments, in July 2014, the IASB completed its project to replace the classification and measurement, as well as the impairment guidance for financial instruments. In January 2016, the FASB issued its new recognition and measurement guidance – Accounting Standards Update 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, and in June 2016, the FASB issued its new impairment guidance – Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326).

The new classification and measurement guidance was effective for both US GAAP and IFRS as of January 1, 2018, and the similarities and differences are covered in detail in this section. The new impairment guidance under ASC 326 is not yet effective for US GAAP, while the IFRS 9 impairment guidance was effective as of January 1, 2018. The impairment guidance in this section therefore compares the current US GAAP guidance (pre-ASC 326) with the new impairment guidance under IFRS 9. IFRS vs US GAAP Financial assets

Under US GAAP, various specialized pronouncements provide guidance for the classification of financial assets. Unlike US GAAP, IFRS 9 contains all of the classification and measurement guidance for financial assets, and does not provide any industry-specific guidance. The specialized US guidance and the singular IFRS guidance in relation to classification can drive differences in measurement (because classification drives measurement under both IFRS and US GAAP). IFRS vs US GAAP Financial assets

Under IFRS 9, investments in equity instruments are measured at fair value through profit or loss (FVPL) (with an irrevocable option to measure those instruments at fair value through other comprehensive income (FVOCI) with no subsequent reclassification to profit or loss). Under US GAAP, investments in equity instruments are generally measured at FVPL, with an alternative measurement option for equity investments without a readily determinable fair value. IFRS vs US GAAP Financial assets

Under IFRS 9, investments in debt instruments are either measured at: (1) amortized cost, (2) FVOCI (with subsequent reclassification to profit or loss) or (3) FVPL, depending on the entity’s business model for managing the assets and the cash flows characteristic of the instrument. Under US GAAP, the legal form of a debt instrument primarily drives classification. For example, available-for-sale debt instruments that are securities in legal form are typically carried at fair value, even if there is no active market to trade the securities.

At the same time, a debt instrument that is not in the form of a security (for example, a corporate loan) is accounted for at amortized cost even though both instruments (i.e., the security and the loan) have similar economic characteristics. Under IFRS, the legal form does not drive classification of debt instruments; rather, the nature of the cash flows of the instrument and the entity’s business model for managing the debt instruments are the key considerations for classification. In addition to these classification differences, the interest income recognition models also differ between the frameworks. IFRS vs US GAAP Financial assets

Additionally, until the new impairment model is effective for US GAAP (beginning in 2020 for public business entities, if not early adopted), there is a fundamental difference in the impairment guidance for debt instruments carried at amortized cost and FVOCI; the current US GAAP guidance is an incurred loss model while the IFRS 9 guidance is an expected loss model.

Finally, this section describes the fundamental differences in the way US GAAP and IFRS assess the derecognition of financial assets. These differences can have a significant impact on a variety of transactions, such as asset securitizations and factoring transactions. IFRS focuses on whether a qualifying transfer has taken place, whether risks and rewards have been transferred, and, in some cases, whether control over the asset in question has been transferred. US GAAP focuses on whether an entity has surrendered effective control over a transferred asset; this assessment also requires the transferor to evaluate whether the financial asset has been “legally isolated,” even in the event of the transferor’s bankruptcy or receivership. IFRS vs US GAAP Financial assets

This chapter focuses on financial assets – both debt and equity investments – which do not result in the investor having significant influence or control over the investee. The consolidation and equity method of accounting models are covered in Chapter 12. IFRS vs US GAAP Financial assets

Standards Reference IFRS vs US GAAP Financial assets

US GAAP1

IFRS2

ASC 310 Receivables

– 10 Overall

– 20 Nonrefundable Fees and Other Costs

– 30 Loans and Debt Securities Acquired with Deteriorated Credit Quality

ASC 320 Investments – Debt and Equity securities

ASC 321 Investments – Equity securities

ASC 325 Investments – Other

ASC 815-15-25-4 through ASC 815-15-25-5 Derivatives and hedging – Embedded Derivatives – Recognition

ASC 820 Fair value measurement

ASC 825 Financial instruments

ASC 860 Transfers and Servicing

IFRS 9 Financial Instruments

IFRS 13 Fair value measurement

IAS 32 Financial Instruments: Presentation

Note

The following discussion captures a number of the more significant GAAP differences. It is important to note that the discussion is not inclusive of all GAAP differences in this area.

Determining the overall appropriate classification model

Under both frameworks, the determination of whether a financial asset is considered debt or equity has implications on its classification and subsequent measurement. However, the criteria for making this determination are different. Therefore, certain investments could be accounted for as a debt investment under one framework and as an equity investment under the other.

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

To determine the appropriate accounting treatment for a financial interest not consolidated or accounted for under the equity method, a reporting entity should first determine whether the interest meets the definition of a security, which, to a large extent, is a legal determination.

If the entity determines that an interest meets the definition of a security, it should then determine whether that security meets the definition of an equity or debt security based on the definitions in ASC 321 and ASC 320 and follow the measurement models described in those sections unless industry-specific guidance applies.

If the entity determines that the interest does not meet the definition of an equity security, it may still have to follow the guidance in ASC 321 if the interest is in the form of an investment in a

partnership, unincorporated joint venture, or LLC (See Equity investments—measurement below).

If the entity determines that the interest is not a security, and does not represent a partnership or similar interest, other guidance would apply. For example, for trade account receivables, loans, and other similar assets, ASC 310 would generally be applicable, unless the entity follows industry-specific guidance (See Loans and receivables—classification below).

For financial assets that are not consolidated or accounted for using the equity method, an entity first considers whether the financial asset is an investment in an equity instrument by evaluating the classification of the instrument from the perspective of the issuer under IAS 32 (see Financial liabilities and equity for a discussion of the issuer’s classification model).

If the financial asset is an investment in an equity instrument, the entity should follow the guidance for equity instruments. If the financial asset is not an investment in an equity instrument, the entity should follow the guidance for debt investments.

There is one exception to this rule, which applies to instruments that are classified as equity under the “puttable instruments” provisions of IAS 32, such as investments in mutual funds (see Puttable shares/redeemable upon liquidation).

An entity should follow the guidance for debt investments for these instruments (even when they are presented as equity from the issuer’s perspective).

Equity investments—measurement

Under both IFRS and US GAAP, equity investments are generally required to be measured at fair value with changes in fair value recognized in earnings. Unlike US GAAP, IFRS does not include simplifications such as the “NAV exception” or “measurement alternative,” which exist under US GAAP. However, IFRS provides an option to recognize the changes in the fair value of equity investments in other comprehensive income, with no subsequent reclassification to profit or loss. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

All equity investments are generally measured at fair value with changes in fair value recognized through earnings. ASC 321 no longer provides an available for-sale classification for equity securities with changes in fair value recognized in other comprehensive income.

If certain conditions are met, entities can use net asset value (NAV), without adjustment, as a practical expedient to measure the fair value of investments in certain funds (e.g., hedge funds, private equity funds, real estate funds, venture capital funds, commodity funds, funds of funds) when fair value is not readily determinable.

Investments in equity instruments (as defined in IAS 32, from the perspective of the issuer) are always measured at fair value. Equity instruments that are held for trading are required to be classified at FVPL.

For all other investment in equity instruments, an entity can irrevocably elect on initial recognition, on an instrument-by-instrument basis, to present changes in fair value in OCI rather than profit or loss.

Under that option, there is no subsequent reclassification of amounts from accumulated other comprehensive income (AOCI) to profit or loss – for example, on sale of the equity investment – and no requirement to assess the equity investment for impairment. However, an entity may transfer amounts within equity; for example, from AOCI to retained earnings.

Entities are able to elect the “measurement alternative” in ASC 321 for equity interests without readily determinable fair value and for which the NAV practical expedient does not apply. Under that alternative, the equity interest is recorded at cost, less impairment.

The carrying amount is subsequently adjusted up or down for observable price changes (i.e., prices in orderly transactions for the identical investment or similar investment of the same issuer); any adjustments to the carrying amount are recorded in net income.

The selection of the measurement alternative is optional, but should be applied upon acquisition of an equity instrument on an instrument-by-instrument basis.

Under IFRS, since NAV is not defined or calculated in a consistent manner in different parts of the world, IFRS does not include a similar practical expedient.

Loans and receivables—classification

Classification is not driven by legal form under IFRS, whereas legal form drives the classification of debt instruments under US GAAP. The potential classification differences drive subsequent measurement differences under IFRS and US GAAP. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

The classification and accounting treatment of loans and receivables generally depends on whether the asset in question meets the definition of a debt security under ASC 320. To meet the definition of a security under ASC 320, the asset is required to be of a type commonly available on securities exchanges or in markets, or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.

Loans and receivables are also evaluated for embedded derivative features, which could require separate fair value accounting.

Loans and receivables that are not within the scope of ASC 320 fall within the scope of other guidance, such as ASC 310, Receivables. Loans are generally:

  • Classified as loans held for investment, in which case they are measured at amortized cost,
  • Classified as loans held for sale, in which case they are measured at the lower of cost or fair value (market), or
  • Carried at fair value if the fair value option is elected.

 

 

 

 

IFRS vs US GAAP Financial assets

Classification under IFRS 9 of all debt investments – including debt securities, loans, and receivables – is based on a single model, which is driven by:

The business model determination is not made at the individual asset level; rather, it is performed at a higher level of aggregation. An entity can have different business models for different portfolios. Business practices, such as factoring, might affect the business model (and hence, classification and measurement).

Under the SPPI test, an entity needs to determine whether the contractual cash flows of the financial asset represent solely payments of principal and interest. Contractual features that introduce exposure to risks or volatility unrelated to a basic lending arrangement, such as exposure to changes in equity or commodity prices, do not give rise to contractual cash flows that are SPPI.

The financial asset should be subsequently measured at amortized cost if both of the following conditions are met:

  • The financial asset is held within a “hold to collect” business model. Although the objective of an entity’s business model might be to hold financial assets in order to collect contractual cash flows, the entity does not necessarily need to hold all of those instruments until maturity; and
  • The contractual terms of the financial asset give rise, on specified dates, to cash flows that are SPPI.

A financial asset should be subsequently measured at FVOCI if both of the following conditions are met:

  • The financial asset is held within a business model whose objective is achieved by both holding financial assets in order to collect contractual cash flows and selling financial assets (“hold to collect and sell” business model); and
  • The contractual terms of the financial asset give rise on specified dates to cash flows that are SPPI.

If the financial asset is measured at FVOCI, movements in fair value are recorded through OCI. However, interest income computed using the effective interest method, foreign exchange gains and losses, impairment losses, and gains and losses arising on derecognition of the asset, are recognized in profit or loss.

If the financial asset does not pass the business model assessment or SPPI test, it is measured at FVPL. This is the residual measurement category under IFRS 9.

Debt securities—classification

Classification is not driven by legal form under IFRS, whereas legal form drives the classification of debt securities under US GAAP. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

If the asset meets the definition of a security under ASC 320, it is generally classified as trading, available for sale, or held-to-maturity. If classified as trading or available for sale, the debt security is carried at fair value.

Held-to-maturity securities are carried at amortized cost. Debt securities are also evaluated for embedded derivative features that could require separate fair value accounting.

The same general model described in Loans and receivables—classification above applies to investments in debt securities.

Debt investments at FVOCI—foreign exchange gains/losses

The treatment of foreign exchange gains and losses on debt securities measured at FVOCI (available-for-sale under US GAAP) will create more income statement volatility under IFRS.

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

The total change in fair value of available-for-sale debt securities—net of associated tax effects—is recorded in OCI.

Any component of the overall change in fair market value that may be associated with foreign exchange gains and losses on an available-for-sale debt security is treated in a manner consistent with the remaining overall change in the instrument’s fair value.

For debt instruments measured at FVOCI, the total change in fair value is bifurcated, with the portion associated with foreign exchange gains/losses on the amortized cost basis separately recognized in the income statement. The remaining portion of the total change in fair value (except for impairment losses)

is recognized in OCI, net of tax effect.

Embedded derivatives in financial assets

Under IFRS 9, an entity does not need to determine whether embedded derivatives need to be bifurcated from financial assets. The contractual features of the financial asset are assessed as part of the SPPI test, which drives the classification of the instrument as a whole. Under US GAAP, bifurcation of embedded derivatives is required. IFRS vs US GAAP Financial assets

This can create a significant difference between the models, since under US GAAP only a particular feature may require bifurcation and measurement at fair value through profit or loss, whereas under IFRS 9, the entire instrument may require measurement at fair value through profit or loss. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

When the terms of a financial asset involve returns that vary in timing or amounts, the asset should be evaluated to determine if there are any embedded derivatives that should be accounted for separately and measured at fair value through profit or loss.

A financial asset that is within the scope of IFRS 9 is not assessed for embedded derivatives because the SPPI test is applied to the entire hybrid contract to determine the appropriate measurement category. If an entity fails the SPPI test, the entire instrument is measured at FVPL.

Effective interest rate—expected vs contractual cash flows

Differences between the expected and contractual lives of financial assets carried at amortized cost have different implications under the two frameworks. The difference in where the two accounting frameworks place their emphasis (contractual term for US GAAP and expected life for IFRS) can affect the asset’s carrying values and the timing of income recognition.

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

Under US GAAP, to determine the appropriate interest income recognition model, an entity must first consider the nature of the financial instrument, any industry-specific guidance, and the accounting model being applied to the instrument. US GAAP can be prescriptive in certain instances, such as interest income recognition for beneficial interests or structured notes.

However, generally, for loans, receivables, and debt securities, the interest method is applied over the contractual life of the asset for purposes of recognizing accretion and amortization associated with premiums, discounts, and deferred origination fees and costs. However, estimated cash flows can be used when certain criteria are met.

For example, when a reporting entity holds a large number of similar loans, investments in debt securities, or other receivables for which prepayments are probable, and the timing and amount of prepayments can be reasonably estimated, an entity may elect to consider estimates of future principal prepayments in the calculation of the effective interest rate.

Under IFRS 9, there is only one effective interest model. The calculation of the effective interest rate is based on the estimated cash flows (excluding expected credit losses) over the expected life of the asset.

Contractual cash flows over the full contractual term of the financial asset are used in the rare case when it is not possible to reliably estimate the cash flows or the expected life of a financial asset.

Although not specifically prescribed in US GAAP, the accrual of interest income is generally suspended when the collection of interest is less than probable or the collection of any portion of the loan’s principal is doubtful (i.e., a non-performing loan). These are referred to as “non-accrual loans.”

Under IFRS, the accrual of interest is not suspended.

Effective interest rates—changes in expectations

Differences in how changes in expectations (associated with financial assets carried at amortized cost) are treated can affect asset values and the timing of income recognition.

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

Different models apply to the way revised estimates are treated depending on the nature of the asset. Changes may be reflected prospectively or retrospectively. However, none of the prescribed US GAAP models is the equivalent of the IFRS cumulative-catch-up-based approach.

If an entity revises its estimates of payments or receipts, the entity adjusts the carrying amount of the financial asset (or group of financial assets) to reflect revised estimated cash flows.

Revisions of the expected life or the estimated future cash flows may occur, for example, in connection with debt instruments that contain a put or call option that does not cause the asset to fail the SPPI test described in Loans and receivables—classification above.

The carrying amount is recalculated by computing the present value of estimated future cash flows at the financial asset’s original effective interest rate. The adjustment is recognized as income or expense in the income statement (i.e., by the cumulative-catch-up approach).

Generally, floating rate instruments (e.g., LIBOR plus spread) issued at par are not subject to the cumulative-catch-up approach; rather, the effective interest rate is revised as market rates change.

Restructuring of debt investments

The guidance to determine whether a restructuring of a debt investment represents an extinguishment or a modification varies between the two frameworks. Additionally, under IFRS, there is a requirement to recognize a modification gain or loss when a restructuring of a debt investment is accounted for as a modification. Under US GAAP, a restructuring (that is not a troubled debt restructuring) accounted for as a modification does not have a “day 1” impact to the income statement. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

When a creditor and a debtor agree to modify the terms of an existing debt instrument (or to exchange debt instruments) the creditor should first evaluate whether the restructuring constitutes a troubled debt restructuring (i.e., whether the debtor is experiencing financial difficulties and the creditor has granted a concession).

For debt restructurings that are not considered troubled debt restructurings, a creditor and debtor each must determine whether the modification or exchange should be accounted for as (a) the creation of a new debt instrument and the extinguishment of the original debt instrument or (b) the modification of the original debt instrument.

When a change in cash flow arises in connection with a renegotiation or other modification, a careful analysis is required.

An entity first needs to determine whether the change in cash flows arises under the contractual terms. For example, in a fixed rate loan that is prepayable at par (or with only an insignificant amount of compensation), having the lender reset the interest rate to market may not be considered a change in contractual terms.

In this case, the entity would follow the guidance for changes in interest rates applicable to floating rate instruments.

A new or restructured debt instrument is considered an extinguishment of the existing instrument and origination of a new instrument by the lender/investor when both of the following conditions are met:

  • The terms of the new or restructured debt instrument are at least as favorable to the lender as the terms for comparable debt instruments to customers with similar creditworthiness.
  • A modification is more than minor quantitatively or if facts and circumstances (and other relevant considerations) indicate that the modification is more than minor.

Where an entity determines that the change is due to a renegotiation, the entity then needs to determine whether the modification is substantial. If the change in terms is considered substantial, it is accounted for as a derecognition of a financial asset and the recognition of a new financial asset (i.e., an extinguishment). If the renegotiation does not result in a substantial change in terms, it is accounted for as a modification.

Judgment is required to assess whether the change in terms is substantial enough to represent an extinguishment (i.e., derecognition of the asset). The assessment is based on all relevant factors, such as deferral of certain payments to cover a shortfall, insertion of substantial new terms, significant extension of the term, change in interest rate, insertion of collateral or other credit enhancement, changes to loan covenants, or change in the currency of the instrument.

For a refinancing or restructuring that is not a troubled debt restructuring and is considered a modification of the debt instrument, the amortized cost basis of the new loan should comprise the remaining amortized cost basis in the original loan, any additional amounts loaned, any fees received, and direct loan origination costs associated with the refinancing or restructuring. A new effective interest rate is calculated using the new contractual cash flows.

IFRS does not have the concept of a troubled debt restructuring.

For a modification or renegotiation that does not result in derecognition, an entity is required to recognize a modification gain or loss immediately in profit or loss. The gain or loss is determined by recalculating the gross carrying amount of the financial asset by discounting the new contractual cash flows using the original effective interest rate.

Eligibility for the fair value option

The IFRS eligibility criteria for use of the fair value option are much more restrictive than the US GAAP criteria. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

With some limited exceptions for certain financial assets addressed by other applicable guidance (e.g., an investment in a consolidated subsidiary, employer’s rights under employee benefit plans), US GAAP permits entities to elect the fair value option for any recognized financial asset.

The fair value option may only be elected upon initial recognition of the financial asset or upon some other specified election dates identified in ASC 825-10-25-4.

Under IFRS 9, the only instance when an entity can irrevocably designate financial assets as measured at FVPL at initial recognition is when doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as “an accounting mismatch”) that would otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases.

Under IFRS 9, the only instance when an entity can irrevocably designate financial assets as measured at FVPL at initial recognition is when doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as “an accounting mismatch”) that would otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases.

See Exemption from applying the equity method for differences related to the fair value option for equity-method investments.

See Exemption from applying the equity method for differences related to the fair value option for equity-method investments.

Reclassifications

Transfers of financial assets into or out of different categories are only permitted in limited circumstances under both frameworks. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

Changes in classification between trading, available-for-sale, and held-to-maturity categories can occur only when justified by the facts and circumstances within the concepts of ASC 320. Given the nature of a trading security, transfers into or from the trading category should be rare.

For loans, reclassification between the held for sale and held for investment categories should generally occur at the point the intent changes.

Once the initial classification has been determined, reclassification of investments in debt instruments is only permitted when an entity changes its business model for managing the financial assets.

Changes to the business model are expected to be infrequent; the change is determined by the entity’s senior management as a result of external or internal changes. It must be significant to the entity’s operations and should be evident to external parties.

Changes in intention related to particular financial assets (even in circumstances of significant changes in market conditions) and transfers of financial assets between parts of the entity with different business models, are examples for circumstances that are not considered changes in business model.

For equity investments, the initial election to present fair value changes in OCI is irrevocable.

Impairment principles—overall model

The IFRS 9 impairment model is an expected loss model. Current US GAAP (until the effective date of the CECL model – see SD 7.19) is an incurred loss model. The impairment models are therefore currently fundamentally different. The models will be more converged when the US GAAP CECL model is effective; however, many significant differences will still exist.

For a comparison of the impairment models after the CECL model is effective for US GAAP, refer to our In depth US2017-24, Contrasting the new US GAAP and IFRS credit impairment models (Please also consider developments since the issue of this publication, such as the issuance of ASU 2019-05 Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief and ASU 2019-04 Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments.)

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

Under current US GAAP, a number of impairment models exist for various types of financial instruments not measured at fair value through net income (i.e., assets measured at amortized cost or at fair value through other comprehensive income). These models recognize impairments when losses have been incurred, as opposed to expected in the future.

For loans, the overriding concept in US GAAP is that impairment losses should be recognized when, based on all available information, it is probable that a loss has been incurred based on events and conditions existing at the date of the financial statements.

Losses are not to be recognized before it is probable that they have been incurred, even though it may be probable or expected based on past experience that losses will be incurred in the future.

For trade receivables, most entities use reserving matrices in which historical loss percentages are applied to the respective aging categories. Those historical loss percentages typically are not adjusted for future expectations.

Receivables that are either current or not yet due do not generally have a reserve.

For available for sale securities, entities generally record an impairment loss when the decline in fair value is “other than temporary.”

IFRS 9 introduced an expected loss model for financial assets. While certain simplifications exist for trade receivables, contract assets, and lease receivables, the overall model applies to assets at amortized cost and FVOCI.

Unlike current US GAAP, the model is forward looking and incorporates historical information, current information, and reasonable and supportable forecasts of future conditions.

The model contains three stages for measuring impairment losses based on the changes in credit quality of the instrument since inception.

Stage 1 includes financial instruments that have not had a significant increase in credit risk (SICR) since initial recognition or that have low credit risk at the reporting date. For these assets, an entity will typically record a 12-month Expected Credit Losses (ECL) (i.e., the expected credit loss that result from default events that are possible within 12 months after the reporting date).

It is not the expected cash shortfalls over the 12-month period, but the entire credit loss on an asset weighted by the probability that the loss will occur in the next 12 months.

Stage 2 includes financial instruments that have had a SICR since initial recognition (unless they have low credit risk at the reporting date and elect the practical expedient described in Impairments—AFS debt securities measured at FVOCI below). For these assets, lifetime ECL is recognized, but interest revenue is still recognized on the gross carrying amount of the asset.

Stage 3 includes financial assets that have objective evidence of impairment at the reporting date. For these assets, lifetime ECL is recognized and interest revenue is calculated on the net carrying amount (i.e., net of the credit allowance).

An entity is required to continually assess whether a SICR has occurred.

The ECL measurement must reflect the time value of money. The entity should discount the cash flows that it expects to receive at the effective interest rate determined at initial recognition, or an approximation thereof, in order to calculate ECL.

Impairments—AFS debt securities measured at FVOCI

US GAAP has a trigger-based two-step test that considers the intent and ability to hold the debt securities, as well as the expected recovery of the cash flows. Under IFRS, the general “expected loss” model applies. Generally, an allowance for the 12-month expected loss is recorded on initial recognition, and an allowance for lifetime expected losses is recognized upon a significant increase in credit risk. IFRS vs US GAAP Financial assets

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

An investment in certain debt securities classified as available for sale is assessed for impairment if the fair value is less than amortized cost. When fair value is less than amortized cost, an entity needs to determine whether the shortfall in fair value is temporary or other than temporary.

In determining whether an impairment is other than temporary, the following factors are assessed for available-for-sale securities:

Step 1—Can management assert (1) it does not have the intent to sell and (2) it is more likely than not that it will not have to sell before recovery of the amortized cost basis? If no, then impairment is triggered. If yes, then move to Step 2.

Step 2—Does management expect recovery of the entire cost basis of the security? If yes, then impairment is not triggered. If no, then impairment is triggered.

Once it is determined that impairment is other than temporary, the impairment loss recognized in the income statement depends on the impairment trigger:

  • If impairment is triggered as a result of Step 1, the loss in AOCI due to changes in fair value is released into the income statement.
  • If impairment is triggered in Step 2, the impairment loss is measured by calculating the present value of cash flows expected to be collected from the impaired security. The determination of such expected credit loss is not explicitly described; one method could be to discount the best estimate of cash flows by the original effective interest rate. The difference between the fair value and the post-impairment amortized cost is recorded within OCI.

As described in SD 7.13, IFRS 9 has a three-stage model for impairment based on the changes in credit quality of the instrument since inception. The same general impairment model applies to debt investments measured at FVOCI.

Upon initial recognition of a financial asset, an entity will typically record a 12-months ECL. Subsequently, the entity is required to continually assess whether a SICR has occurred. If such an increase occurs, the allowance is increased to an amount equal to lifetime ECL.

Movements in the ECL allowance are recognized in the income statement. However, the allowance itself is credited to a FVOCI reserve.

A practical expedient is available for assets with low credit risk. This expedient applies, for example, to investment grade assets. For such assets, an entity can choose to measure the impairment loss at the 12-months ECL and assume that no significant increase in credit risk has occurred, as long as the asset continues to be low credit risk.

Impairment principles—HTM instruments (at amortized cost)

US GAAP is an “incurred loss” model whereas IFRS is an “expected loss” model. US GAAP looks to a two-step test based on intent and ability to hold and expected recovery of the cash flows.

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

The two-step impairment test described in Impairments—AFS debt securities measured at FVOCI above is also applicable to certain investments classified as held-to-maturity.

Held-to-maturity investments would generally not trigger Step 1 (as tainting would result). Rather, evaluation of Step 2 may trigger impairment.

Once triggered, impairment is measured with reference to expected credit losses, as described for available-for-sale debt securities.

The same general model (and practical expedient for investment grade assets) described in Impairment principles—overall model above applies to investments measured at amortized cost.

Impairment principles—Equity investments

Under US GAAP, for equity investments accounted for under the measurement alternative, an impairment assessment is required every reporting period. Under IFRS, there is no impairment requirement for investments in equity instruments (including those classified at FVOCI).

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

For equity investments without readily determinable fair values, for which the “measurement alternative” was elected, there is a single-step impairment model.

An entity is required to perform a qualitative assessment at each reporting period to identify impairment. When a qualitative assessment indicates that an impairment exists, the entity will need to estimate the fair value of the investment and recognize in current earnings an impairment loss equal to the difference between the fair value and the carrying amount of the equity investment.

The impairment charge is a basis adjustment, which reduces the carrying amount of the equity investment to its fair value; it is not a valuation allowance.

For equity investments with readily determinable fair values measured at FVPL, all decreases in value are reflected in profit and loss, eliminating the need for an impairment assessment.

There are no impairment requirements for investments in equity investments.

For those equity investments measured at FVPL all decreases in value are reflected in profit and loss, eliminating the need for an impairment assessment.

For those equity investments measured at FVOCI, all changes in fair value are recorded through OCI with no subsequent reclassification to profit or loss.

Impairments—reversal of losses

Under the IFRS “expected loss” model, the allowance is updated every period to reflect the current assessment of expected losses. Under US GAAP, reversals are permitted for debt instruments classified as loans; however, reversal of impairment losses on debt securities is prohibited. Expected recoveries are reflected over time by adjusting the interest rate used to accrue interest income.

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

Impairments of loans held for investment measured under ASC 310-10-35 and ASC 450 are permitted to be reversed; however, the carrying amount of the loan can at no time exceed the recorded investment in the loan.

Reversals of impairment losses for debt securities classified as available-for-sale or held-to-maturity securities are prohibited. Rather, any expected recoveries in future cash flows are reflected as a prospective yield adjustment.

The amount of ECL or reversal that is required to adjust the loss allowance at the reporting date to the amount necessary under IFRS 9 is recognized in the income statement as an impairment loss or gain.

Financial asset derecognition

The determination of whether transferred financial assets should be derecognized (e.g., in connection with securitizations of loans or factorings of trade receivables) is based on different models under the two frameworks. Under US GAAP, the derecognition framework focuses exclusively on control, unlike IFRS, which requires consideration of risks and rewards.

The IFRS model also includes a continuing involvement accounting model that has no equivalent under US GAAP. Under US GAAP, either the transferred asset is fully derecognized or the transfer is accounted for as a collateralized borrowing. There is no concept of a “partial sale” under US GAAP.

IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets IFRS vs US GAAP Financial assets

US GAAP

IFRS

ASC 860 does not apply to transfers in which the transferee is a consolidated affiliate of the transferor, as defined in the standard. If this is the case, regardless of whether the transfer criteria are met, derecognition is not possible as the assets are, in effect, transferred within the consolidated entity.

The guidance focuses on an evaluation of the transfer of control. The evaluation is governed by three key considerations:

  • Legal isolation of the transferred asset from the transferor
  • The ability of the transferee (or, if the transferee is a securitization vehicle, each third-party beneficial interest holder) to pledge or exchange the asset (or the beneficial interest)
  • The transferor has no right or obligation to repurchase the transferred assets

As such, derecognition can be achieved even if the transferor has significant ongoing involvement with the transferred assets, such as significant exposure to credit risk.

If a transfer of an entire financial asset qualifies for sale accounting, the transferred asset must be derecognized from the transferor’s balance sheet. All assets received and obligations assumed in exchange are recognized at fair value.

If the transferor continues to service the transferred assets, a related servicing asset or servicing liability should be recorded at its fair value. Any gain or loss on the transfer should be recognized, calculated as the difference between the net proceeds received and the carrying value of the assets sold.

A transfer may comprise only a portion of an entire financial asset (e.g., a transfer involving a loan participation).

To potentially qualify for sale accounting, the transferred portion must first meet the stringent accounting definition of a “participating interest.” If the transferred portion does not satisfy this definition, the exchange must be accounted for as a secured borrowing.

If the definition is met, the transfer of the participating interest must then satisfy the three derecognition criteria cited above to qualify for sale accounting.

If a transfer of a participating interest qualifies for derecognition, the transferor must allocate the carrying value of the entire financial asset between the participating interest sold and the portion retained on a pro-rata basis.

All assets received and obligations assumed in exchange are recognized at fair value, consistent with the measurement principles that govern derecognition of an entire financial asset.

The transferor first applies the consolidation guidance and consolidates any and all subsidiaries or special purpose entities it controls.

The guidance focuses on evaluation of whether a qualifying transfer has taken place, whether risks and rewards have been transferred, and, in some cases, whether control over the asset in question has been transferred.

The model can be applied to part of a financial asset (or part of a group of similar financial assets) or to the financial asset in its entirety (or a group of similar financial assets in their entirety).

Under IFRS 9, full derecognition is appropriate once both of the following conditions have been met:

  • The financial asset has been transferred outside the consolidated group.
  • The entity has transferred substantially all of the risks and rewards of ownership of the financial asset.

The first condition is achieved in one of two ways:

  • When an entity transfers the contractual rights to receive the cash flows of the financial asset, or
  • When an entity retains the contractual rights to the cash flows but assumes a contractual obligation to pass the cash flows on to one or more recipients (referred to as a pass-through arrangement)

Many securitizations do not meet the strict pass-through criteria to recognize a transfer of the asset outside of the consolidated group and as a result fail the first condition for derecognition.

If there is a qualifying transfer, an entity must determine the extent to which it retains the risks and rewards of ownership of the financial asset. IFRS 9 requires the entity to evaluate the extent of the transfer of risks and rewards by comparing its exposure to the variability in the amounts and timing of the transferred financial assets’ net cash flows, both before and after the transfer.

If the entity’s exposure does not change substantially, derecognition would be precluded. Rather, a liability equal to the consideration received would be recorded (i.e., a financing transaction).

If, however, substantially all risks and rewards are transferred, the entity would derecognize the financial asset transferred and recognize separately any asset or liability created through any rights and obligations retained in the transfer (e.g., servicing assets).

Many securitization transactions include some ongoing involvement by the transferor that causes the transferor to retain substantial risks and rewards, thereby failing the second condition for derecognition, even if the pass-through test is met.

See also: The IFRS Foundation

IFRS vs US GAAP Financial assets

Leave a comment