The impairment requirements are applied to:
- Financial assets measured at amortised cost (originated, purchased, reclassified or modified debt instruments incl. trade receivables),
- Financial assets measured at fair value through other comprehensive income,
- Loan commitments except those measured at fair value through profit or loss,
- Financial guarantees contracts except those measured at fair value through profit or loss,
- Lease receivables.
In addition, although contract assets recorded in accordance with IFRS 15 Revenue from Contracts with Customers are excluded from the scope of IFRS 9, they are within the scope of its impairment requirements.
At initial recognition of a financial asset, an entity recognises a loss allowance equal to 12-month expected credit losses. These are the credit losses that are expected to result from default events that are possible within 12 months from the entity’s reporting date. This means that the actual loss does not need to take place within the 12 month period; it is the occurrence of the default event that ultimately results in that loss. An exception is purchased or originated credit impaired financial assets.
Subsequent measurement – Each reporting date
After initial recognition, the three stages under the proposals would be applied each reporting date as follows:
- Stage 1: Credit risk has not increased significantly since initial recognition – continue recognising the (updated) 12-month expected credit losses
- Stage 2: Credit risk has increased significantly since initial recognition – recognise lifetime expected losses, with interest revenue being calculated based on the gross amount of the asset
- Stage 3: There is objective evidence of impairment as at the reporting date – recognise lifetime expected losses, with interest revenue being based on the net amount of the asset (that is, based on the impaired amount of the asset).
Because the model is forward looking, expected credit losses will be recognised from the point at which the financial assets are originated or purchased. This means that a Day 1 loss will be recognised for 12-month expected credit losses. Although this might appear counter intuitive from an individual asset perspective, from a portfolio perspective this is intended to approximate a more sophisticated approach which identifies the amount of the interest charge that relates to expected credit losses (the ‘credit spread’ – for example, 2% out of an interest charge of 8%) and accounts for interest revenue at 6% and credits the 2% credit spread to an expected loss impairment account.
The following table shows the stage the loan is classified, the gross amount, the allowance account and the interest revenue recognised:
Stage 1: 12 month expected credit losses
12-month expected credit losses are calculated by multiplying the probability of a default occurring in the next 12 months with the total (lifetime) expected credit losses that would result from that default, regardless of when those losses occur. Therefore, 12-month expected credit losses represent a financial asset’s lifetime expected credit losses that are expected to arise from default events that are possible within the 12 month period following origination of an asset, or from each reporting date for those assets in Stage 1, with no significant increase in credit risk since initial recognition, but updated expected credit losses at each reporting date.
Stage 2 and 3: Lifetime expected losses
Lifetime expected credit losses are the present value of expected credit losses that arise if a borrower defaults on its obligation at any point throughout the term of a lender’s financial asset (that is, all possible default events during the term of the financial asset are included in the analysis). Lifetime expected credit losses are calculated based on a weighted average of expected credit losses, with the weightings being based on the respective probabilities of default.
Definition of default
IFRS 9 includes guidance about what constitutes default. When considering the probability of default, an entity should apply the definition used for its own internal credit risk management purposes. However, there is a rebuttable presumption that default occurs when amounts are no later than 90 days past due (unless there is other reasonable and supportable information to indicate a more lagging default criterion is appropriate).