Although the focus for IFRS 9 Financial Instruments is on financial institutions such as banks and insurance companies, ‘normal’ operating entities are also affected by IFRS 9. Maybe their investment and loan portfolios are less complex but in operating a business and as part of the internal credit risk management practice policy making it is still important to implement the impairment model under IFRS 9 Financial Instruments. This is step 3 which started with an introduction in Impairment of investments and loans.
Under IFRS 9 entities apply one of the following two approaches in recognising and measuring ECL: Step 2 Use the general or simplified approach
- the general approach, mainly for debt securities, intercompany loans and financial guarantee contracts, or
- the simplified approach, mainly for certain trade receivables and contract assets recognised in accordance with IFRS 15 and lease receivables.
Summarised the two approaches applied look like this. Step 2 Use the general or simplified approach
‘General approach’ to impairment Step 2 Use the general or simplified approach
Under the ‘general approach’, a loss allowance for lifetime expected credit losses is recognised for a financial instrument if there has been a significant increase in credit risk (measured using the lifetime probability of default) since initial recognition of the financial asset. If, at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, a loss allowance for 12-month expected credit losses is recognised. In other words, the ‘general approach’ has two bases on which to measure expected credit losses; 12-month expected credit losses and lifetime expected credit losses. Impairment of investments and loans
‘Simplified approach’ to impairment Step 2 Use the general or simplified approach
IFRS 9 establishes a simplified impairment approach for qualifying trade receivables, contract assets within the scope of IFRS 15 and lease receivables. For these assets an entity can, or in one case must, recognize a loss allowance based on Lifetime ECLs rather than the two step process under the general approach. The simplified approach does not apply to intercompany loans.
Lifetime expected credit loss is the expected credit losses that result from all possible default events over the expected life of a financial instrument. 12-month expected credit loss is the portion of the lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date.
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