Basel Committee IFRS 9 Guidance

Basel Committee IFRS 9 Guidance

Expected credit losses continuously in focus

In December 2015, the Basel Committee on Banking Supervision (‘the Committee’) issued its Guidance on credit risk and accounting for expected credit losses (‘Basel Committee IFRS 9 Guidance’). The Guidance sets out supervisory guidance on sound credit risk practices associated with the implementation and ongoing application of expected credit loss (ECL) accounting frameworks, such as that introduced in IFRS 9, Financial Instruments.

The Committee expects a disciplined, high-quality approach to assessing and measuring ECL by banks. The Basel Committee IFRS 9 Guidance emphasises the inclusion of a wide range of relevant, reasonable and supportable forward looking information, including macroeconomic data, in a bank’s accounting measure of ECL. In particular, banks should not ignore future events simply because they have a low probability of occurring or on the grounds of increased cost or subjectivity.

In addition, the Basel Committee IFRS 9 Guidance notes the Committee’s view that that the use of the practical expedients in IFRS 9 should be limited for internationally active banks. This includes the use of the ‘low credit risk’ exemption and the ‘more than 30 days past due’ rebuttable presumption in relation to assessing significant increases in credit risk.

Obviously, banks keep in continued talks to their local regulator about the extent to which their regulator expects the (below) Banking IFRS 9 Guidance to apply to them.

Principles underlying the Banking IFRS 9 Guidance – in Summary

Supervisory guidance for credit risk and accounting for expected credit losses

Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance Basel Committee IFRS 9 Guidance

Principle 1

Responsibility

A bank’s board of directors and senior management are responsible for ensuring appropriate credit risk practices, including an effective system of internal control, to consistently determine adequate allowances.

Principle 2

Methodology

The measurement of allowances should build upon robust methodologies to address policies, procedures and controls for assessing and measuring credit risk

Banks should clearly document the definition of key terms and criteria to duly consider the impact of forward-looking information including macro-economic factors, different potential scenarios and define accounting policies for restructurings

Principle 3

Credit Risk Rating

A bank should have a credit risk rating process in place to appropriately group lending exposures on the basis of shared credit risk characteristics

Principle 4

Allowances adequacy

A bank’s aggregate amount of allowances should be adequate and consistent with the objectives of the applicable accounting framework

Banks must ensure that the assessment approach (individual or collective) does not result in delayed recognition of ECL, e.g. by incorporating forward-looking information incl. macroeconomic factors on collective basis for individually assessed loans

Principle 5

Validation of models

A bank should have policies and procedures in place to appropriately validate models used to assess and measure expected credit losses

Principle 6

Experienced credit judgment

Experienced credit judgment in particular with regards to forward looking information and macroeconomic factors is essential

Consideration of forward looking information should not be avoided on the basis that banks consider costs as excessive or information too uncertain if this information contributes to a high quality implementation

Principle 7

Common systems

A bank should have a sound credit risk assessment and measurement process that provides it with a strong basis for common systems, tools and data

Principle 8

Disclosure

A bank’s public disclosures should promote transparency and comparability by providing timely, relevant, and decision-useful information

Principle 9

Assessment of Credit Risk Management

Banking supervisors should periodically evaluate the effectiveness of a bank’s credit risk practices

Principle 10

Approval of Models

Supervisors should be satisfied that the methods employed by a bank to determine accounting allowances lead to an appropriate measurement of expected credit losses

Principle 11

Assessment of Capital Adequacy

Banking supervisors should consider a bank’s credit risk practices when assessing a bank’s capital adequacy

Principles underlying the Banking IFRS 9 Guidance

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30 days past due rebuttable presumption – simple and sufficient

Past due status and more than 30 days past due rebuttable presumption

– making loss provision calculations simple –

The second simplification available in IFRS 9 sets out a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due. [IFRS 9.5.5.11]

The first simplification available in IFRS 9 is the low credit presumption.

When payments are 30 days past due, a financial asset is considered to be in stage 2 and lifetime expected credit losses are recognised.

An entity can rebut this presumption when it has reasonable and supportable information available that demonstrates that even if payments are 30 days or more past due, it does not represent a significant increase in the credit risk of a financial instrument.

This 30 days past due simplification permits the use of delinquency or past due status, together with other more forward-looking information, to 30 days past dueidentify a significant increase in credit risk. The IASB decided that this simplification should be required as a rebuttable presumption to ensure that its application does not result in an entity reverting to an incurred loss model.[IFRS 9.BC5.190]

The IASB is concerned that past due information is a lagging indicator. Typically, credit risk increases significantly before a financial instrument becomes past due or other lagging borrower-specific factors (for example, a modification or restructuring) are observed.

Consequently, when reasonable and supportable information that is more forward-looking than past due information is available without undue cost or effort, it must be used to assess changes in credit risk and an entity cannot rely solely on past due information. However, if more forward-looking information (either on an individual or collective basis) is not available without undue cost or effort, an entity may use past due information to assess changes in credit risks.

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IAS 1 Common control transactions v Newco formation

Common control transactions v Newco formation

are two different events, that sometimes interactCommon control transactions v Newco formation

  • Common control transactions represent the transfer of assets or an exchange of equity interests among entities under the same parent’s control. “Control” can be established through a majority voting interest, as well as variable interests and contractual arrangements. Entities that are consolidated by the same parent—or that would be consolidated, if consolidated financial statements were required to be prepared by the parent or controlling party—are considered to be under common control.Determining whether common control exists requires judgment and could have broad implications for financial reporting, deals and tax. Just a few examples are:
    • A reporting entity charters a newly formed entity to effect a transaction.
    • A ‘Never-Neverland‘-domiciled company transfers assets to a subsidiary domiciled in a different jurisdiction.
    • Two companies under common control combine to form one legal entity.
    • Prior to spin-off of a subsidiary by a parent entity, another wholly owned subsidiary transfers net assets to the “SpinCo.”
    • As part of a reorganization, a parent entity merges with and into a wholly owned subsidiary.
  • Newco formations may be used in Business Combinations or businesses controlled by the same party (or parties). Just a few examples are: Common control transactions v Newco formation
    • A Newco can be formed by the controlling party (for example, to facilitate subsequent disposal of the newly created group through an initial public offering (IPO) or a spin-off or by a third-party acquirer (for example to raise funds to effect the acquisition); Common control transactions v Newco formation
    • A Newco can pay cash or shares to effect an acquisition; and
    • A Newco can be formed to acquire just one business or more than one business.

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Limitations to financial reporting

Limitations to financial reporting are many times presented with two clear limitations to the information provided by a general purpose financial report that are materiality and cost.

  1. Materiality. Information is material if its omission or misstatement could influence the decisions that users make on the basis of an entity’s financial information. Because materiality depends on the nature and amount of the item judged in the particular circumstances of its omission or misstatement, it is not possible to specify a uniform Read more

Introduction IFRS 17 Insurance contracts

Introduction IFRS 17 Insurance contracts – More than 20 years in development, IFRS 17 represents a complete overhaul of accounting for insurance contracts. The new standard applies a current value approach to measuring insurance contracts and recognises profit as insurers provide services and are released from risk. Introduction IFRS 17 Insurance contracts

The profit or loss earned from underwriting activities are reported separately from financing activities. Detailed note disclosures explain how items like new business issued, experience in the year, cash receipts and payments, and changes in assumptions affected the performance and the carrying amount of insurance contracts. Introduction IFRS 17 Insurance contracts

IFRS 17 establishes principles for the recognition, measurement, presentation and disclosure of insurance contracts issued, reinsurance contracts Read more

Insurance modelling

Insurance modelling – The estimates of future cash flows should incorporate all reasonable and supportable information available without undue cost or effort about amount, timing and uncertainty of those future cash flows. To accomplish this, an entity should estimate the expected value of the full range of possible outcomes. Estimates and assumptions should be unbiased (that is, neither conservative nor optimistic). Insurance modelling

The objective of considering the full range of all possible outcomes is to incorporate all reasonable and supportable information. An insurer is not required to identify every possible scenario. Explicit scenarios are not required if the result meets the objective. However, a single scenario based on the most likely outcome or the more-likely-than-not outcome would not meet Read more

Estimates of future cash flows

Estimates of future cash flows – The first element of measuring fulfilment cash flows in the general model (see ‘General model of measurement of insurance contracts‘)┬áis an estimate of future cash flows within the contract boundary period of each contract in a group.

Here is how the estimates of future cash flows fit into the general model of measurement of insurance contracts. The general model is based on the following estimation parameters:

  • fulfillment cash flows, comprising of: Estimates of future cash flows
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What are Alternative performance measures?

What are Alternative performance measuresWhat are Alternative performance measures – Alternative performance measures (APMs) may supplement Generally Accepted Accounting Principles (GAAP) reporting, and often represent an effective way of communicating important entity specific developments.

However, APMs need to be defined using appropriate descriptions and disclosures to avoid the risk of misleading the users of the financial reports.

Regulators in many jurisdictions have issued guidelines for the use of APMs that are helpful benchmarks when developing communication strategies and preparing financial reports. Entities can use these guidelines, both for compliance purposes and to facilitate effective communication.

Background

Financial statements are the cornerstone of financial reporting for entities. In addition to GAAP measures, management often uses a variety of other financial measures to communicate information about Read more

Valuing deferred tax assets – How 2 best account it in IAS 12

Valuing deferred tax assets

Judgement! Judgement! Judgement! Judgement! Judgement! Judgement! Judgement! Judgement! OK?

The telecommunications industry is very dynamic, driven by technological developments and changes in the competitive and regulatory environment. Due to the significant capital expenditure involved in building infrastructure, investment recovery periods tend to be longer than in many other industries. In the past, a number of telecom operators have recorded significant start-up trading losses and losses due to impairment charges on licences or goodwill and other assets resulting from business combinations. Depending on local tax legislation, operators can use these losses to offset future taxable income.

Companies are required to assess the accumulated losses and the recoverability of any related deferred tax assets (deferred tax asset) each Read more