ECL

Low credit risk operational simplification

by

Low credit risk operational simplification

IFRS 9 contains an important simplification that, if a financial instrument has low credit risk, then an entity is allowed to assume at the reporting date that no significant increases in credit risk have occurred. The low credit risk concept was intended, by the IASB, to provide relief for entities from tracking changes in the credit risk of high quality financial instruments. Therefore, this simplification is only optional and the low credit risk simplification can be elected on an instrument-by-instrument basis.

This is a change from the 2013 ED, in which a low risk exposure was deemed not to have suffered significant deterioration in credit risk. The amendment to make the simplification optional was made in response to requests from constituents, including regulators. It is expected that the Basel Committee SCRAVL consultation document will propose that sophisticated banks should only use this simplification rarely for their loan portfolios.

For low risk instruments, the entity would recognise an allowance based on 12-month ECLs. However, if a financial instrument is not considered to have low credit risk at the reporting date, it does not follow that the entity is required to recognise lifetime ECLs. In such instances, the entity has to assess whether there has been a significant increase in credit risk since initial recognition that requires the recognition of lifetime ECLs.

The standard states that a financial instrument is considered to have low credit risk if: [IFRS 9.B5.22]

  • The financial instrument has a low risk of default
  • The borrower has a strong capacity to meet its contractual cash flow obligations in the near term
  • Adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations Low credit risk operational simplification

A financial instrument is not considered to have low credit risk simply because it has a low risk of loss (e.g., for a collateralised loan, if the value of the collateral is more than the amount lent (see collateral) or it has lower risk of default compared with the entity’s other financial instruments or relative to the credit risk of the jurisdiction within which the entity operates.

Read more

Payment holidays on loans

by

Payment holidays on loans under IFRS 9

Governments and banks have introduced payment deferral programs to support borrowers affected by Covid-19. But deferred payments are not forgiven and must be repaid in the future, raising prospective risks to the banking system. Thus, they should be designed to balance near-term economic relief benefits with longer-term financial stability considerations.

The Basel Committee on Banking Supervision (BCBS) and several prudential authorities have issued statements clarifying how payment deferrals should be considered in assessing credit risk under applicable accounting frameworks. These measures aim to encourage banks to continue lending, to avert an even deeper recession.

Prudential authorities are caught “between a rock and a hard place” as they encourage banks – through various relief measures – to provide credit to solvent, but cash-strapped borrowers, while keeping in mind the longer-term implications of these measures for the health of banks and national banking systems.

In navigating these tensions, banks and supervisors face a daunting task as borrowers that may be granted payment holidays have varying risk profiles. Distinguishing between illiquid and insolvent borrowers – amidst an uncertain outlook – should help guide banks’ efforts to support viable borrowers, while preserving the integrity of their reported financial metrics.

What is this all about?

Read more

Going concern and pandemics

by

Going concern and pandemics

IAS 1 Presentation of Financial Statements requires management, when preparing financial statements, to make an assessment of an entity’s ability to continue as a going concern, and whether the going concern assumption is appropriate.

Furthermore, disclosures are required when the going concern basis is not used or when management is aware, in making their assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern.

Disclosure of significant judgement is also required where the assessment of the existence of a material uncertainty is a significant judgement.

In assessing whether the going concern assumption is appropriate, the standard requires that all available information about the future, which is at least, but not limited to, twelve months from the end of the reporting period, should be taken into account.

This assessment needs to be performed up to the date on which the financial statements are issued.

Refer to ‘Current vulnerability due to concentration and liquidity risks‘ below for further discussion on the current vulnerability entities are facing due to concentration and liquidity risks.

Read more

Landlord accounting model – IFRS 16 best replacement for IAS 40

by

Landlord accounting model

Landlords continue to classify leases as finance or operating leases, and continue to classify many real estate leases as operating leases.

1 Overview

The lessor follows a dual accounting approach for lease accounting. The accounting is based on whether significant risks and rewards incidental to ownership of an underlying asset are transferred to the lessee, in which case the lease is classified as a finance lease. This is similar to the previous lease accounting requirements that applied to lessors.

What are the impacts of IFRS 16 on lessors?

Much of the guidance in IFRS 16 on lessor accounting is a ‘carry forward’ from IAS 17 Leases – literally a cut-and-paste. This reflects feedback from financial statement users and other stakeholders that lessor accounting was not ‘broken’.

However, there are a number of changes in the details of lessor accounting. For example, lessors apply the new:

  • definition of a lease (see this page);
  • guidance on separating components of a contract (see this page);
  • guidance on lease term (see this page);
  • guidance on lease modifications (see this page);
  • guidance on sub-lease (see this page); and
  • guidance on sale-and-leaseback (see this page).

The same definition of ‘lease term’ applies to both lessees and lessors. IFRS 16 includes guidance on when extension options and termination options are taken into consideration when determining the lease term. Additional guidance has been issued about determining the lease term – an estimate that could significantly impact the overall lease accounting.

In addition, IFRS 16 includes specific guidance on separating the components of a contract and accounting for lease modifications by lessors.

The new guidance may significantly impact the accounting for sub-leases and sale-and-leaseback transactions.

2 Lease classification

Read more

Equity – 2 understand it all at best

by

Equity

There are, at least, two ways to discuss equity:

  • Equity is the residual interest in the assets of the entity after deducting all its liabilities, or
  • An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

But also:

1. Equity the residual interest in the assets of the entity after deducting all its liabilities

1. Statement of Financial Position

Assets

Equity and liabilities

1. Non-current assets

2. Current assets

Help

Help

A – TOTAL ASSETS [1 + 2] = B

3. Non-current liabilities (including Provisions)

4. Current liabilities (including Provisions)

5. Equity [1 + 2 -/- 3 -/- 4]

Help

B – TOTAL EQUITY AND LIABILITIES [3 + 4 + 5] = A

Read more

What Is Fintech reporting IFRS 15

by

What Is Fintech or Financial Technology And Its Benefits?

New and fast-growing technologies like Financial Technology or Fintech have the potential benefits to collect and process data in real-time. This transforms how all businesses are working, how products and services are creating in the new economy, and how customers are engaging in this process. Every professional and commercial industry is affecting due by this change in workflows and business processes. The financial and economic sector is no exception.

Financial Technology or Fintech?

Fintech, short for Financial Technology, is a growing field and is now an economic revolution by the tech-savvy. It is the development of new technology to transform traditional institutions such as banks and insurance companies by uplift how they handle their finances and economic services. The process is not only digitizing money but also monetizing data to fit into the digitized world.

FinTech solutions have huge potential benefits for all businesses, especially new and existing small businesses. Small and medium-sized enterprises (SMEs) are essential for economic maturity and employment. However, others may find it difficult to get the financing they need to survive and thrive.

Example

Automated drafting of portfolio management commentaries – Analytics & Reporting (October 2018, Societe Generale Securities Services)

Addventa Fintech exclusive partnership for automated drafting of portfolio management commentaries based on artificial intelligence solutions.

Read more

Basel Committee IFRS 9 Guidance

by

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

Read more

30 days past due rebuttable presumption – simple and sufficient

by

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.

Read more

IFRS 7 Other price risks Step-by-step

by

IFRS 7 Other price risks Step-by-step – Other price risks is part of the risk disclosures requirements under IFRS 7 Financial Instruments: Disclosures. Other price risks is part of market risk (the other main market risk categories being currency risk and interest rate risk) and is defined as the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices (other than those arising from interest rate risk or currency risk), whether those changes are caused by factors specific to the individual financial instrument or its issuer or by factors affecting all similar financial instruments traded in the market. IFRS 7 Other price risks Step-by-step

Management should disclose information … Read more

How to best account for COVID-19 under IAS 10

by

How to best account for COVID-19 under IAS 10 Events after the reporting period? The question is whether the COVID-19 crises is an adjusting event of a non-adjusting event for the Financial Statements for the period ended 31 December 2019 that have not been authorised for final distribution to stakeholders or for filing at a chamber of commerce or similar institute.

If it is a non-adjusting event what disclosures does it still require in the financial statements or management report accompanying these financial statements?

In terms of accounting implications, the current consensus is that an entity shall not adjust the amounts recognized in its financial statements (IAS 10 10 Non-adjusting events) as at 31 December 2019 to reflect … Read more