The best 1 in overview – IFRS 9 Impairment requirements

IFRS 9 Impairment requirements

forward-looking information to recognise expected credit losses for all debt-type financial assets

 

Under IFRS 9 Impairment requirements, recognition of impairment no longer depends on a reporting entity first identifying a credit loss event.

IFRS 9 instead uses more forward-looking information to recognise expected credit losses for all debt-type financial assets that are not measured at fair value through profit or loss.

IFRS 9 requires an entity to recognise a loss allowance for expected credit losses on:

  • debt instruments measured at amortised cost
  • debt instruments measured at fair value through other comprehensive income
  • lease receivables
  • contract assets (as defined in IFRS 15 ‘Revenue from Contracts with Customers’)
  • loan commitments that are not measured at fair value through profit or loss
  • financial guarantee contracts (except those accounted for as insurance contracts).

IFRS 9 requires an expected loss allowance to be estimated for each of these types of asset or exposure. However, the Standard specifies three different approaches depending on the type of asset or exposure:

IFRS 9 Impairment requirements

* optional application to trade receivables and contract assets with a significant financing component, and to lease receivables

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Determining a leases discount rate

Determining a leases discount rate

IFRS 16.26 sets out the discount rate requirement as follows:

At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.”

Given a significant number of organisations are unlikely to have the necessary historical data to determine the interest rate implicit in the lease (“IRIIL”) for transition, it seems logical that the use of the incremental borrowing rate (“IBR”) will be relatively common at the date of adoption.

Additionally, any company choosing to use one of the modified retrospective approaches is required to use the IBR. For leases signed after transition, companies may be more readily able to determine IRIIL, however it is likely that companies will enter into leases which require the continued use of the IBR.

Lessee’s incremental borrowing rate

The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right of use asset in a similar economic environment.”

Additional detail on determining the incremental borrowing rate can be found in the guidance outlining the transition related practical expedient for using a single discount rate for a portfolio of leases:

a lessee may apply a single discount rate to a portfolio of leases with reasonably similar characteristics (such as leases with a similar remaining lease term for a similar class of underlying asset in a similar economic environment).”

Combining these two aspects together results in the six factors (in green) requiring consideration in determining an IBR, either for an individual lease or a portfolio of leases.

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Revolving credit facilities IFRS 9

Revolving credit facilities IFRS 9 – The 2013 ED specified that the maximum period over which expected credit losses (ECLs) are to be calculated should be limited to the contractual period over which the entity is exposed to credit risk. This would mean that the allowance for commitments that can be withdrawn at short notice by a lender, such as overdrafts and credit card facilities, would be limited to the ECLs that would arise over the notice period, which might be only one day. Revolving credit facilities IFRS 9

However, banks will not normally exercise their right to cancel the commitment until there is already evidence of significant deterioration, which exposes them to risk over a considerably longer period. The … Read more