IFRS 9 Expected Credit Loss Model
IFRS 9 Financial Instruments requires impairment allowance to be recognised based on expected credit losses. What are expected credit losses?
Expected credit loss = Exposure at default x Loss given default x Probability of default.
The general approach requires an entity to track changes in credit risk.
If an entity concludes that there has been a significant increase in credit risk since origination, then lifetime expected credit losses are required to be provided for. This is the case even if there is no actual default.
Did you know that the general approach requires a financial asset to be classified either in Stage 1, Stage 2 or Stage 3, and it is possible for the financial asset to move from one stage to another, forwards as well as backwards during its life?
The expected credit loss model requires continuous monitoring of changes in credit risk and the impairment provision can cause volatility in the profit or loss. It allows both individual and collective assessment of impairment.
The five key areas of judgement and estimates are:
- Determining whether there is a significant increase in credit risk since initial recognition
- Measurement of expected credit losses, for example, determining whether loans will be paid as due and if not, how much might be recovered and when, and probability-weighting different scenarios
- Incorporating forward-looking macro-economic information into the assessment of changes in credit risk and measurement of expected credit losses
- Determining whether a collective or individual and collective assessment is needed for portfolios of shared risk characteristics
- Determining the appropriate period over which to measure expected credit losses for revolving credit facilities
IFRS 9 allows use of simplified model and practical expedients for relatively smaller portfolios and those with low credit risk. This is beneficial to corporates who may not have readily available calculation of probability of default.
If you are interested to learn more about application of the expected credit loss principles, please get in touch.