a significant financing component, or when the entity applies the practical expedient
for contracts that have a maturity of one year or less, in accordance with IFRS 15
(see Chapter 28). [IFRS 9.5.5.15(a)(i)]. Paragraphs
60-65 of IFRS
15 provide the
requirements for determining the existence of a significant financing component in
the contract, including the use of the practical expedient for contracts that are one
year or less.
A contract asset is defined as an entity’s right to consideration in exchange for
goods or services that the entity has transferred to a customer when that right is
conditioned on something other than the passage of time (for example, the entity’s
future performance). [IFRS 15 Appendix A]. IFRS 15 describes contracts with a
significant financing component as those for which the agreed timing of payment
provides the customer or the entity with a significant benefit of financing on the
transfer of goods or services to the customer. Hence, in determining the transaction
price, an entity is required to adjust the promised amount of consideration for the
effects of the time value of money. [IFRS 15.60]. However, if the entity expects, at
contract inception, that the period between when the entity transfers a promised
good or service to a customer and when the customer pays for that good or service
will be one year or less, as a practical expedient, an entity need not adjust the
promised amount of consideration for the effects of a significant financing
component. [IFRS 15.63].
Financial instruments: Impairment 3743
Application of the simplified approach to trade receivables and contract assets that do
not contain a significant financing component intuitively makes sense. In particular, for
trade receivables and contract assets that are due in 12 months or less, the 12-month
ECLs are the same as the lifetime ECLs.
However, an entity has a policy choice to apply either the simplified approach or the
general approach for the following: [IFRS 9.5.5.16]
• all trade receivables or contract assets that result from transactions within the
scope of IFRS 15, and that contain a significant financing component in accordance
with IFRS 15. The policy choice may be applied separately to trade receivables and
contract assets (see 10.1 below and Chapter 28); [IFRS 9.5.5.15(a)(ii)] and
• all lease receivables that result from transactions that are within the scope of IAS 17
and IFRS 16 (when applied). The policy choice may be applied separately to
finance and operating lease receivables (see 10.2 below, Chapter 23 and
Chapter 24). [IFRS 9.5.5.15(b)].
The IASB noted that offering this policy choice would reduce comparability. However,
the IASB believes it would alleviate some of the practical concerns of tracking changes
in credit risk for entities that do not have sophisticated credit risk management systems.
[IFRS 9.BC5.225].
In practice, trade receivables may be sold to a factoring bank, whereby all risks and
rewards are transferred to the bank. Consequently, the trade receivables are
derecognised by the transferring entity and recognised by the factoring bank which
obtains the right to receive the payments made by the debtor for the invoiced amount.
In such a case, we believe that the ‘factored’ trade receivables are outside the scope of
the simplified approach for the purpose of the factoring bank when applying the IFRS 9
ECL model. This is because the simplified approach is limited to trade receivables that
result from transactions within the scope of IFRS 15, i.e. based on a contract to obtain
goods or services. This is not the case for the factoring bank since it has acquired the
trade receivables through a factoring agreement. Moreover, the simplified approach
was introduced to assist entities with less sophisticated credit risk management systems.
[IFRS 9.BC5.104]. Factoring banks are likely to have more sophisticated credit risk
management systems in place.
3.3
Purchased or originated credit-impaired financial assets
On initial recognition of a financial asset, an entity is required to determine whether the
asset is credit-impaired. The criteria are set out at 3.1 above. [IFRS 9.5.5.3, 5.5.5, 5.5.13].
A financial asset may be purchased credit-impaired because it has already met the
criteria. Such an asset is likely to be acquired at a deep discount. However, this does not
mean that an entity is required to apply the credit-adjusted EIR to a financial asset solely
because the financial asset has a high credit risk at initial recognition, if it has not yet
met those criteria. [IFRS 9.B5.4.7].
It may be also possible that an entity originates a credit-impaired financial asset, for
example following a substantial modification of a distressed financial asset that resulted
in the derecognition of the original financial asset (see 8 below). [IFRS 9.B5.5.26].
3744 Chapter 47
Again this does not mean that the asset should be considered credit-impaired just
because it is high risk. Consider an example of a bank originating a loan of €100,000
with interest of 30% per annum charged over the term of the loan, payable in monthly
amortising instalments. The bank’s customer has a high credit risk on origination and
the bank expects a large portion of this type of customer to pay late or fail to pay
some or all of their instalment payments. Although the loan is of high credit risk
(which is supported by the high interest rate), none of the loss events listed above
have occurred and the loan was not the result of a substantial modification and
derecognition of a distressed debt, hence, the bank should assess the loan not to be
credit-impaired on origination.
For financial assets that are considered to be credit-impaired on purchase or
origination, the EIR (see Chapter 46 at 3) is calculated taking into account the initial
lifetime ECLs in the estimated cash flows. [IFRS 9.B5.4.7, Appendix A, BC5.214, BC5.217]. This
accounting treatment is the same as that under IAS 39 for similar assets. [IAS 39.AG5]. It is
also consistent with the original method for measuring impairment proposed in the
2009 Exposure Draft.
Consequently, no allowance is recorded for 12-month ECLs for financial assets that are
credit-impaired on initial recognition. The rationale for not recording a 12-month ECL
allowance for these assets is that the losses are already reflected in the fair values at
which they are initially recognised. The same logic could be applied to all the other
financial assets which are not credit-impaired, arguing that they, too, are initially
recognised at a fair value that reflects expectations of future losses. However, the
distinction is made because the double-counting of 12-month ECLs on initial
recognition would be too large for assets with such a high credit risk since default has
already occurred and the 12-month ECLs are already reflected in the initial fair value.
The exclusion of initial ECLs from the computation of the EIR would lead to a distortion
that would be too significant to be acceptable.
For financial assets that were credit-impaired on purchase or origination, the credit-
adjusted EIR is also used subsequently to d
iscount the ECLs. In subsequent reporting
periods an entity is required to recognise:
• in the statement of financial position, the cumulative changes in lifetime ECLs
since initial recognition, discounted at the credit-impaired EIR (see 5.7 below), as
a loss allowance; [IFRS 9.5.5.13, B5.5.45] and
• in profit or loss, the amount of any change in lifetime ECLs as an impairment gain
or loss. An impairment gain is recognised if favourable changes result in the lifetime
ECLs estimate becoming lower than the original estimate that was incorporated in
the estimated cash flows on initial recognition when calculating the credit-adjusted
EIR. [IFRS 9.5.5.14].
For favourable changes that result in a lower lifetime ECLs than the original estimate on
initial recognition, IFRS 9 does not provide guidance on where in the statement of
financial position the debit entry should be booked. In our view, the impairment gain
should be recognised as a direct adjustment to the gross carrying amount. This is
supported by the application guidance in IFRS 9 on revision of estimates which requires
adjusting the gross carrying amount of the financial asset. [IFRS 9.B5.4.6]. For purchased or
Financial instruments: Impairment 3745
originated credit-impaired financial assets, since the ECLs are included in the estimated
cash flows when calculating the credit-adjusted EIR, it would be consistent to follow
the same principle and adjust the gross carrying amount when revising the original
estimates of ECLs. An alternative treatment would be to recognise a negative loss
allowance which would reflect the favourable changes in lifetime ECLs.
Along with the other credit risk disclosures requirements (see 15 below and Chapter 50
at 5.3), the holder is required to explain how it has determined that assets are credit-
impaired (including the inputs, assumptions and estimation techniques used). It is also
required to disclose the total amount of undiscounted ECLs at initial recognition for
financial assets initially recognised during the reporting period that were purchased or
originated credit-impaired. [IFRS 7.35H(c)].
The accounting treatment for a purchased credit-impaired financial asset is illustrated
in the following example.
Example 47.2: Calculation of the credit-adjusted effective interest rate and
recognition of a loss allowance for a purchased credit-impaired
financial asset
On 1 January 2013, Company D issued a bond that required it to pay an annual coupon of €800 in arrears and
to repay the principal of €10,000 on 31 December 2022. By 2018, Company D was in significant financial
difficulties and was unable to pay the coupon due on 31 December 2018. On 1 January 2019, Company V
estimates that the holder could expect to receive a single payment of €4,000 at the end of 2020. It acquires
the bond at an arm’s length price of €3,000. Company V determines that the debt instrument is credit-impaired
on initial recognition, because of evidence of significant financial difficulty of Company D and because the
debt instrument was purchased at a deep discount.
It can be shown that using the contractual cash flows (including the €800 overdue) gives rise to an EIR of
70.1% (the net present value of €800 now and annually thereafter until 2022 and €10,000 receivable at the
end of 2022 equals €3,000 when discounted at 70.1%). However, because the bond is credit-impaired, V
should calculate the EIR using the estimated cash flows of the instrument. In this case, the EIR is 15.5% (the
net present value of €4,000 receivable in two years equals €3,000 when discounted at 15.5%).
All things being equal, interest income of €465(€3,000 × 15.5%) would be recognised on the instrument
during 2019 and its carrying amount at the end of the year would be €3,465 (€3,000 + €465). However if
at the end of the year, based on reasonable and supportable evidence, the cash flow expected to be
received on the instrument had increased to, say, €4,250 (still to be received at the end of 2020), an
adjustment would be made to the asset’s amortised cost. Accordingly, its carrying amount would be
increased to €3,681 (€4,250 discounted over one year at 15.5%) and an impairment gain of €217 would
be recognised in profit or loss.
On the other hand, if at the end of the year, based on reasonable and supportable evidence, the cash flow
expected to be received on the instrument had decreased to, say, €3,500 (still to be received at the end of
2020), an adjustment would be made to the asset’s amortised cost. Accordingly, its carrying amount would
be decreased to €3,031 (€3,500 discounted over one year at 15.5%) and an impairment loss of €433 would be
recognised in profit or loss.
4 IMPAIRMENT
FOR
CORPORATES
For corporates, the IFRS 9 ECL model does not usually give rise to a major increase in
allowances for many of the financial assets they hold.
There is a limit to the increase in allowances for short-term trade receivables and
contract assets because of their short term nature. Moreover, the standard includes
3746 Chapter 47
practical expedients, in particular the use of the simplified approach and a provision
matrix, which should help in measuring the loss allowance for short-term trade
receivables: [IFRS 9.B5.5.35]
• The simplified approach does not require the tracking of changes in credit risk, but
instead requires the recognition of lifetime ECLs at all times. [IFRS 9.5.5.15]. For trade
receivables or contract assets that do not contain a significant financing component
(see 10.1 below), entities are required to apply the simplified approach.
[IFRS 9.5.5.15(a)(i)]. For trade receivables or contract assets that do contain a
significant financing component, and lease receivables (see 10.2 below), entities
have a policy choice to apply the simplified approach (see 3.2 above) or the general
approach (see 3.1 above).
• IFRS 9 allows using a provision matrix as a practical expedient for determining
ECLs on trade receivables (see 10.1 below). Many corporates may already use a
provision matrix to calculate their current impairment allowance, but they would
need to calculate ECLs for receivables that are not yet delinquent and also consider
how they can incorporate forward-looking information into their historical
customer default rates (see 5.9.3 below). Entities would also need to group
receivables into various customer segments that have similar loss patterns (e.g. by
geography, product type, customer rating or type of collateral) (see 6.5 below).
The IFRS 9 ECL model can give rise to challenges for the measurement of other assets
for which the general model applies. These include long-term trade receivables and
contract assets for which the simplified approach is not applied, lease receivables and
debt securities which are measured at amortised cost or at fair value through other
comprehensive income (see 9 below). For example, a corporate that has a large portfolio
of debt securities that were previously held as available-for-sale under IAS 39, is likely
to classify its holdings as measured at fair value through other comprehensive income if
the contractual cash flow characteristics and business model test are met (see
Chapter 44 a
t 5 and 6). For these debt securities, the corporate would be required to
recognise a loss allowance based on 12-month ECLs, even for debt securities that are
highly rated (e.g. AAA- or AA-rated bonds).
Under the general approach, at each reporting date, an entity is required to assess
whether there has been a significant increase in credit risk since initial recognition as
this will determine whether a 12-month ECLs or lifetime ECLs should be recognised
(see 6 below). When applying the general approach, a number of operational
simplifications and presumptions are available to help entities assess significant
increases in credit risk since initial recognition. These include:
• If a financial instrument has low credit risk (equivalent to investment grade quality),
then an entity may assume no significant increases in credit risk have occurred
(see 6.4.1 below). The low credit risk simplification may be useful for corporates as
it provides relief for entities from tracking changes in the credit risk of high quality
financial instruments. However, collateral does not influence whether a financial
instrument has a low credit risk.
• If more forward-looking information (either on an individual or collective basis) is
not available, there is a rebuttable presumption that credit risk has increased
significantly when contractual payments are more than 30 DPD (see 6.2.2 below).
Financial instruments: Impairment 3747
• The change in risk of a default occurring in the next 12 months may often be used
as an approximation for the change in risk of a default occurring over the remaining
life when assessing significant in credit risk (see 6.4.3 below).
• The assessment may be made on a collective basis (see 6.5 below) or at the
counterparty level (see 6.4.4 below).
In measuring ECLs, financial institutions often already have sophisticated ECL models
and systems for capital adequacy purposes, including data such as the probability of
default (PD), loss given default (LGD) and exposure at default (EAD). Many non-financial
entities do not have models and systems in place that capture such information. One
possibility is to make use of credit default swap (CDS) spreads and bond spreads. For
financial instruments that are rated by an external agency such as Standard & Poor’s, for
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 740
