In terms of the ECL, like credit risk Stage 2, these are recognised on a lifetime basis. Examples might include evidence of significant financial difficulty of the debtor, or default. This is where the financial asset has become credit impaired: the point when there is objective evidence of impairment as defined under IAS 39 (the predecessor to IFRS 9). Under IFRS 9, there is a rebuttable presumption that there is a significant increase in credit risk if a contractual repayment is more than 30 days past its due date. Interest income is calculated on the gross carrying amount of the financial asset. ECLs over the lifetime of the financial asset must be recognised. There is a significant increase in credit risk from initial recognition. Only the ECLs within 12 months of a reporting date are calculated. There is no significant increase in credit risk from initial recognition. Under each stage there is a different prescribed method of calculating the ECL (by using PDs calculated over different periods – 12 months or over the entire life of the financial asset) and recognising interest income: Under IFRS 9, there are three stages of credit risk. As such, the lifetime ECL will be higher than the 12-month ECL. The PD calculated on a lifetime basis will be higher than the PD calculated over 12 months. The credit loss that is calculated on a 12-month basis involves analysis of historical credit losses over 12 months.īut credit loss calculated over the lifetime of the financial asset is derived from historical losses over the life of the asset. This depends on whether there has been a significant increase in credit risk since the date of initial recognition. The calculation can be either for 12 months or based on the lifetime of the financial asset. The calculation processOnce the three functions are determined, the ECL is calculated as EAD x PD x LGD. The LGD is based on an analysis of historical post-default recoveries. These can be in the form of cash repayments, proceeds from the realisation of security or sale of the debt to a third party. This is an adjustment to the ECL calculation for post-default recoveries. Forward-looking macro-economic information relating to, say, future GDP and/or unemployment is then considered and the calculated historical PD is adjusted. This historic PD is then adjusted by a factor, determined by reviewing the historic relationship between key economic parameters such as GDP and unemployment and PD. PD is determined based on the historical loss experience of an entity. This is an estimate of the likelihood of default over a given period. EAD = The principal amount outstanding x (1- the calculated repayment rate in the period to default). A repayment rate is calculated based on an historic analysis of repayments in the period to default. This is the amount of principal to which the calculated probability of default rate and the loss given default rate is applied. There are three functions that need to be considered: The general approach is used by banks and other financial institutions that have longer-term financial assets. The simplified approach involves the calculation of historical loss rates. It usually involves, among other things, calculation of the probability of default, considering whether there have been significant increases in credit risk, and forward-looking macro-economic information. IFRS 9 permits two approaches: the general approach and the simplified approach. With these different types and characteristics of financial assets, there is the question ‘How should entities calculate the ECLs for each type?’. These are amounts billed by companies to customers upon delivery of goods or services and are usually due within 12 months. In other entities, such as manufacturing and retail companies, their most common financial asset may be trade receivables. This is common for banks and consumer lending companies. Some entities offer loan products that are long-term in nature and some may be secured on collateral. These assets may be in the form of loans, debt securities or trade receivables.įinancial assets vary from entity to entity depending on the nature of the business and the products they provide. The calculation of ECLs applies to financial assets that are measured under amortised cost or at fair value through other comprehensive income. We look at the methods and considerations along the way.įor a financial asset, the expected credit loss (ECL) is the difference between the contractual cash flows that are due to an entity and the cash flows that an entity expects to receive. Since IFRS 9 replaced IAS 39, entities have been getting to grips with new reporting requirements. Service: Financial reporting Sector: Financial services
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