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IFRS 9 Impairment new exposure draft issued

At a glance

  • New exposure draft released March 2013
  • Divergence in the IASB and the US FASB approach
  • Transfer between Bucket One and Bucket Two/Three based on significant deterioration in credit quality and only if credit quality is below investment grade.      

Fast facts

Deloitte’s 3rd Global IFRS Banking Survey found that:

  • Despite significant support for the convergence process, most banks consider that the two boards (IASB and FASB) are no longer on track to achieve it
  • Capital and pricing impacts of the changes, including impairment, will be significant
  • Constituents are putting their implementation efforts on standby due to delays in the process

The Bottom line

The multi-delayed IASB Financial Instruments Expected Credit Losses exposure draft was issued 7 March - 2013 (Draft ED/2013/3) with comments due back 5 July 2013. It proposes the following with respect to the recognition, measurement, presentation, and disclosure of expected credit losses:

  • IASB model applies to all financial assets subject to measurement of expected credit losses as well as some loan commitments and financial guarantee contracts
  • In the case of purchased or originated credit impaired financial assets and other financial instruments where credit risk has increased significantly since initial recognition, the loss allowance is measured at an amount equal to lifetime expected credit losses
  • For all other financial instruments subject to the proposals, the loss allowance is measured at an amount equal to the 12-month expected credit losses
  • The estimate of expected credit losses reflects an unbiased and probability weighted amount (determined by evaluating the range of possible outcomes) as well as the time value of money
  • Depending on the status of a financial asset with regard to credit impairment (reflecting criteria similar to IAS 39 guidance), interest revenue is calculated in different ways
  • The proposals include extensive disclosure requirements that aim to identify and explain the amounts in the financial statements arising from expected credit losses and the effect of deterioration and improvement in the credit risk of financial instruments subject to the proposals.

The context

This IASB draft follows on the FASB’s own exposure draft containing the Current Expected Credit Loss (CECL) proposals that were issued in December 2012 and is open to submissions until April 2013.  Despite the efforts over a three year period the IASB and FASB were unable to reach an agreed response to the treatment of financial instruments expected credit losses.  

To that end the FASB CECL model was developed on US banks’ feedback that the proposed IASB model was difficult to understand, audit, and operationalise. The banks also felt that the IASB approach would be likely to result in lower allowances for impairment losses on some loan portfolios.

FASB’s alternative model proposes a single, rather than a dual-measurement approach for impaired financial assets, and also recognises full life-time expected credit losses. An entity would recognise an allowance for credit impairment equal to the entity’s current estimate of the contractual cash flows that are not expected to be collected on initial recognition of the financial asset and on each subsequent reporting date.

The detail

The IASB Exposure Draft’s three-bucket approach - Recognition of Expected Losses

Bucket One

Bucket One would consist of financial assets where there has been no identified credit deterioration since initial recognition. All financial assets, except for purchased credit-impaired assets, would start in this bucket regardless of their level of credit quality. Financial assets in this bucket would have a credit allowance for 12 months ‘expected’ losses.

This means that the credit allowance will be measured as all cash shortfalls expected over the lifetime of an asset associated with the likelihood of a loss event in the next 12 months. The expected losses would be estimated using an ‘expected value’ approach (i.e. probability-weighted average approach). However, use of other reasonable methods to approximate expected values, such as probabilities of default (PDs), loss given defaults (LGDs) and/or exposures at default (EADs) would be permitted with acknowledgement that several statistical approaches may approximate a present value amount.


Financial assets would transfer from Bucket One to Bucket Two or Bucket Three when:

  • There has been significant deterioration in credit quality since initial recognition considering the term and original credit quality, and
  • The credit quality of the asset would not be considered ‘investment grade’.

Note: Change in pricing of an existing financial asset due to increased credit risk would be an example of significant deterioration.

The IASB emphasised that, when applying the transfer criteria, judgement would be required and agreed not to include any ‘bright-line’ threshold. The Board decided that an entity should use the best information available without undue cost and effort and that a 12-month probability of default (PD) can be used to assess the lifetime expected loss criterion, unless this would contradict a lifetime PD.
Also that delinquency information may be considered to assess the need to recognise lifetime expected losses with presumption (rebuttable) that the criterion is met if an asset is 30 days past due.

Bucket Two/Three

Once transferred from Bucket One, the financial assets in Bucket Two or Three would have an allowance measured as the lifetime expected credit losses for the financial assets. For Bucket Two this is at a portfolio level, while Bucket Three would be at the individual instrument level. Portfolios would transfer from Bucket One to Bucket Two, while individual instruments would transfer from Bucket One or Two, to Bucket Three.

When evaluating assets on an aggregated basis, to ensure sufficient granularity, the financial assets should not be aggregated at a higher level if there are shared risk characteristics for a sub-group that would indicate whether recognition of lifetime losses is appropriate as of the assessment date. The grouping may change each period.

Shared risk characteristics may include asset type, credit risk ratings, past-due status, collateral type, date of origination, term to maturity, industry, geographical location of the debtor, the value of collateral relative to commitment for non-recourse assets, which may influence a likelihood of the debtor electing to default and other relevant factors.  It is permitted to individually evaluate a financial asset within the group for recognition of lifetime losses as an alternative to a collective assessment.

Indicators such as PDs, pricing, credit ratings, origination rates, general market conditions, performance of the borrower, expected breach of loan covenants and change in the credit risk management approach in relation to the financial asset, are examples of the information available to assist in determination when the lifetime expected losses should be recognised.

That is when the financial asset moves from Bucket One to Bucket Two or Three. The estimate of expected losses will require consideration of all reasonable and supportable information, consideration of a range of possible outcomes including their likelihood and consideration of the time value of money.

Accounting for purchased credit-impaired assets

The IASB tentatively decided that the purchased credit-impaired assets should be initially classified in Buckets Two or Three and would not be permitted to be moved to Bucket One should credit improvements occur after initial recognition. An impairment allowance would be recognised based on the changes in lifetime expected cash flows since acquisition. Both favourable and unfavourable changes in expected cash flows would be recognised immediately in profit and loss in the same line item.

Trade receivables

For trade receivables with a significant financing element the ‘simplified approach’ would permit a policy election to apply lifetime expected losses at initial recognition and throughout the life of the asset instead of applying the three-bucket model. For trade receivables without a significant financing component, lifetime expected losses would be applied on initial recognition and throughout the life of the asset.


Entities should use the credit quality at initial recognition for existing financial assets when initially applying the new impairment model unless obtaining such credit quality information requires undue cost or effort. If the credit quality at initial recognition is not used at the date of initial application, the transition provisions would require these financial assets to be evaluated only on the basis of the second criterion in the transfer notion: whether the credit quality is below ‘investment grade’ at the date of initial application. When assessing the need to recognise lifetime expected losses based on delinquency information, the application of lifetime expected losses at transition will be required if the asset is considered delinquent, otherwise, a 12-month allowance would be required.

What's next?

The IASB exposure draft addresses some of the initial challenges of the three bucket approach, however a few issues remain including whether entities:

  • Have sufficient data to obtain expected losses for 12 months such as LGDs, PDs, EADs
  • Can determine an adjustment from a through-the-cycle estimate (used for calculation of reserves for regulatory purposes) to a point-in-time estimate required by accounting standards
  • Can practically interpret the term ‘significant deterioration in credit quality’ and ‘investment grade’ and the impact of this interpretation on comparability of the financial results of financial institutions
  • Can determine when an asset is transferred back to Bucket One from Bucket Two/Three
  • Have sufficient future economic forecast data available to calculate lifetime expected losses and so determine the impact on the volatility of the reported results.

Failure to achieve convergence between the IASB and FASB does not help comparability between those entities reporting under US GAAP and IFRS (or its equivalent). The two approaches differ in terms of operational requirements, pro/counter-cyclicality and ultimately credit losses recognised, with the flow on impact on capital requirements and profitability. It is expected that both boards will re consider their respective models following the public commentary.

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