Financial assets can lose value, and accounting rules help track these losses. This section covers how to spot and measure impairment using the Expected Credit Loss model. It's a key part of managing financial instruments and their risks.

The rules differ based on how assets are classified and measured. For some, you'll use a three-stage model, while others need simpler approaches. Understanding these methods is crucial for accurate financial reporting and risk assessment.

Impairment Models for Financial Assets

Expected Credit Loss (ECL) Model Overview

• IFRS 9 introduced ECL model replaced incurred loss model from IAS 39
• ECL model requires entities to recognize expected credit losses at all times
• Entities must update expected credit loss amounts at each reporting date
• Three main approaches for measuring expected credit losses
  • General approach
  • Simplified approach
  • Credit-adjusted effective interest rate approach

General Approach: Three-Stage Model

• Based on changes in credit quality since initial recognition
• Stage 1: 12-month ECL for financial instruments without significant increase in credit risk
• Stage 2: Lifetime ECL for financial instruments with significant increase in credit risk
• Stage 3: Lifetime ECL for credit-impaired financial assets
• Movement between stages based on relative credit risk changes

Simplified and Credit-Adjusted Approaches

• Simplified approach used for trade receivables, contract assets, and lease receivables
  • Always recognize lifetime ECL
  • Typically utilizes provision matrix based on historical loss rates
• Credit-adjusted effective interest rate approach applied to purchased or originated credit-impaired assets
  • Incorporates lifetime ECL into effective interest rate calculation
  • Used for assets already credit-impaired at initial recognition (distressed debt)

Indicators of Impairment

Financial Distress and Market Indicators

• Significant financial difficulty of issuer or borrower indicates potential impairment
  • Negative cash flows, declining revenues, increasing losses
• Breach of contract signals possible impairment
  • Default on payments, violation of debt covenants
• Disappearance of active market for financial asset due to financial difficulties
  • Sudden illiquidity of previously traded bonds
  • Delisting of company shares from stock exchange

Lender Concessions and Economic Factors

• Lender granting concessions to borrower due to economic or contractual reasons related to financial difficulties
  • Debt restructuring, extended payment terms, interest rate reductions
• Observable data indicating measurable decrease in estimated future cash flows
  • Changes in economic conditions correlating with defaults (rising unemployment, industry downturns)
  • Negative changes in borrower's credit rating
• For equity instruments, significant or prolonged decline in fair value below cost
  • Market price consistently below purchase price for extended period (6-12 months)
  • Substantial price drop (20-30% below cost)

Impairment Methodology for Financial Assets

Amortized Cost and Fair Value Through Other Comprehensive Income (FVOCI)

• Financial assets measured at amortized cost subject to general or simplified approach for ECL calculation
  • Loans, held-to-maturity investments
• Debt instruments measured at FVOCI follow general approach for ECL calculation
  • Impairment gains or losses recognized in profit or loss
  • Carrying amount not reduced in statement of financial position
• Equity instruments measured at FVOCI not subject to impairment accounting
  • All fair value changes recognized in other comprehensive income

Fair Value Through Profit or Loss (FVTPL) and Off-Balance Sheet Items

• Financial assets measured at FVTPL do not require separate impairment assessment
  • Fair value changes inherently reflect credit risk (trading securities, derivatives)
• Loan commitments and financial guarantee contracts not measured at FVTPL subject to ECL model
  • Consider exposure period for ECL calculation
  • May require recognition of provision liability
• Impairment methodology must align with asset classification and characteristics
  • Ensures appropriate risk assessment and loss recognition

Impairment Loss Recognition

Calculation Methods

• For amortized cost assets, impairment loss calculated as difference between:
  • Asset's carrying amount
  • Present value of estimated future cash flows discounted at original effective interest rate
• General approach: Calculate 12-month ECL (Stage 1) or lifetime ECL (Stages 2 and 3)
  • Consider multiple economic scenarios and probability-weighted outcomes
• Simplified approach: Calculate lifetime ECL using provision matrix
  • Based on historical credit loss experience
  • Adjusted for forward-looking factors (economic forecasts, industry trends)

Recognition and Presentation

• Recognize impairment losses through loss allowance account
  • Presented as reduction of gross carrying amount in statement of financial position
• For FVOCI debt instruments, recognize impairment loss in profit or loss
  • Corresponding adjustment to other comprehensive income
  • No reduction in carrying amount on statement of financial position
• Subsequent changes in expected credit losses recognized as impairment gain or loss in profit or loss
• For credit-impaired assets, calculate interest revenue using effective interest rate on amortized cost
  • No longer use gross carrying amount for interest calculation