A Summary of Expected Credit Loss (ECL) under IFRS 9. In this blog, we will discuss the provision of ECL and its impact on financials.
Impairment of Financial Assets: A financial asset is impaired when its carrying amount cannot be reasonably expected to be recovered through future generation of income or sale proceeds. This information dives into IFRS 9’s approach to Expected Credit Loss (ECL), a forward-looking method for recognising potential loan defaults. Here’s a breakdown of the key points:
Underlying Principles:
- Focus on the Future: IFRS 9 emphasises an entity’s future financial health, requiring consideration of potential credit losses.
- Applicable Assets: Applies to financial assets where the business model relies on collecting contractual cash flows (principal and interest). Examples include loans held at amortised cost and debt instruments measured at fair value through OCI (Other Comprehensive Income).
Recognition of ECL:
- Ongoing Process: After initial recognition of a financial asset, loss allowance for ECL needs to be recognized in every subsequent reporting year.
- ECL Calculation: The ECL represents the difference between the cash flows due to the entity and the realizable value (discounted cash flows).
Initial ECL Recognition:
- 12-Month ECL: An initial loss allowance equal to the estimated loss expected within the first year (12 months) from the reporting period is recognised.
- Lifetime ECL: Represents the total expected loss over the entire life of the financial asset.
Determining the Appropriate ECL:
- Significant Increase in Default Risk: Management assesses if there’s a significant increase in default risk. This triggers the recognition of either 12-month or lifetime ECL.
- Effective Interest Calculation:
- 12-month ECL: Effective interest is calculated on the gross carrying amount of the financial asset.
- Lifetime ECL: Effective interest is calculated on the net carrying amount (carrying amount minus allowance for ECL) if there’s objective evidence of impairment.
Based on the increase in significant credit risk management should recognize the ECL either as 12 month ECL or life time ECL. ECLs reflect management’s expectations of shortfalls in the collection of contractual cash flows.
Download the ECL Calculation Sample Template
Please note: This ECL file is intended as a sample to illustrate the concept. It’s recommended to consult the IFRS 9 standard for specific requirements before implementing it in your practice
Measurement of Credit Losses:
- Amortized Cost Investments: Losses are recognised in profit or loss (P&L) if held in a separate allowance account, offsetting the carrying amount.
- Fair value Through Profit or loss: Where the Financial assets are measured on this basis, any impairment of an asset is automatically reflected in the measurement basis, so no further action is required.
- Fair Value Through OCI Investments:
- A portion of the fair value decline is recognized in the P&L.
- The remaining balance stays in OCI.
Impairment Loss Reversal:
- When conditions improve, the previously recognised ECL can be reversed, resulting in an impairment gain reflected in P&L.
Treatment of Other Assets:
- Trade Receivables: Recognized loss is based on lifetime ECL under IFRS 15 if they lack a significant financing component.
As far as trade receivables are concerned, as a simplifying measure, IFRS9 allows the loss allowance to always be measured based on lifetime credit losses.
Entry for the provision for ECL
Dr Expected credit losses XX
Cr Allowance for receivables XX
Conclusion: The ECL model under IFRS 9 is a significant improvement over the old approach that only considered past losses. While challenges exist, the benefits of early risk identification and enhanced transparency make ECL valuable for lenders and investors.
Additional Points:
- The data emphasizes the importance of accurate data, including historical losses, loss forecasts, and economic projections, for calculating ECL effectively.
- The subjectivity involved in estimating probability of default (PD) and loss given default (LGD) can impact ECL accuracy.
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