Financial Instruments (Replacement of IAS 39): Impairment - 2013 Exposure Draft

The replacement of IAS 39 Financial Instruments: Recognition and Measurement was part of the IASB and FASB joint project to improve their respective accounting standards on financial instruments. The delayed recognition of credit losses and the complexity of multiple impairment approaches used, were identified as the primary weaknesses in the existing accounting standards.

The IASB developed its original proposals on impairment of financial instruments in its Exposure Draft issued in November 2009. The FASB developed different proposals in its respective Exposure Draft that it issued in May 2010. The comments received by the IASB on its November 2009 proposals highlighted support for the measurement principles, but also indicated significant operational difficulties in applying those principles, especially in the context of open portfolios.

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In January 2011, the IASB and the FASB published a joint Supplementary Document (SD) that proposed an approach for open portfolios on the basis of the advice received from the Expert Advisory Panel and outreach activities undertaken after the publication of the November 2009 proposals. However, the boards did not receive strong support for the joint approach in the SD. In particular, constituents expressed operational and conceptual concerns on the calculations in the good book. In addition, the feedback did not indicate a single preferred approach and was split geographically.

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In May 2011, the IASB and the FASB commenced development of a variation of their previous proposals, taking into account the feedback from their original EDs and the SD, in an attempt to arrive at a converged model. The so-called 'three-bucket model' would reflect the general pattern of credit deterioration in the credit quality of financial instruments. However, although the boards agreed on several different aspects, they did not manage to agree on a converged impairment solution and have now published separate proposals.

On 20 December 2012, the FASB issued a proposed Accounting Standards Update Financial Instruments-Credit Losses on impairment that, unlike the IASB's approach, did not distinguish between assets that have deteriorated and those that have not. Instead, it proposed a single measurement approach that will require an entity to recognise at each reporting date an allowance for all lifetime expected credit losses.

The Exposure Draft (the ED) published by the IASB, on 7 March 2013, proposed to eliminate the existing requirement to recognise an impairment loss only after a credit loss event has occurred. Instead the ED would require expected credit losses to be always recognised, even if there is not a specific credit loss event, and updated for any changes. The ED identified three different stages in the proposed expected credit loss model that reflect the general pattern of deterioration in the credit quality of a financial instrument. The extent of credit deterioration in each stage will determine:

• the amount and timing of the recognition of expected credit losses; and
• the calculation and presentation of interest revenue.

The ED would generally require an entity to establish an impairment allowance for all the financial instruments that are subject to the proposals from their initial recognition. The ED proposed that an entity should recognise:

• a 12-month expected credit loss for financial instruments that have not deteriorated significantly in credit quality since initial recognition. For these assets interest revenue will be calculated on the gross carrying amount;
• lifetime expected credit losses for financial instruments that have deteriorated significantly in credit quality since initial recognition but for which there is no objective evidence of impairment. For these assets interest revenue will also be calculated on the gross carrying amount; and
• lifetime expected credit losses for financial instruments for which there is objective evidence of impairment at the reporting date. For these assets interest revenue will be calculated on the net carrying amount.

On 9 July 2013, EFRAG issued its final comment letter. In that letter, while EFRAG had conceptual concerns about the 12-month expected credit loss measurement, it accepted the proposals as it expected that they would result in a more timely recognition of expected credit losses, and thereby address the weakeness of an incurred loss model. However, EFRAG was concerned that the proposals would require significant implementation and ongoing costs. EFRAG assessment was that the proposed credit deterioration approach could strike an acceptable balance between the cost of implementation and the underlying economics.

EFRAG also noted that its field-test highlighted that the current proposals did not allow entities to leverage existing risk management and regulatory practices and that not all necessary data was available. Therefore, EFRAG suggested the IASB to consider how the model could be implemented in such a way that entities would be able to leverage their existing practices and hence limit the costs and increase the reliabiliy of their estimates.

On 9 July 2013, EFRAG issued a feedback statement to its constituents and on 22 July, EFRAG issued a report on the joint field-test it undertook with the Standard Setters of UK, France, Germany and Italy.

For further information on all phases of the development of IFRS 9, please refer to the following project: IFRS 9 - Financial Instruments