Confusion Over Accounting Policies and Accounting Estimates?

This confusion has implications when an entity applies the requirements of IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, to a change in a policy or an estimate.

Changes proposed by the IASB are aimed at removing this confusion by clarifying the definition of accounting policies and their relationship with accounting estimates and by adding a definition of accounting estimates.

While the changes go a long way in improving the clarity of the standard, they may create further and different confusion. My suggestions are that:

  • the distinction between judgements made at different stages of the financial statement preparation process be explained explicitly in the standard itself; and
  • the definition of accounting estimates be amended.

My comment letter can be found here.


Statement of Financial Position, Controversy?

The Question

An entity is required to disclose a summary of what constitutes capital, based on internal reporting to key management. For example, capital may not simply be total equity because some entities consider subordinated debt to be capital. Others consider the equity components of cash flow hedges to be excluded from capital. To date this quantitative disclosure has been provided in a note to the financial statements.

With the amendments to IAS 1, Presentation of Financial Statements, the question arises: Can a subtotal of “capital under management” be presented in the statement of financial position?

Prior to the Amendment

For annual periods ending on December 31, 2015 and before, the minimum line items to be included in the statement of financial position were listed. Guidance was also provided on when to include line items, namely: when the “size, nature or function of an item” is relevant to understanding the financial position.

The standard explicitly stated that the “order or format” of line items is not prescribed and that the terminology and the ordering and aggregation of similar items can be determined by the entity to suit the nature of the business and the balances reported. However, different measurement bases used for different balances would suggest that their nature or function differs therefore warranting presentation on separate lines.

Preparers were allowed to include headings and subtotals where relevant to an understanding of financial position. However, the requirements were typically interpreted as prescribing the minimum line items to be presented and subtotals were therefore used sparingly.

The Amended Standard

IAS 1 was amended in December 2014, effective for annual periods beginning on or after January 1, 2016, to address these application issues (with similar changes related to the income statement) by:

i. explicitly stating that the minimum line items should be disaggregated; and

ii. that when additional subtotals are presented, they “shall:

(a) be comprised of line items made up of amounts recognized and measured in accordance with IFRS;

(b) be presented and labelled in a manner that makes the line items that constitute the subtotal clear and understandable;

(c) be consistent from period to period…; and

(d) not be displayed with more prominence than the subtotals and totals required in IFRS for the statement of financial position.”

Such subtotals are explicitly required when they are relevant to an understanding of an entity’s financial position. They are therefore referred to as “additional GAAP measures.”

As examples of line items that could be disaggregated, the standard refers to the classifications that are often provided in note disclosures. For example, property, plant and equipment into the classes used by IAS 16 and receivables between trade receivables, balances due from related parties, prepayments and so on. Clearly any disaggregation that is applied by an entity will depend on the circumstances.


Consider an entity that has convertible debt and considers that instrument plus equity to constitute the capital it manages. In such a case, ordering the statement of financial position line items in a way that a subtotal of capital under management can be presented appears to be supported by these amendments. Similarly, using some other descriptive term (Permanent capital, perhaps) would also be permitted with appropriate explanation provided in a note.

Including such a subtotal on the balance sheet would assist users in assessing the entity’s financial strength.

In arriving at this conclusion, we make the following observations:

• All the items included in the subtotal are recognized and measured in accordance with the relevant IFRS.

• Users of financial statements are already familiar with the concept of capital under management as a measure of the risk of an entity and its ability to weather economic adversity. Various regulatory requirements have existed for eons and the disclosure requirements for capital under management in IAS 1 became effective for annual periods commencing on or after January 1, 2007.

• There is no requirement in IAS 1 to present on the statement of financial position a subtotal of liabilities. This is even the case where an entity presents current and non-current liabilities.

• An entity is able to order the line items to suit the business or nature of the entity.

• Furthermore, information that is required to be disclosed can be included in either the statements themselves or in the notes unless ‘specified to the contrary’ by an IFRS. The fact that the capital disclosures are listed, amongst other required disclosures, under a section labelled “Notes” appears to be a drafting convenience given the qualitative nature of most of the required information. I do not read this as being “specified to the contrary.”

• For a public company, management’s discussion and analysis (MDA) should complement and supplement the financial statements. Therefore, the regulator would be satisfied if management discusses and refers to the subtotal presented.

Some Caveats

As with most financial reporting, consistency would be needed from period to period, and the subtotal cannot be displayed with more prominence than required subtotals.

Given the different nature of equity and convertible debt these amounts would still have to be presented separately with a subtotal and could not be combined on one line.

Some entities have more than one class or type of convertible debt instrument issued. IAS 1 comments that “some entities consider some forms of subordinated debt” to be capital. Therefore, how each convertible debt instrument is presented would have to be given some thought.

The High Cost of Low Corporate Taxes

This investigative project – by Marco Oved of Toronto Star and Toby Heaps of Corporate Knights – is the first comprehensive attempt to combine Canadian corporations’ audited financial statements with government data to quantify the extent of corporate tax avoidance.  Paul Rhodes contributed financial reporting expertise.

The full article is available here:

Ten Common Mistakes in Preparing IFRS Financial Statements

The following is a list of ten common errors & omissions in financial statements prepared under the International Financial Reporting Standards (IFRS) framework.

Several represent differences between Canadian Accounting Standards for Private Enterprises (ASPE) and IFRS. Others relate to questions that are omitted from the accounting and financial reporting process.

These items should be on your To-Do list for 2018, as we come into the new reporting season.

  1. Concept of “conditions that existed at the end of the reporting period” not applied

For those events occurring after the reporting period, IFRS differentiates between events that are recognized (that is, adjusted in the financial statements) and events that are not recognized but may require disclosure. The basis for making the determination is whether the event reflected conditions at the balance sheet date – if it did not, it is considered for disclosed only.

A commonly overlooked example is long term debt where there has been a breach of financial covenants making the debt repayable on demand. Such a breach is often fixed after the reporting period by either amendment to the agreement or by an injection of cash by a shareholder or other related party. On this basis it is still presented as long-term debt on the balance sheet when financial statements are prepared under ASPE.

Under IFRS, however, the “conditions at the balance sheet date” concept is strictly applied, so, since the debt was due on demand at the date of the financial statements it should be presented as a current liability.  The fact that the breach was cured after the reporting period would be disclosed.

A similar presentation difference arises between private and international frameworks where there is demand debt owed to the shareholder or to another related party. Under ASPE, a representation is often obtained by the auditor to justify presenting the debt as long term on the balance sheet.

  1. Classification of financial instruments as debt or as equity ignored

Plain vanilla loans and plain vanilla common shares are presented as debt and equity respectively on the statement of financial position. However, all of the characteristics of a financial instrument should be analysed in detail to ensure the correct presentation. Those that have characteristics of both debt and equity are often required to be split with the respective components accounted for and presented as debt and as equity.

Similarly, some features of an instrument mean it is automatically treated as either debt or as equity, regardless of its other characteristics. For example, an instrument that is automatically repaid in cash on the occurrence of some future event (a so-called, puttable instrument) is presented as a liability on the statement of financial position. This can arise, for example, where the terms of a unanimous shareholders’ agreement require shares held by a member of management to be automatically redeemed by the company in the event of his/her death.

Note that this is the case even though the future event has not yet occurred, because the feature of the instrument existed at the reporting date.

Distributions made on shares presented as debt are expensed through the income statement as a financing cost. Therefore, incorrectly presenting these instruments can have a significant impact on financial covenants and on operating results.

  1. “Income before the undernoted” or similar subtotals used in the income statement

The phrase extraordinary item has long since been disallowed in financial reporting.  Recently, however, the heading “Income before the undernoted” is used to achieve a similar objective. When this subtotal is used, whether items of expense are placed above it or below it is often arbitrary and usually inconsistent.

Undernoted items can be one off costs (such as impairment losses), non-cash expenses (stock option expense) or be related to acquisitions (acquisition costs and depreciation of intangible assets).  Companies would like the reader to exclude such items from the analysis of performance.

An income statement prepared in accordance with IFRS needs to comply with certain minimum disclosures. Additional subtotals can be included, provided they are necessary to understand the performance of the entity.  The most common additional subtotal is Income before tax, which is often included (but is not required as a minimum disclosure) on the grounds that the income tax expense is to some extent outside the control of the company. In this case, income before tax is considered a more appropriate measure of performance.

Meaningless subtotals and the arbitrary presentation of expenses should be avoided.

  1. Incorrectly accounting for related party transactions

This often arises due to a misunderstanding of the standard on related party transactions: it defines the disclosures required with respect to related party transactions only. It does not prescribe their accounting treatment. Any transactions with related parties are accounted for in accordance with the appropriate standard for such transactions.

For example, a term loan with a non-market interest rate between the entity and a related party would be accounted for in accordance with the financial instrument standard. That standard requires that the loan be recognized at its fair value on the date it is advanced with interest recognized over the term.

  1. Accounting for certain debits

An entity applying ASPE has accounting policy choices available to it, for example: choosing to capitalize borrowing costs to a qualifying asset or expense them as incurred; and to capitalize the costs of developing internally created intangible assets or to expense them as incurred.

Conversely, IFRS requires an entity to capitalize:

  • borrowing costs where the construction or development of an asset takes a substantial period of time. The requirement would also apply to inventory where the ‘substantial period of time’ criterion is met.


  • the costs of developing an intangible asset where defined conditions are met.

For entities considering adopting IFRS, these considerations need to be identified at an early stage of the decision-making process because the accounting consequences can be time consuming to resolve.

  1. Failing to ask if an acquisition represents a business combination

A business is defined as a combination of inputs and processes applied to those inputs that are able to generate outputs, even though outputs are not necessary to meet the definition.

There are no practical differences between the two frameworks in this respect: the ASPE standard was copied from the international standard prior to Canada’s adoption of IFRS to avoid creating unnecessary accounting differences on transition to IFRS.

A business combination can arise where an entity purchases assets and some processes, so addressing this question should not be overlooked.

  1. Going concern issues

An entity is no longer a going concern where management intends to cease operations or has no realistic alternative but to do so. In this case some other basis of accounting needs to be applied which will require consideration of many other issues, such as: the write down of assets to recoverable amounts; recognition of provisions for staff terminations and onerous leases; and so on.

The fact that management’s intention to cease operations means the entity is no longer a going concern can often go unnoticed.

More frequently an entity’s continued operation will depend on one or more factors, typically ramping up revenues and/or sourcing refinancing or additional financing rounds. Where that is the case, the financial statements need to include disclosures sufficient to paint an accurate picture for users.  Including a clear reference to that disclosure on the statement of financial position is required under IFRS.

  1. Boilerplate language used in disclosures

The IFRS and ASPE frameworks have the same roots and therefore have many similarities. However, many differences exist and these are often ignored when an entity reporting under ASPE changes to reporting under IFRS. For professional accounting firms that are preparing financial statements on behalf of their clients, problems can arise when an ASPE financial statement template is used for a client reporting under IFRS.

Some can be very subtle and depend on a detailed understanding of the standards. For example, under ASPE, where operating losses are available for carry forward for tax purposes but are unlikely to be used by the entity they are recognized for accounting purposes but with an allowance of equal value against them. Under IFRS such a deferred tax asset is recognized only ‘to the extent’ that it is likely to be used.

Similarly, accounting policies and other disclosures are often based on boilerplate language which is frequently borrowed from the continuous disclosures of public companies.

A financial statement prepared under IFRS should be convincing: it should look and feel like an IFRS financial statement. In addition, standard disclosures should be avoided. Instead they should be specific to the company and its business.

  1. Accounting for financial instruments

The current rules on accounting for financial instruments require an impairment loss on a financial instrument asset accounted for at amortized cost to be calculated as the difference between the present value of the cash expected to be collected and the carrying amount of the asset. The corollary of which is that interest revenue on the instrument is still earned after the impairment loss has been recognized.

Furthermore, that impairment loss can only be recognized where there is objective evidence that a loss has arisen at the date of the reporting period.  Any event occurring after that date that gives rise to a loss is not an adjusting event.

These accounting requirements are often misapplied.

  1. Failing to consider the question of functional versus reporting currency

The reporting currency can be any currency selected at the option of the entity.  The functional currency, however, must be identified based on the facts and circumstances.

A company is required to determine the functional currency by applying a list of criteria to the company’s operations and environment. In some cases that application and the resulting decision of functional currency is readily apparent.  In other cases, for example where the company earns significant revenues and is financed in other currencies, the decision can come down to a judgement call based on the weighting of the various criteria.

Conflict between management and external user needs

The following article was originally published by Wiley Insight IFRS.

Conflict is inherent between management’s use of historical financial statements for interpreting and explaining the financial position and performance of an entity and investors’ use which includes comparability between entities.

The ultimate decision to be made is in answer to the question: Should management be permitted to incorporate their discussion and analysis into the general purpose financial statements prepared in accordance with IFRS?

In raising this question, the IASB staff are blurring the distinction between non-GAAP and additional GAAP measures which may also make global regulatory differences more apparent.

A note on terminology and source

The IASB has adopted the terminology of Alternative Performance Measures (APMs) and describes those measures as “competing with” IFRS measures, and as typically receiving more emphasis than the IFRS measures. The equivalent term, non-GAAP measures, is used in this article, and also by the Canadian regulator.

IAS 1 distinguishes between information that is specifically required to be included in financial statements because it is necessary for an understanding of financial position or performance (additional GAAP measures), and any other information that is not required for an understanding or non-GAAP.

The agenda papers in which the staff discuss these and related issues can be found at the end of the article.

Inclusion of non-GAAP information in financial statements

The staff papers contemplate allowing the inclusion of non-GAAP information in general purpose financial statements prepared in accordance with IFRS. Examples include sales per square metre, churn rates and capital expenditure.

IASB staff do appear to be addressing investor needs:

“placing some types of information together, such as management’s plans and strategy together with actual results, can help an entity to tell an integrated story about its financial position and financial performance.”

The Canadian regulators specifically disallow a reporting issuer from including non-GAAP measures in financial statements. Therefore, the change would go well beyond the Canadian rules and be a fundamental shift in international financial reporting.

The change would also bring financial statements more into line with – and indeed, competing with – management’s discussion and analysis (MD&A) which is intended to be written from management’s perspective, “through the eyes of management.”

Issues arising

Under current rules, entities must determine which information is above and beyond what is actually required by IFRS to make the financial position and performance understandable. That is a judgment call. If non-GAAP information is permitted, or required, to be included in financial statements then the difference between GAAP measures and non-GAAP measures becomes academic.

Gross profit and operating profit

It seems clear that presenting non-GAAP information in financial statements would make such differences apparent. For example, the staff provide examples such as gross profit and operating profit as non-IFRS. Global differences in what are considered non-GAAP as opposed to additional GAAP measures already exist. In some jurisdictions those sub-totals would be considered non-GAAP measures by regulators. To avoid regional versions of financial reporting any disclosure standard would have to provide detailed guidance and examples.

Presentation and prominence of non IFRS metrics

Other concerns include that the additional information would draw attention away from the IFRS information, or that it may be “given undue prominence or credibility merely because of its location.” Ultimately, the staff paper concludes that the benefits of bringing MD&A-type discussion and metrics into the financial statements would provide better information for users and would outweigh the concerns.

Audit costs and requirements

The IASB staff consider including such MD&A type discussion and information in the financial statements, but excluding certain information from the audit requirement. This gives rise to a concern about being able to “identify a complete set of financial statements, including, in a set of audited financial statements, whether the information is audited or not.”

Annual financial statements of reporting issuers are subject to audit. The paper points out that audit cost and the sensitivity of disclosing information to competitors would act to control the volume of such information included in financial statements.

What is required to make this happen

The IASB staff considers that the primary financial statements act as a high altitude overview of the financial position and performance of an entity and allow a user of the financial statements to go into more detail in certain areas of interest. In addition, the consistency of presentation also allows a comparison of financial position and performance between different entities.

The information included in the primary statements has a “summary and signposting role” which may be given “undue prominence” by management and “hence receive excessive attention” by users. Therefore the IASB staff recommend that a new disclosure standard would be necessary.

The IASB has approved narrow focus amendments to IAS 1 which are effective for annual periods commencing on or after 1 January 2016 with earlier adoption permitted. Those amendments provide standards that need to me met for an entity to include additional subtotals on the face of the statement of financial position and comprehensive income. The broader discussion over non-GAAP measures continues.

Criteria for inclusion

In serving the needs of the investor community and making historical financial statements more relevant and useful, the IASB is looking to identify the criteria that would need to be in place to allow non-GAAP information to be included in the financial statements or in the notes. Possible criteria suggested by the IASB staff could include:

“(a) be reconciled (where possible) to the most directly comparable measure defined or specified in IFRS and presented in the statement of financial position or performance;

(b) explain why the APM provides relevant information about an entity’s financial position or performance and why the adjustments to the most directly comparable measure …have been made;

(c) be presented and labelled in a manner that makes it clear and understandable what the APMs show and how they are constructed;

(d) provide comparatives and be clear and consistent…from period to period and explain if adjustments have been made…;

(e) not be displayed with more prominence than the subtotals and totals required in IFRS for that statement; and

(f) be clear whether the APM forms part of the financial statements and whether it is audited…on the same basis as the IFRS information.”

Similarly, guidance could also be put in place regarding the presentation or disclosure of items that are non-recurring or that only occur infrequently. And that guidance would include definitions of those terms which are currently not provided in IFRS.

In conclusion

The staff paper concedes that investors find additional measures useful in analysing financial position and performance. At the extreme the IASB staff note that “even APMs that are viewed as being biased can provide information that is useful in assessing management’s character.”

The needs of investors are driving the IASB staff argument for including such information in financial statements, and the IASB is looking to expand the IFRS framework to not only allow, but to encourage, their use within the confines of new reporting rules.

Such a shift in the IFRS financial reporting framework would require the Canadian regulators to change their position to allow non-GAAP measures in the financial statements of reporting issuers.

In the Canadian market the regulators have consistently raised concerns over the biased way in which certain entities have reported results outside of the audited financial statements. It seems clear that requiring an audit opinion to cover all the information included in the financial statements would act as a control over the quality of that information in addition to acting to limit the volume of such content.

Related material

IASB staff papers (February 2015): Disclosure Initiative: Principles of Disclosure

IASB staff paper on the Performance Reporting project (Global Preparers Forum Meeting) March 2015

Mind the Gap (Between non-GAAP and GAAP) – Speech by Hans Hoogervorst

Korean Accounting Review International Symposium, Seoul, Korea, 31 March 2015

Identifying the amount of an entity’s liabilities that should be classified as current

The following scenarios and questions were initially published by Wiley Insight IFRS

Scenario One

At the reporting date, Entity A enters into an interest only loan of CU1 million repayable in ten years’ time with interest of CU 100,000 payable annually. Under IFRS, the loan would be recorded at the reporting date at CU1 million (ignoring transaction costs). Assume that the present value at the reporting date of the CU 100,000 interest payable at the end of the reporting period is CU 92,500.

Scenario Two

At the reporting date, Entity B borrows CU5 billion over 30 years. Payments of CU600 million, comprising principal and interest are due at the end of each year. Under IFRS, the loan would be recorded at the reporting date at CU5 billion (ignoring transaction costs). At the end of the first year, the principal component of the payment of CU600 million is CU60 million. Assume that the present value at the reporting date of the CU600 million payable at the end of the reporting period is CU550 million and the present value at the reporting date of the principal component of the payment is CU55 million.

  1. In Scenario One, what portion, if any, of the CU1 million should Entity A classify as a current liability at the reporting date?
  1. For both scenarios can you identify, based on your experience, the amount that reporting entities would typically classify as current?

Debt that is accounted for at amortised cost requires that the interest cost of the debt be allocated to periods using the effective interest rate, which is the rate that exactly discounts estimated future cash payments through the life of the financial instrument to the net carrying amount of the liability. Therefore at any time, the current carrying amount of the liability is equal to the present value of all future cash payments. To consider this from the opposite direction of time, the principal amount of the debt compounds at the effective interest rate during the life of the instrument.

On each anniversary date when the interest is paid, the present value of all future cash flows will be CU1 million. In the example, since the interest is only paid annually, this relationship will not hold true – assume interest for the year is paid on December 31. Between January 1 and December 30 of the following calendar year the future cash outflows remain the same in nominal dollars, however, the time period over which they are discounted changes (the time period decreases as the year progresses).

Therefore the effect of the discount becomes less, and the carrying amount of the liability increases. This increase in the liability is the interest cost which is accrued but not yet paid. This change in the carrying amount of the liability only occurs because the interest is paid annually (this effect would disappear if interest was paid daily). At all times the CU1 million loan will be presented as long term, and the difference between the CU1 million and the present value of the instrument, namely the accrued interest, will be shown as current.

The amount of the accrued interest will not be the same as the present value of the next interest payment. Instead, the carrying amount of the debt at the reporting date will be the present value of all future cash flows. Individual cash flows are not discounted. This can be seen in the response below to Scenario Two.

  1. In Scenario Two, what portion, if any, of the CU5 billion should Entity B classify as a current liability at the reporting date?
  2. For both scenarios can you identify, based on your experience, the amount that reporting entities would typically classify as current?

Assuming the calculation as presented in the scenario is correct, the CU60 million portion of the combined principle and interest payment should be presented as the current component of the debt. The present value of this amount is not relevant to the current versus long term classification question. Recall the effective interest method described above: the total of the cash flows are discounted to determine the carrying amount of the debt. Therefore the CU5 billion on initial recognition is the discounted amount of those total cash flows. The CU60 million principle component is a portion of that principle balance, that is, it is discounted already. If it was discounted again to determine the classification, then we would be doubly discounting the amount.

By constructing an amortization table for the loan it can proved that the effective interest rate is approximately 11.547776%. I am clarifying the scenario by assuming the loan is entered into on the last day of one reporting period and the first repayment is made on the last day of the following reporting period (year 1 in the table following).



initial loan interest repayment closing


1 5,000,000,000 577,388,800 (600,000,000) 4,977,388,800
2 4,977,388,800 574,777,709 (600,000,000) 4,952,166,509
3 4,952,166,509 571,865,096 (600,000,000) 4,924,031,605
28 1,452,373,314 167,716,817 (600,000,000) 1,020,090,131
29 1,020,090,131 117,797,723 (600,000,000) 537,887,854
30 537,887,854 62,114,085 (600,000,000) 1,939

The table illustrates the effective interest method: interest calculated at this effective rate on the opening balance each period with combined principle and interest payments of CU600 million at the end of each year leaves a zero balance after 30 years.

From the table the closing principle balance at the end of the first year, after making the first repayment, is CU4,977 million. Therefore of the CU5 billion initial debt, CU23 million is due within one year and is presented as current, and the remaining CU4,977 million is presented as long term. The principle and interest components of the CU600 million payments are not individually discounted.

  1. For both scenarios state the amount you believe should be classified as current in accordance with the requirements of the standard. Please provide a rationale for your view.

The current balances for each of these instruments have previously been referred to.

From my experience, reporting entities in the Canadian jurisdiction would also take the approach described above in measuring current liabilities. The rationale, which I agree with, is based on the principle stated in the preamble, and that principle represents the definition of the amortised cost of a financial liability. The definition from IAS 39 paragraph 9 reads, “The amortised cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured at initial recognition minus principle repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between the initial amount and the maturity amount…”

Applying this calculation method to the future cash flows for Scenario Two is a proof (effectively performing the calculation in reverse) of the amortization table presented above. Performing the calculation at the opening and closing dates for any year proves the amounts presented in the table. Logically, the difference between those two amounts is the amount of principle repaid during the period which should therefore be presented as current on the statement of financial position.

Impairment losses of financial instruments, current and future

Consider a financial instrument asset accounted for at amortized cost in accordance with IAS 39. The allowance rules under IAS 39 mean:

  • No loss is allowed to be recognized when a financial instrument is initially recorded; and
  • After initial recognition, a loss is allowed only if (i) there is objective evidence of impairment; and (ii) that evidence has to be due to a past event (that is, after the asset was recognized and before the balance sheet date).

Therefore, losses as a result of future events, even events that have already occurred in the period subsequent to the report date, are not allowed to be included in the provision.

An impairment loss under IFRS is calculated as the difference between the present value of the future cash flows expected from the asset (discounted at the effective interest rate) and its carrying amount at the report date.

The above criteria for recognizing an impairment loss under Accounting Standards for Private Enterprises (ASPE) is consistent, in that an entity must only consider “whether a significant adverse change has occurred during the period in the expected timing or amount of future cash flows.”

When the new IFRS 9 is adopted, which is for years commencing after January 1, 2018 at the latest, the loss provision will look quite different and the new standard will mean a significant divergence in IFRS from ASPE.

Without getting bogged-down in the details, under IFRS 9:

  • An impairment allowance is recognized for all financial instrument assets, and not just after their initial recognition. For an asset recognized on the last day of the reporting period, an impairment allowance is also required to be set up.
  • The impairment loss calculated is based on the credit risk, or more accurately changes in credit risk, since the asset was initially recognized:
    • If the credit risk has not increased significantly since the asset was recognized, then the allowance set up is equal to the 12-month expected credit loss.
    • If the credit risk has increased significantly, then the allowance is equal to the lifetime expected credit loss.
  • The assessment of changes in credit risk between initial recognition and the report date is based on the change in the risk of default occurring over the expected life of the asset, and that assessment must consider:
    • reasonable and supportable information;
    • including forward looking information;
    • that is available without undue cost or effort; and
    • that is indicative of significant increases in credit risk.
  • If reasonable and supportable information is available, an entity cannot rely solely on past-due information.
  • There is a rebuttable presumption that risk has increased significantly when contractual payments are more than 30 days past due.

Our observations of the new impairment rules are:

  • Recognition of impairments under the new rules are aligned with the business model and the pricing of risk.
  • The new test is future looking, which is explicitly disallowed under the current rules.
  • Furthermore, the impairment must be based on ‘evidence,’ so there has to be some fact or information that proves or corroborates the impairment – management cannot hide behind an estimate.
  • In looking for indicative information entities are required to look for data that is correlated with historical losses and to use that information in IFRS 9 loss allowances. For example, if there is an upswing in unemployment rates in advance of increased credit losses historically, then forecasts of future unemployment could be identified as the relevant forward looking information on which to base impairment losses under IFRS 9.

When entities are adopting the new rules in a downward economic cycle impairment losses could be expected to increase. Clearly, however, this depends on what factors an entity identifies as being correlated with its historic losses.