ICAI Dubai Chapter NPIO Practical Insights to IFRS 9

ICAI Dubai Chapter NPIO
Practical Insights to IFRS 9 – Expected Credit Loss

27th April 2021
S P E J & Associates
1 Strictly Confidential: For internal use only and not for circulation Chartered Accountants
SPEJ & Associates
Chartered Accountants
IFRS 9 – Expected Credit Loss - Topics of Discussion
 1. IFRS 9 - Introduction & UAE’s Impact Analysis
 2. Classification of financial assets & Financial

Liabilities
 3. Impairment of Financial Assets
 Simplified Approach
 General Approach
 POCI Approach
 4. How About Some Examples?
 5. Q&A
Strictly Confidential: For internal use only and not for circulation
SPEJ & Associates
2
1. IFRS 9 – Financial Instruments - Introduction
Background Major changes
• Expected credit loss model for impairments versus the

• IFRS 9 is the regulatory “tsunami.” Like Basel II and incurred loss model.
Basel III, it requires entities to make investments in
models, data, and infrastructure for long-term • Classification categories of financial assets changed –
implementation. Contractual cash flow and business model tests
determines the classification.
• IFRS 9 issued in July 2014 which completed the project
launched in 2008 in response to the global financial • Accounting for financial guarantees to be on balance
crisis. IFRS 9 replaces the existing standard on IAS 39. sheet.
• Impact on entities with large and diversified
• The output of IFRS 9 will be a more resilient financial investment portfolios.
system, capable of forecasting losses instead of
accounting them after they occur • No major changes to classification of financial
liabilities.
• IFRS 9 was globally applicable form 1 January 2018. • De-recognition requirements from IAS 39 has been
However, India adopted Ind AS 109 nine months
ahead of the world on 1 April 2017. carried forward under IFRS 9.
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1. IFRS 9 – Transition Impact on Banks Across GCC region – A Study
 UAE’s Accounting Framework
Some Key Highlights from Regulatory Circular CBUAE/BSD/2018/458:
 Applicable of laws in UAE: The UAE  All Banks and Financial Institutions (BFIs) are required to publish IFRS Financial Statements starting from 1st Jan, 2018.
Commercial Companies Law No 2 of Early adoption of IFRS 9 not permitted.
2015, which came into force on 1 July  BFIs should endeavour to develop robust models to determine expected credit loss under IFRS 9 considering the guidance
2015, requires all companies to apply
on Credit risk and accounting for expected credit losses issued by BCBS.
international accounting standards
 BFIs should provide for impairment losses as per the requirements of IFRS 9 BFIs should have a minimum of 5 years credit
issued by IASB and practices when
data to start with and thereafter move to collect at least 10 years data.
preparing their accounts.
 Sound governance controls over data quality, classification changes, models, assumptions for forecasting.
 Regulatory Guidance: Central Bank
 Business models policy should be approved by the Board.
of the UAE (CBUAE) (Circular No.
CBUAE/BSD/2018/458 final Guidance

 Covers guidance on assessment of significant increase in credit risk (Stage2)-
Note on IFRS 9 dated 30th April 2018  Suitable approximations in assessing PD etc. for loans originated before IFRS 9,
“GUIDANCE NOTE TO BANKS AND  Changes in credit risk, consider both counter party level & individual credit level, sources of credit information to
FINANCE COMPANIES ON THE considered

IMPLEMENTATION OF IFRS 9 FINANCIAL  Un-collateralised bullet repayment loan should be classified at a minimum Stage 2
INSTRUMENT IN UAE”.
 Source: IFRS 9 – Financial Instruments : A Study: Transition Impact on Banks Across the Globe 2019 by ICAI Accounting Standard Board
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1. IFRS 9 – Transition Impact on Banks Across GCC region – A Study (Cont.)
 IFRS 9 Qualitative Analysis
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 IFRS 9 Measurement Category Wise Distribution of Financial Assets  IFRS 9 Transition Impact on Total Equity
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 Credit Quality – Stage Wise GCA At The End Of Transition Year  Impairment Loss Allowance Stage Wise Break At Transition Year
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 2. Classification: Financial Assets & Financial Liabilities
 POCI Approach
 5. Q&A
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2. IFRS 9 – Financial Instruments – Classification of Financial Assets
Debt (including hybrid contracts) Derivatives Equity
‘Contractual cash flow characteristics’ test (at

instrument level)
Pass Fail Fail Fail

‘Business model’ assessment
Held for trading?
(at an aggregate level)
Hold to collect BM with objective that Neither (1) Yes No
1 contractual cash
2 3 nor (2)
results in collecting
flows contractual cash flows
and selling FA
No FVTOCI option
Conditional fair value Yes
elected ?
option (FVO) elected?
No No Yes
Amortised FVTOCI FVTOCI

FVTPL
cost (with recycling) (no recycling)
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2. IFRS 9 - FA Classification – Debt instruments in the scope of IFRS 9
Step 1: SPPI Assessment

Cash flows solely payments of principal and interest
No Yes
Step 2: Business model assessment
Are assets in the business model managed both to collect Is the business model’s objective to hold to collect contractual
contractual cash flows and for sale? cash flows?
Yes Yes
FVOCI (debt instruments)*

 Interest revenue, credit impairments and foreign exchange gain or
loss recognised in P&L in same manner as amortised cost
FVTPL  Other gains and losses in OCI Amortised cost*
 On derecognition, cumulative gains and losses in OCI reclassified to
P&L
*FVTPL designation is available only to eliminate or significantly reduce accounting mismatch
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2. IFRS 9 – Financial Instruments – Classification of Financial Liabilities
Financial liabilities has been classified into two categories:
Category Applicability
Fair value through  Financial liabilities that are held for trading (including derivatives)
profit or loss
 Financial liabilities that are designated as FVTPL on initial recognition
 Contingent consideration recognised by an acquirer in a business combination
Amortised Cost  All liabilities not in the above category
Primarily, liabilities will be classified

under this category
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 2. Classification: financial assets & Financial Liabilities
 POCI Approach
 5. Q&A
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3. IFRS 9 – Expected Credit Loss – Scope of The Standard
The new model should be applied to:

 Investments in debt instruments measured at amortised cost
 Investments in debt instruments measured at fair value through other comprehensive income (FVOCI)
 Loan commitments issued not measured at FVTPL

Not previously in
 Financial guarantee contracts issued in the scope of IFRS 9 not measured at FVTPL IAS 39 scope
 Lease receivables that are within the scope of IFRS 16, Leases, and trade receivables or contract assets within the
scope of IFRS 15 that give rise to an unconditional right to consideration.
Out of the Scope
 Equity investments measured at FVTPL or FVOCI
 Financial instruments measured at FVTPL
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3. IFRS 9 – Expected Credit Loss – Method of ECL
Purchase or Originated
General Approach Simplified Approach
Credit Impaired Approach
1. The general approach requires an entity to 1. This approach does not require
recognise, at each reporting date, an an entity to track changes in 1. This approach is applicable to
impairment loss allowance using either 12 credit risk. Rather, each entity financial assets which are
month ECL or lifetime ECL recognises impairment loss credit impaired on
allowance based on lifetime purchase/origination
2. 12 month ECL typically results in lower
ECLs at each reporting date,
impairment since it focuses only on PD within
right from initial recognition.
next 12 months period as against PD over the
life of the instrument 2. The application of simplified
approach is mandatory for trade
3. The use of ECL depends on whether there has
receivables or any contractual
been a significant increase in credit risk on the
rights to receive cash or another
instrument since its initial recognition.
financial assets that result from
4. This approach is applicable to all the financial transactions that are within the
instruments covered by impairment scope of IFRS 15
requirements of IFRS 9, except instruments
3. A provision matrix could be
covered in the following two approaches.
used to estimate ECL for these
financial instruments.
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3. IFRS 9 – Impairment model – Decision Tree
Consider forward looking information
Is asset being tested a trade receivable, lease Yes Does the asset have a significant financing
receivable (IFRS 16/IFRS 17) or contract asset
component?
(IFRS 15)?
No
No Yes Provision matrix
Option 2 approach
Policy choice
Lifetime expected credit losses
3 stage IFRS 9 model Option 1
Calculate the credit loss provision using the 3 stage IFRS 9 model
Analyse credit risk deterioration or improvement since initial recognition
[Stage 1, 2 and 3]
Stage 1: Stage 2 and 3:

12 month expected credit loss Lifetime expected credit loss
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3. IFRS 9 – Expected Credit Loss – Significant Increase in Credit Risk
Significant
increase in credit
risk not defined
Increase in Credit Risk Since Initial Recognition
Stage 1 Stage 2 Stage 3
Impairment Recognition: A Forward Looking “Expected Credit Loss” Model
12 Month Expected Lifetime Expected Lifetime Expected
Credit Loss Credit Loss Credit Loss
Interest Revenue Recognition
Effective Interest on Effective Interest on Effective Interest on
Gross Carrying Gross Carrying Amortised Cost
Amount Amount
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3. IFRS 9 – Expected Credit Loss – Standard Guidelines
Factors to consider: The calculation of ECL should reflect:

1 an unbiased and probability weighted amount;
2 the time value of money; and
3 reasonable and supportable information that is available without undue cost or effort
► A credit loss is the difference between the cash flows that are due to an entity in accordance with the contract and the cash flows that the entity
expects to receive discounted at the original effective interest rate
► An Expected Credit Loss (ECL) is the probability weighted estimate of credit loss over the life of a financial instrument
Dual measurement approach: The model uses two approaches for measurement of expected credit loss:
12 month Expected Credit Loss Cash shortfalls that will result if a default occurs within 12 months (or shorter period if the expected life is
(12M EL) less than 12 months), weighted by probability of the default
Lifetime Expected Credit Loss Cash shortfalls that will result from default events occurring over the expected life (residual maturity) of
(Lifetime EL) financial instruments, weighted by probability of the default
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3. IFRS 9 – Expected Credit Loss – Calculation
ECL = PD * LGD * EAD * D

ECL Parameters Description
Probability of default IFRS 9 requires PD to be Point-in-Time and the ECL estimates shall be Forward Looking depending on the Macro-Economic
(PD) Outlook. (Refer next slide for detailed explanation)
12 month PD: 12 month probability of default is likelihood of an obligor defaulting in 12 months from the reporting date
required for Stage 1 provisioning
Lifetime PD: Lifetime probability of default is likelihood of an obligor defaulting over the lifetime of the loan. PIT estimates
would be adjusted using survival rates for Stage 2 provisioning.
Loss given default (LGD) “LGD - Loss Given Default” is the portion of the exposure that the entity will lose in case of default. It is based on the
difference between contractual cash flows that are due and expected to be received including from collateral.
(Refer next slide for detailed explanation)
Exposure at default EAD is one of the key component for ECL computation. EAD can be seen as an estimation of the extent to which the financial
(EAD) entity may be exposed to a counterparty in the event of a default and at the time of the counterparty default.
Discount Rate (D) Used to discount an expected loss to a present value at the reporting date using the effective interest rate at initial
recognition
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3. IFRS 9 – Expected Credit Loss – PD & LGD Information Requirements
Forward Looking Macro
Probability of Default Loss Given Default
Economic Information
IFRS 9 standards require an estimate of probability 1. In view of the futuristic IFRS 9 requires an estimate of loss
of default (PD) that is consistent with the following computations, a number of percentage that is consistent with
principles: macroeconomic factors such as the following principles:
1. Considers all relevant information inflation, interest rates,
currency fluctuations, GDP
2. Reflects current economic circumstances (i.e., 1. Considers all relevant
Outlook, economic growth,
it is a best estimate rather than a conservative information and includes a
unemployment, fiscal and
estimate) forward-looking element
monetary measures, money
3. Provides the likelihood of a default occurring demand and supply etc. need to 2. Reflects current economic
within the next 12 months or during the be considered. circumstances (i.e., is a best
lifetime of the instrument estimate rather than an
2. It is pertinent to note that
4. Includes forward-looking economic forecasts economic downturn estimate)
macroeconomic factors applied
5. Existing internal ratings-based (IRB) Basel should be relevant to the 3. Considers only costs directly
models can be reused but particular attention underlying portfolio/assets for attributable to the collection
should be paid to point-in-time versus through- which ECL is required to be of recoveries
the-cycle models. computed.
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3. IFRS 9 – Expected Credit Loss – Key Challenges
01 04 Segmentation of Portfolio
02
01 Data Availability
04
03
05 Reconciliation with
Financial Statement
05 02 Data Accuracy
06 06 Coordination with Multiple

Departments
07
03 Data Validation
07 Overlay Assessment during

COVID 19 times
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 2. Classification: Financial assets & Financial Liabilities
 POCI Approach
 5. Q&A
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IFRS 9 – Expected Credit Loss – Calculation (Cont.)
Questions?
22 Strictly Confidential: For internal use only and not for circulation
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ICAI Dubai Chapter NPIO

Practical Insights to IFRS 9 – Expected Credit Loss

 1. IFRS 9 - Introduction & UAE’s Impact Analysis

 2. Classification of financial assets & Financial

 3. Impairment of Financial Assets

 4. How About Some Examples?

Background Major changes

• Expected credit loss model for impairments versus the

CBUAE/BSD/2018/458 final Guidance

FINANCE COMPANIES ON THE considered

 1. IFRS 9 - Introduction & UAE’s Impact Analysis

 2. Classification: Financial Assets & Financial Liabilities

 3. Impairment of Financial Assets

 4. How About Some Examples?

Debt (including hybrid contracts) Derivatives Equity

‘Contractual cash flow characteristics’ test (at

Pass Fail Fail Fail

Amortised FVTOCI FVTOCI

Step 1: SPPI Assessment

FVOCI (debt instruments)*

*FVTPL designation is available only to eliminate or significantly reduce accounting mismatch

Financial liabilities has been classified into two categories:

Amortised Cost  All liabilities not in the above category

Primarily, liabilities will be classified

 1. IFRS 9 - Introduction & UAE’s Impact Analysis

 2. Classification: financial assets & Financial Liabilities

 3. Impairment of Financial Assets

 4. How About Some Examples?

The new model should be applied to:

 Loan commitments issued not measured at FVTPL

Consider forward looking information

Stage 1: Stage 2 and 3:

Stage 1 Stage 2 Stage 3

Impairment Recognition: A Forward Looking “Expected Credit Loss” Model

12 Month Expected Lifetime Expected Lifetime Expected

Credit Loss Credit Loss Credit Loss

Interest Revenue Recognition

Effective Interest on Effective Interest on Effective Interest on

Gross Carrying Gross Carrying Amortised Cost

Factors to consider: The calculation of ECL should reflect:

ECL = PD * LGD * EAD * D

06 06 Coordination with Multiple

07 Overlay Assessment during

 1. IFRS 9 - Introduction & UAE’s Impact Analysis

 2. Classification: Financial assets & Financial Liabilities

 3. Impairment of Financial Assets

 4. How About Some Examples?

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