Professional Documents
Culture Documents
AND ECL
MODELING
REAL LIFE APPLICATION
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IFRS 9
Impairment
Hedge accounting
Scope
Can the contract be settled net in cash or Yes Has the contract been entered into and continues to No
another financial instrument, or by exchanging be held for the purpose of the receipt or delivery of a
financial instruments, as if the contract was a non-financial item in accordance with the entity’s
financial instrument? expected purchase, sale or usage requirements (own
use exemption)?
Yes
Apply
Has the entity chosen to irrevocably designate the
IFRS 9
Yes
No contract at fair value through profit or loss in order to
eliminate or significantly reduce a recognition
inconsistency (accounting mismatch)?
No
Revenue from
Loan to Trade
Sales of Loan to Staff Lease of Cars
Related Party Receivable
Inventories
Issue of
Purchase of Purchase of
Hire Purchase Commercial
PPE Bonds
Paper
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Initial recognition
• recognize a financial asset or financial liability • accounting policy choice by class of asset – but
when, and only when, the entity becomes a party apply same method consistently (treating assets
to the contractual provisions of the instrument mandatorily at fair value through profit or loss,
assets designated at fair value through profit or
loss and investments in equity instruments for
which fair value is presented in other
comprehensive income as a separate classes)
• only for ‘regular way’ purchases or sales (contract
must not permit net settlement)
Classification
Classification Financial assets
Step 1 Business
Business Other
model = hold
Step 2 model = hold business
to collect and
to collect models
sell
7 *Excludes investments in equity instruments. An entity can elect to present FV changes in OCI.
Classification of financial assets
Fair value through profit or loss (FVTPL)
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Classification of financial assets
Fair value through other comprehensive income
Financial assets with contractual cash flows that are solely payments of principal
and interest (SPPI) are measured at amortised cost or FVOCI depending on the
business model in which the asset is held.
Principal = amount transferred by holder (fair value at initial recognition)
Interest is consideration for:
◦ time value of money and credit risk;
◦ other lending risks (for example, liquidity risk);
◦ other associated costs (for example, administrative costs); and
◦ a profit margin
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Contractual cash flow characteristics (step )
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Types of business model (step 2)
Holding assets in order to • Realise cash flows by collecting contractual payments over the life of the instrument
collect contractual cash • Typically involve lower frequency and value of sales
• Measurement: amortised cost
flows
Both collecting contractual • Both collecting contractual cash flows and selling – sale integral to achieving the
objective of the business model
cash flows and selling • Typically involve greater frequency and value of sales
financial assets • Measurement: FVOCI
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Business Model (Case Studies)
What’s the business model?
Instrument A Instrument B
• Entity A holds investments to collect their contractual cash • A financial institution holds financial assets to meet its
flows. everyday liquidity needs.
• Entity A performs credit risk management activities – to • The entity seeks to minimise the costs of managing those
minimise credit losses. liquidity needs and therefore actively manages the return
• In the past, sales have typically occurred when the financial on the portfolio.
assets’ credit risk has increased, i.e. credit criteria specified in • Return = collecting contractual payments + gains and
the entity’s documented investment policy no longer met. losses from the sale of financial assets.
• Infrequent sales have occurred as a result of unanticipated • The entity holds financial assets to collect contractual
funding needs. cash flows and sells financial assets to reinvest in higher
• Reports to key management personnel focus on the credit yielding financial assets or to better match the duration
quality of the financial assets and the contractual return. of its liabilities.
• Entity A also monitors fair values of the financial assets, • In the past, this strategy has resulted in frequent sales
among other information. activity of significant value.
• This activity is expected to continue in the future.
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Classification: Financial liabilities
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Reclassification: Conditions
Financial assets
• When, and only when, an entity changes its business
model for managing financial assets – expected to be very
infrequent
Financial liabilities
• An entity shall not reclassify any financial liability
Reclassification shall be applied prospectively from the reclassification date.
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Measurement
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Initial Initial
carrying = Fair value carrying Initial
amount amount carrying
amount
•If part of the consideration might not be for the financial instrument itself, eg
◦ ‘Interest free’ loan to a subsidiary
◦ Providing below-market interest rate loan for rebates or minimum purchase volume regarding other items
o In the cases above, an entity measures the fair value of the financial instruments
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Fair value versus transaction price (Case Studies)
Bond Purchased @ Below market rate loan from Below market rate loan
Discounted Price Parent to subsidiary Staff Loan
• ABC Company bought 200 units • ABC Company (Parent) availed DCB • ABC availed a loan of $500,000 to
of MMM Bond @ a discounted Company (a subsidiary of ABC Jack (an employee of ABC) at a
price of $95 (face value - $100). A Company) an interest free loan of $1 below market rate of 1% (average
fee of $120 was paid to MMM at million repayable (equal repayment commercial bank rate is 20%) for
purchase date (fee must be paid amount) over 5 years. DBC pays a yearly a period 5 years, he is expected to
before the bond is sold to clients). repayment of $200,000. Market pay $8,546.87 every month for
• How much should I recognise as interest rate is 21%. ABC hopes to the next 60 months.
fair value at initial recognition leverage on the client list of DCB to • How much should I recognise as
create and move its new line of fair value at initial recognition
business over the next 10 years.
• You are required to:
• Advise management on the
accounting entries to pass at initial
recognition.
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Subsequent measurement of financial asset
Amortised cost
Impairment
Amortised cost Nil
Foreign exchange gains & losses
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Amortised cost
Cumulative amortisation
Amount at using effective interest Loss
Principal
initial - +/- method of any difference allowance for Amortis
repayments - =
recognition between initial amount financial ed cost
and maturity amount assets
Effective interest method is the method that is used in the calculation of the amortised cost of a financial
asset or a financial liability and in the allocation and recognition of the interest revenue or interest expense
in profit or loss over the relevant period.
Effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through
the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or
to the amortised cost of a financial liability.
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Amortised cost (Case Study)
Bond Purchased @ Below market rate loan from Below market rate loan
Discounted Price Parent to subsidiary Staff Loan
• ABC Company bought 200 units • ABC Company (Parent) availed DCB • ABC availed a loan of $500,000 to
of MMM Bond @ a discounted Company (a subsidiary of ABC Jack (an employee of ABC) at a
price of $95 (face value - $100). A Company) an interest free loan of $1 below market rate of 1% (average
fee of $120 was paid to MMM at million repayable (equal repayment commercial bank rate is 20%) for
purchase date (fee must be paid amount) over 5 years. DBC pays a yearly a period 5 years, he is expected to
before the bond is sold to clients). repayment of $200,000. Market pay $8,546.87 every month for
• How much should I recognise in interest rate is 21%. ABC hopes to the next 60 months.
month 1 and 2 leverage on the client list of DCB to • How much should I recognise in
create and move its new line of month 1 and 2
business over the next 10 years.
• You are required to:
• Advise management on the
accounting entries to pass at the end
of year 1
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Amortised cost (Case Study)
The FC of Chavelet Plc. has asked you to interest income for the period ending 31 December 2021 and the balance on the instruments
held by the company at the same date. Calculate the interest income and amortized cost balance @ 31 December 2021The instruments
are listed below:
N Bank/ Issuer Face value Discounted value Value date Maturity date
1 First Bank Of Ghana Plc 230,000,000.00 206,781,027.40 03 April 2021 03 April 2022
2 First City Monument Bank Plc 55,000,000.00 50,905,890.41 05 July 2020 01 January 2021
3 First Bank Of Nigeria Plc 50,000,000.00 46,242,294.52 07 May 2020 07 May 2021
4 First Bank Of Zambia Plc 50,000,000.00 47,430,821.92 10 February 2021 10 February 2022
5 First City Monument Bank Plc 80,000,000.00 75,153,315.07 03 April 2021 30 September 2021
6 First Bank Of America Plc 100,000,000.00 95,331,506.85 05 July 2020 05 July 2021
7 First Bank Of London Plc 20,000,000.00 19,125,479.45 07 May 2020 07 May 2021
8 First Bank Of Israel Plc 100,000,000.00 94,171,095.89 10 February 2021 09 August 2021
9 First Bank Of Nigeria Plc 500,000,000.00 477,643,835.60 03 April 2021 03 April 2022
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Subsequent measurement of financial asset
Fair value through OCI (debt instruments)
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Subsequent measurement of financial asset
Fair value through OCI (investments in equity instruments)
Statement of
Profit or loss Other Comprehensive Income
financial position
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Subsequent measurement of financial asset
Fair Value through Profit or Loss
Changes in
Fair value
Fair value Nil
Gain or los on
derecognition
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Dividends
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Measurement- Financial liabilities
MEASUREMENT AT INITIAL RECOGNITION
Fair value*—the price that would be paid to transfer a liability in an orderly transaction between market
participants at the measurement date.
SUBSEQUENT MEASUREMENT
It depends:
- amortised cost using the effective interest method;
- fair value through profit or loss: derivatives, liabilities accounted for under the fair value option and
other financial liabilities
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Expected Credit Loss
Modeling
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Expected Loss Model
ECL = PD * LGD * EAD
Expected Loss = Probability of Default (PD) * Loss Given Default (LGD) * Exposure at Default (EAD)
◦ Probability of Default (PD): This is the probability that a counterparty would default on his loan/facility.
◦ Loss Given Default: Ratio of loss on an exposure due to default of a counterparty to the amount outstanding
◦ Exposure at Default: EAD is the amount of loss that a entity may face due to default.
Compliant with:
- Basel II
- Basel III
- Solvency II
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Expected Loss Model
𝑁 𝑚
ECL= 𝑠𝑐=1
𝑃𝑅𝑠𝑐 ∗[ 𝑖=1 𝑃𝐷𝑡 ∗ 𝐷𝑓𝑡 ∗ 𝐸𝐴𝐷 ∗ 𝐿𝐺𝐷 ]
𝑁 𝑚
ECL= 𝑠𝑐=1
𝑃𝑅𝑠𝑐 ∗[ 𝑖=1 𝑃𝐷𝑡 (𝑅𝐷𝑠𝑐,𝑡 |𝑠𝑐) ∗ 𝐷𝑓𝑡 ∗ 𝐸𝐴𝐷(𝑅𝐷𝑠𝑐,𝑡 |𝑠𝑐) ∗ 𝐿𝐺𝐷(𝑅𝐷𝑠𝑐,𝑡 |𝑠𝑐) ]
Legends
• Internal data
PD MODELING • External data
• Application
DEFINE
• Risk rating
PREPARE CREATE scorecard definition
• Expert RATING &
DATA MODEL • Behavioural • PD
judgement CALIBERATE
scorecard Calibration
(for direction)
EAD MODELING
- Application Score Card- Used
to score new credit
- Expert Judgement gives applications. To determine if
some level of direction credit should be granted or not - Calibrate Macro
while forecasting expected economics
- Behavioural Score Card- Used
credit loss
for ongoing monitoring of
credit
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Expected Credit Loss
Data Accuracy
Data
Data Recency
Completeness
Data
Quality
Criteria
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Expected Loss Model- PD
Probability of Default (PD)
◦ This is the probability that a counterparty would default on his loan/facility. Ranging between 0 and I.
◦ Two broad techniques for calculating PD: Empirical and Market-based (also known as structural or reduced-form) models
◦ Empirical approach uses historical default data to characterize counterparties that default. This is calculated with logit or
probit regressions to define a score :
◦ Z (Logit) = β0+ β1*x1 + β2*x2 + β3*x3 + β4*x4 + β5*x5 + β6*x6……….. + βk*xk
◦ β0= Intercept
◦ β1 – βk = Slopes along independent variables
◦ X1 – xk = Independent variables (values from variables from the score card)
𝑒𝑧
◦ PD= 1+ 𝑒 𝑧 (EXP(CF6)/(1+EXP(CF6)))
◦ Market-based approach uses current market data about debt and/or equity to “back out” a market-driven measure of PD.
This method was developed by Merton (1974) and popularized by the company KMV (now owned by Moody’s).
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Expected Loss Model- PD
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Expected Loss Model- LGD
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Expected Loss Model- LGD
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Exposure At Default
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Expected Loss Model
𝑁 𝑚
ECL= 𝑠𝑐=1
𝑃𝑅𝑠𝑐 ∗[ 𝑖=1 𝑃𝐷𝑡 ∗ 𝐷𝑓𝑡 ∗ 𝐸𝐴𝐷 ∗ 𝐿𝐺𝐷 ]
𝑁 𝑚
ECL= 𝑠𝑐=1
𝑃𝑅𝑠𝑐 ∗[ 𝑖=1 𝑃𝐷𝑡 (𝑅𝐷𝑠𝑐,𝑡 |𝑠𝑐) ∗ 𝐷𝑓𝑡 ∗ 𝐸𝐴𝐷(𝑅𝐷𝑠𝑐,𝑡 |𝑠𝑐) ∗ 𝐿𝐺𝐷(𝑅𝐷𝑠𝑐,𝑡 |𝑠𝑐) ]
Legends
PDt = 𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝐷𝑒𝑓𝑎𝑢𝑙𝑡 𝑖𝑛 𝑡th 𝑝𝑒𝑟𝑖𝑜𝑑
t =𝑃𝑒𝑟𝑖𝑜𝑑𝑠 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑟𝑒𝑝𝑜𝑟𝑡𝑖𝑛𝑔 𝑑𝑎𝑡𝑒 𝑎𝑛𝑑 𝑡ℎ𝑒 𝑑𝑒𝑓𝑎𝑢𝑙𝑡 𝑒𝑣𝑒𝑛𝑡
m = 𝑃𝑒𝑟𝑖𝑜𝑑𝑠 𝑡𝑖𝑙𝑙 𝑀𝑎𝑡𝑢𝑟𝑖𝑡𝑦
PRsc = 𝑃𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑅𝑖𝑠𝑘 𝑆𝑐𝑒𝑛𝑎𝑟𝑖𝑜
Dft = 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝐹𝑎𝑐𝑡𝑜𝑟 𝑓𝑜𝑟 𝑡th 𝑝𝑒𝑟𝑖𝑜d
EAD = 𝐸𝑥𝑝𝑜𝑠𝑢𝑟𝑒 𝐴𝑡 𝐷𝑒𝑓𝑎𝑢𝑙𝑡 𝑖𝑛 𝑡th 𝑝𝑒𝑟𝑖𝑜𝑑
LGD = 𝐿𝑜𝑠𝑠 𝐺𝑖𝑣𝑒𝑛 𝐷𝑒𝑓𝑎𝑢𝑙𝑡 𝑖𝑛 𝑡th 𝑝𝑒𝑟𝑖𝑜𝑑
RD = 𝐷𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑅𝑖𝑠𝑘 𝐷𝑟𝑖𝑣𝑒𝑟𝑠
N = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑅𝑖𝑠𝑘 𝑆𝑐𝑒𝑛𝑎𝑟𝑖𝑜𝑠
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Expected Loss Model- Incorporating Scenarios into
Expected Credit Loss
“An entity shall measure ECL of a financial instrument in a way that reflects an unbiased and probability weighted amount that is
determined by evaluating arrange of possible outcomes.” (5.5.17)
“When measuring ECL, an entity need not necessarily identify every possible scenario. However, it shall consider the risk of
probability that a credit loss occurs by reflecting the possibility that a credit loss occurs and the possibility that no credit loss
occurs, even if the possibility of a credit loss occurring is very low.” (5.5.18)
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