Malta: IFRS 9 for Non-Financial Institutions (Part 2)

Last Updated: 26 June 2018
Article by Jonathan Dingli

IFRS 9 brings about major changes to the classification and measurement of an entity's financial assets, and the calculation of impairment thereon, and is expected to have a major impact across all organisations, particularly financial institutions.

IFRS 9 Financial Instruments is replacing IAS 39 Financial Instruments: Recognition and Measurement with effect from annual periods beginning on or after 1 January 2018. IFRS 9 brings about major changes to the classification and measurement of an entity's financial assets, reviewed in the first part of this article published in the autumn edition of the Accountant, and the calculation of impairment thereon, and is expected to have a major impact across all organisations, particularly financial institutions.

Although the new impairment model is expected to hit banks and other financial services companies the hardest, Non-Financial Institutions (NFIs) will also be impacted by larger and more volatile bad debt provisions on trade, lease receivables and contract assets, and the impact of expected credit losses on financial investments. The following high-level impact assessment is thus made mainly with reference to financial instruments commonly held by NFIs.

Impairment

The new impairment model revolves around 'expected credit losses' (ECLs) and replaces IAS 39's backwards looking 'incurred loss' model. ECLs are a probability-weighted estimate of credit losses i.e. they are calculated as the present value of cash shortfalls (the difference between the cash flows due under the contract and those expected to be received) over the expected life of the financial asset. These requirements apply to debt assets measured at amortised cost or FVOCI, contract assets under IFRS 15 Revenue from Contracts with Customers, lease receivables, and certain financial guarantees and loan commitments. The impairment model does not apply to financial assets measured at FVTPL and equity instruments however, as these are outside the scope of the impairment requirements.

The ECL model has a dual measurement approach:

Lifetime ECLs, which are defined as ECLs resulting from all possible default events over the life of a financial asset, and

12-month ECLs, which are defined as the portion of lifetime ECLs that represent the ECLs resulting from those default events on the financial asset that are possible within the 12 months after the reporting date.

Hence, a financial instrument which is measured under lifetime ECLs will command a larger loss allowance than an identical financial instrument which is measured under 12-month ECLs.

Significant increase in credit risk

At each reporting date, an entity assesses whether the credit risk on a financial asset has increased significantly since initial recognition. IFRS 9 does not define this term, instead, an NFI has to define it in the context of its type of financial instruments. The consequence of credit risk increasing significantly since initial recognition is that a loss allowance, equal to lifetime ECLs, must be recognised.

To illustrate this assessment in practice, consider two financial assets which have the same risk grading at reporting date. Despite having the same risk-grading, the analysis is made relative to initial recognition and thus only the financial asset which had the largest drop in credit rating, consistent with the NFI's definition of a significant increase, will recognise lifetime ECLs.

Financial Asset

Credit at Initial Recognition

Credit Rating at Reporting Date

Significant increase in credit risk since initial recognition

ECL

A

1

3

Yes

Lifetime

B

2

3

No

12-month

There is however an exception in this assessment if credit risk is low at the reporting date. This is the case when:

  1. the financial asset has a low risk of default;
  2. the borrower has a strong capacity to meet contractual cash flow obligations in the near term, and
  3. adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce ability of the borrower to fulfil its contractual cash flow obligations.

The key impact of this exception is for externally rated investment grade bonds. It is important to note that, just because an instrument is no longer of investment grade, it does not necessarily mean that there has been a significant increase in credit risk. Similarly, a financial asset of investment grade does not automatically meet the low credit risk exception because the credit rating may be out of date.

The standard also includes a rebuttable presumption that credit risk on a financial asset has increased significantly when payments are more than 30 days overdue, and this is the latest point at which lifetime ECLs should start to be recognised. As the delinquency of a debtor is a lagging indicator and thus normally information would have been available to identify a significant increase well before the 30 days indicator, an NFI should seek to obtain this more forward-looking information, if available, without undue cost or effort. There are instances when this presumption may be rebutted, such as if non-payment by the borrower was only due to a technical or administrative oversight rather than resulting from the borrower's financial difficulties.

Impact of impairment requirements on NFIs

The magnitude of the ECL model will depend on the extent and nature of an entity's financial assets. Under IAS 39, impairment losses would only be recognised once objective evidence exists that a loss event happened after initial recognition, such as missed contractual payments by a debtor. Under IFRS 9, impairment losses will be pre-emptively recognised before actual losses occur and thus the scope of impairment has now increased significantly.

Applying the new ECL model to the same broad asset categories identified earlier will allow NFIs to better understand how to approach the new impairment requirements.

Loans, trade and lease receivables and contract assets

Bad debt provisions are likely to be larger and more volatile. Impairment of trade receivables and contract assets without a significant financing component will always carry a loss allowance equal to lifetime ECLs, whilst for those with a significant financing component, and lease receivables, an accounting policy choice is available to either recognise lifetime ECLs or apply the general impairment model. This is known as the 'simplified approach' for trade receivables, contract assets and lease receivables.

Debt securities

Impairment losses must be recognised for investments in debt securities not classified at FVTPL. These reflect probability-weighted estimates of ECLs based on historical experience and forward-looking information: 12-month ECLs for assets that have not suffered a significant increase in credit risk; lifetime ECLs for those that have.NFIs should thus review the contractual terms and redesign impairment methodology to comply with IFRS 9. They should review credit risk management processes and data available, and assess whether credit risk management systems can record changes in credit risk since initial recognition. They will also have to design and test new impairment methodologies.

Disclosures

The standard brings with it extensive qualitative and quantitative disclosures generally by class of financial instruments, including:

  • a description of credit risk management practices, including how an entity determined whether credit risk has increased significantly;
  • an explanation of inputs, assumptions and techniques used when applying the impairment requirements; and
  • a reconciliation of loss allowances and explanation of significant changes in the gross carrying amount.

NFIs should assess current systems to identify data gaps that must be filled to meet the new disclosure requirements. The general financial instrument disclosure requirements covered by IFRS 7 Financial Instruments: Disclosures are of course applicable – NFIs should provide enough disclosures to enable users to understand (i) the significance of financial instruments, (ii) the credit, liquidity and market risk exposures resulting from said instruments, and (iii) how they manage these risks.

Transition

IFRS 9 allows various transition options. NFIs shall apply IFRS 9 retrospectively, in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, with significant exemptions on transition with respect to classification, measurement and impairment requirements. A robust impact assessment phase to transition to IFRS 9 is imperative to ensure a successful implementation project.

Conclusion

Transitioning to the new standard will consume energy and resources over the next few months. Post-implementation reviews following adoption of this standard will be high on the agenda in years to come as entities have to demonstrate adherence to their business models and test the validity of assumptions applied in the ECL model.

---This article was written by Jonathan Dingli (Director) and Georges Xuereb (Assistant Manager) and was published on The Accountant.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Jonathan Dingli
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions