GAAP & IFRS Updates: What you need to know

Transcription

1 GAAP & IFRS Updates: What you need to know Claire Gemmell Account Manager Rhead Hatch Product Owner

2 Learning Objectives Identify differences in the classification and measurement of financial instruments at initial recognition and subsequently under IFRS 9 Learn how to calculate expected losses under both the IASB s ECL model and the FASB s CECL model Learn about FASB Accounting Standards Updates relevant to investments from 2016 and 2017

3 Agenda IFRS 9 updates IFRS 17 updates IFRS 9 ECL model versus US GAAP CECL model Accounting Standards Updates from GAAP relevant to investments» ASU : Recognition & Measurement of Financial Assets and Financial Liabilities» ASU : Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships» ASU : Contingent Put and Call Options in Debt Instruments» ASU : Simplifying the Transition to the Equity Method of Accounting» ASU : Measurement of Credit Losses on Financial Instruments (CECL discussion)» ASU : Targeted Improvements to Accounting for Hedging Activities

4 IFRS 9 What is it? IFRS 9 is an International Financial Reporting Standard It provides guidance on:» Classification and measurement of financial assets» Impairment of financial assets» Hedge accounting

5 IFRS 9 Why did it come about? Anyone who claims that they fully understand IAS 39 has not read it properly. Sir David Tweedie, former IASB chairman

6 IFRS 9 When is it effective? January 1, 2018 There is a deferral option until January 1, 2021 for companies adopting IFRS 17 insurance contracts

7 IFRS 9: Overview

8 Overview of IFRS 9 Initial measurement of financial assets Initially measured at fair value +/- transaction costs (if not FVTPL) Subsequent measurement: two major classifications» Amortized cost» Fair value If at fair value, gains and losses are recognized in one of two ways:» Profit or loss (FVTPL)» Other comprehensive income (FVTOCI)

9 Classification and Measurement IAS 39 classifications (4)» Held for trading (FVTPL)» Available for sale (AFS)» Held to maturity (HTM)» Loans and receivables IFRS 9 classifications (3)» Fair value through profit or loss (FVPL)» Fair value through other comprehensive income (FVOCI)» Amortized cost

10 Key differences between IAS 39 & IFRS 9 IAS 39 IFRS 9 Rule-based Complex and difficult to apply Classification and Measurement rules Complicated Reclassification rules Multiple impairment models Principle-based Classification based on business model and nature of cash flows Business model-driven reclassification One impairment model

11 All Financial Assets: Classification Decision Tree

12 Debt Assets Only

13 Debt Assets Classification considerations Cash flow characteristics test (SPPI test) instrument level Business model test (aggregate level) FVTPL option elected?

14 SPPI Test IFRS 9 basic lending arrangement: Principal versus interest Interest should be the consideration for basic lending risks» TVM, credit risk, liquidity risk, and administrative costs associated with holding the asset Some things wouldn t meet the test» Commodity or index-linked securities» Convertible debt or embedded derivatives (FVTPL)

15 Debt Classifications 1. Amortized cost» Cash flows are solely payments of principal and interest on the principal amount outstanding» Business model where the objective is to hold the assets to collect their contractual cash flows (rather than to sell)» FVTPL option is NOT elected 2. FVTOCI» Cash flows are solely payments of principal and interest on the principal amount outstanding» Business model where the objective is to hold and sell the assets to collect their contractual cash flows» FVTPL option is NOT elected 3. FVTPL is the default option

16 Debt Measurement If debt assets are classified as FVTOCI: What goes through OCI:» Unrealized gains or losses What goes through P/L:» Interest Income» FX» Impairment gains or losses» Unrealized gains and losses reclassified to P/L on derecognition

17 Equity Instruments

18 Equity Instruments FVTPL is the default treatment» The entity has the option to designate an instrument as FVTOCI Only available at initial recognition and is irrevocable This option results in all gains and losses being presented in OCI except for dividend income (P/L) FVTOCI is not the same as available for sale (AFS) in IAS 39:» No recycling to P/L on derecognition» No impairment testing leading to recycling from OCI to P/L

19 Financial Liabilities IFRS 9 is very similar to IAS 39» i.e. classification options are still amortized cost or FVTPL

20 IFRS 9 Impairment Changes Change from an incurred loss to an expected loss model Earlier recognition of impairment losses is likely to result Three-stage impairment model for assets that are:» Performing» Underperforming» Non-performing Stage assessment is based on relative (not absolute) credit risk compared to credit risk at initial recognition

21 Three-Stage ECL Model for Impairment STAGE 1 STAGE 2 STAGE 3 Financial asset Performing Credit risk significantly increased Credit-impaired Loss allowance 12-month expected credit losses Lifetime expected credit losses Lifetime expected credit losses Interest revenue On gross carrying amount On gross carrying amount On amortized cost

22 ECL Inputs PD (probability of default)» Likelihood that a loan will not be repaid and will fall into default LGD (loss given default)» The fractional loss due to default, i.e. 100% less the recovery rate EAD (exposure at default)» The total exposure to credit risk (the amount the borrower owes to the lending institution at the time of default) EL PD LGD EAD

23 IFRS 17

24 IFRS 17 Overview The new IFRS standard for insurance contract accounting Has been under development for many years A more robust standard than the current IFRS 4 Effective date 2021 There are parallels with Solvency II in Europe Building blocks approach

25 Accounting Standards Updates issued in 2016

26 ASU Recognition and Measurement of Financial Assets and Financial Liabilities Equity Investments (excluding those accounted for under the Equity Method or those that result in consolidation of the investee) should be measured at Fair Value through Net Income Special treatment available if they do not have readily available fair values» Can be measured at fair value either upon occurrence of an observable price change or upon impairment» Impairment processes simplified to be a qualitative assessment and impairment to fair value Adoption should include a cumulative effect adjustment to the balance sheet Effective date: 2018, including interim periods» Early adoption is not permitted

27 ASU Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships Novation: Replacing one party in a contract with a new party Historically may have been considered sufficient to require designation of that hedging relationship This update clarifies that a change in counterparty by itself all other hedge accounting criteria remaining the same does not require designation Entities have the option to apply the update on either a prospective basis or a modified retrospective basis Effective Date: 2017

28 ASU Contingent Put and Call Options in Debt Instruments Historically, GAAP indicated that a contingently exercisable put or call option is clearly and closely related to the debt host if it is indexed only to interest rates or credit risk, and not some extraneous event or factor, did not specifically address the contingency itself ASU clarified that an exercise contingency event does not need to be evaluated to determine whether it relates to interest rates and credit risk in an embedded derivative analysis Application upon adoption should be done on a modified retrospective basis Effective Date for public business entities: 2017

29 ASU Simplifying the Transition to the Equity Method of Accounting Changes handling of treatment of a non-equity method investment increases ownership and begins to qualify for equity method treatment FASB eliminated requirement of retrospective equity method treatment, allowing investor to add cost of acquiring additional interest to existing basis, then adopt equity method treatment as of the date it becomes qualified Intent is to ease the burden of transitioning into using Equity Method accounting For adoption, changes should be applied prospectively Effective 2017, including interim periods

30 Current Expected Credit Loss Model (ASU )

31 ASU Why the Update? Measurement of Credit Losses on Financial Instruments Current impairment model required credit losses to be probable before impairment losses could be recognized Both financial institutions and users of their financial statements had concerns about the lack of reporting for credit losses that were expected but had not yet reached the probable threshold Financial crisis in 2008 highlighted this weakness FASB and IASB shared a joint project to rectify this similarity in their impairment guidance ASU is intended to help provide more decision-useful information to financial statement users on a more timely basis

32 ASU Scope Entities holding financial assets and net investments in leases not accounted for at fair value through net income Entities holding loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposure, reinsurance receivables, any other financial asset not excluded from the scope that have the contractual right to receive cash

33 ASU Assets held at Amortized Cost Current Expected Credit Loss (CECL)» Determination of Credit Loss is now based on Current Expected Credit Loss model» This applies to HTM securities, as well as trade receivables, lease receivables, reinsurance receivables that result from insurance transactions, financial guarantee contracts, and loan commitments» Allowance based approach rather than a reduction to the amortized cost of asset» No threshold to impairment (Best Estimate vs. Allowance)» Required to pool assets when similar risk characteristics exist» Forward looking

34 ASU Deeper into CECL Model Forward Looking Must estimate credit losses over the entire life of the instrument» Requires management to create a model for the contractual life of the instrument» Required to not only consider historical information and current conditions, but also use forecasts about future economic conditions Forecasts should be reasonable and supportable Can use historical loss information beyond timeframes that reasonable and supportable forecasts can be made» Use of discounted cash flows is one approach, but is not a required approach An entity should use judgement to develop an approach that allows the best estimate of future credit losses

35 ASU PCD held at Amortized Cost Purchased assets with a more-than-insignificant amount of credit deterioration since origination held at amortized cost» Initial allowance for credit loss is added to the purchase price in determining amortized cost» Interest Income based on effective interest rate, excluding the discount in the purchase price attributable to credit loss assessment at purchase

36 ASU Available For Sale Assets CECL does not apply to AFS securities ASC reorganized impairment guidance (now in ) and eliminated to Other-Than-Temporary Impairment concept Intent to Sell, or More Likely Than Not will be Required to Sell are still triggers for Impairment recognition» Direct write down of amortized cost

37 ASU Available for Sale Credit Losses Credit losses should now be recorded through an allowance for credit losses» No longer decreases amortized cost Calculated as difference between present value of future expected cash flows and amortized cost Limited to amount by which fair value is less than amortized cost Reversals are allowed as allowance may decrease Should no longer use duration of impairment to avoid recognizing credit loss» Most other qualitative criteria were kept (e.g. severity, adverse conditions, etc.)

38 ASU PCD considered Available for Sale Purchased assets with a more-than-insignificant amount of credit deterioration since origination considered Available for Sale» Initial allowance for credit loss is added to the purchase price in determining» amortized cost» Interest Income based on effective interest rate, excluding the discount in the purchase price attributable to credit loss assessment at purchase

39 ASU : AFS Impairment Decisions

40 ASU Impairment Comparison Topic AFS debt security impairment model* HTM current expected credit loss model Unit of Measurement Allowance Recognition Threshold Measurement of credit loss Acceptable methods for measuring credit losses Individual AFS debt security When a decline in fair value below the amortized cost basis has resulted from a credit loss Excess of the amortized cost basis over the best estimate of the present value of cash flows expected to be collected, limited by the amount that fair value is less than amortized cost DCF Collective (pool) when similar risk characteristics exist; otherwise, individual None Expected credit loss that reflects the risk of loss even if that risk is remote Various methods are appropriate, including DCF, loss rate, PD and others that faithfully estimate collectability by applying the principles in ASC *When the entity has decided to see the debt security or it s more likely than not the entity will be required to sell the security before recovery of the security s amortized cost basis, the security s amortized cost basis should be written down to fair value through earnings at the report date. Source: E&Y Technical Line No : A closer look at the New credit impairment standard (

41 ASU Transition and Effective Date Adoption should include a cumulativeeffect adjustment to retained earnings as of the first period in which the guidance is effective A prospective approach is required for debt securities that have had an OTTI in the past PCD assets should also apply this prospectively, adjusting amortized cost to reflect the addition of the allowance for credit losses Effective Date: 2020, including interim periods» Early adoption allowed for 2019

42 ASU Targeted Improvements to Accounting for Hedging Activities Intended to help better align hedge accounting with companies risk management strategies, reduce barriers to application, and make the results more useful to users of financial statements» Makes more financial and non-financial hedging strategies qualify for hedge accounting» Amends presentation and disclosures about hedging activity» Changes how companies assess hedging effectiveness

43 IFRS 9 ECL vs. US GAAP CECL

44 The IASB s ECL vs. the FASB s CECL Similarities More forward-looking expected loss approaches for recognizing credit losses Recognize losses that have already occurred, plus losses that are expected in the future

45 The IASB s ECL vs. the FASB s CECL Differences The IASB, in its new IFRS 9 legislation, does not call for lifetime expected losses to be recognized unless there is evidence of deteriorating credit quality The FASB s CECL model calls for recognition of losses over the life of the loan» Requiring institutions to recognize losses at the origination of the loan (even if the loan is fully performing) The IASB ECL model applies to AFS and HTM securities, the FASB s CECL model does not apply to AFS securities The IASB ECL model requires the use of discounted cash flows, FASB s CECL model allows discounted cash flows, but allows management entities to decide most appropriate forecasting model

46 Questions?

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