IFRS 9 FINANCIAL INSTRUMENTS FOR NON FINANCIAL INSTITUTIONS. New member firm training 2010 Page 1

IFRS 9 FINANCIAL INSTRUMENTS FOR NON FINANCIAL INSTITUTIONS New member firm training 2010 Page 1

AGENDA / OUTLINE IFRS 9 Financial Instruments Objective & Scope Key definitions Background & introduction Classification and measurement of financial assets Classification and measurement of financial liabilities Impairment Transition Page 2

Objective & Scope New member firm training 2010 Page 3

OBJECTIVE & SCOPE IFRS 9 Financial Instruments To establish principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amount, timing and uncertainty of an entity s future cash flows. Page 4

OBJECTIVE & SCOPE IFRS 9 Financial Instruments Applied by ALL entities to all types of financial instruments except: Interest in subsidiaries, associates & JVs; Rights and obligations under leases; Employers rights and obligations under employee benefit plans; Some equity instruments as defined in IAS 32 Rights and obligations arising under insurance contract or contracts Page 5

OBJECTIVE & SCOPE IFRS 9 Financial Instruments Forward contracts that will result into business combinations; Some loan commitments ; Financial instruments, contracts and obligations under share-based payment; Rights to payments to reimburse the entity for expenditure to settle a liability that it recognizes as a provision; and Rights and obligations within the Scope of IFRS 15. Page 6

Key Definitions New member firm training 2010 Page 7

KEY DEFINITIONS IFRS 9 Financial Instruments Financial Instrument - is any contract that gives rise to financial asset of one entity and a financial liability or equity instrument to another entity; Financial Asset is any asset that is: (a) cash (b) an equity instrument of another entity (c) a contractual right: (i) to receive cash or another financial asset; (ii) to exchange financial asset or financial liability with another (d) a contract that may be settled in the entity s own equity instrument Page 8

KEY DEFINITIONS IFRS 9 Financial Instruments Financial Liability is any liability that is: (a) a contractual obligation:(i) to deliver cash or another financial asset; (ii) to exchange financial asset or financial liability with another. (b) a contract that may be settled in the entity s own instrument. Page 9

KEY DEFINITIONS CONT D Financial Institution - a Company licensed to carry on or conduct financial institutions business in Uganda and these include a commercial bank, merchant bank, mortgage bank, post office savings bank account, credit institution, a building society, an acceptance house, a discount house, a finance house or any institution which by regulations is classified as a financial institution by the Central Bank. (Section 3 of the FIA). Page 10

Background & Introduction New member firm training 2010 Page 11

BACKGROUND IFRS 9 Financial Instruments Issued 24 July 2014 Effective 1 January 2018 Early application permitted Not converged with US GAAP Page 12

BACKGROUND IFRS 9 Financial Instruments Developed to replace existing standard IAS 39 Financial Instruments: Recognition and Measurement. IAS 39 criticised by users as difficult to understand, apply and interpret - Users have urged the IASB to develop a principle based and less complex standard for financial instruments. Page 13

BACKGROUND IFRS 9 Financial Instruments Phases IASB Document Date finalised Phase I: Classification and measurement Phase II: Impairment Phase III: Hedge Accounting IFRS 9 Classification and Measurement of Financial Assets IFRS 9 Classification and Measurement of Financial Liabilities and Derecognition of Financial Assets Nov 2009 Dec 2010 IFRS 9 Financial Instruments July 2014 IFRS 9 Financial Instruments July 2014 IFRS 9 Financial Instruments: Hedge Accounting and amendments to IFRS 9, IFRS 7 and IAS 39 November 2013 Page 14

QUIZ 1 What do the following letters stand for? Acronyms FVTPL/FVPL FVTOCI/FVOCI AFS SPPI HTM DIA CFH Stands for Page 15

QUIZ 1 What do the following letters stand for? Acronyms FVTPL/FVPL FVTOCI/FVOCI AFS SPPI HTM DIA CFH Stands for Fair Value Through Profit or Loss Fair Value Through Other Comprehensive Income Available For Sale Solely Payments of Principal and Interest Held To Maturity Date of Initial Application Cash Flow Hedge Page 16

INTRODUCTION IFRS 9 Financial Instruments Key changes financial assets Three measurement categories for financial assets - Fair value through Profit or Loss (FVPL) - Fair value through Other Comprehensive Income (FVOCI) - Amortised cost Change in the boundary between amortised cost and fair value - More restricted use of amortised cost - May lead to more / fewer instruments being recorded at fair value Option to record all changes in fair value of equity instruments not held for trading in OCI - No recycling on disposal Page 17

INTRODUCTION IFRS 9 Financial Instruments Key changes impairment IAS 39 incurred loss model IFRS 9 expected loss model - Introduces more complex three stage model. - Recognise impairment based on expectations of future loss events. - Significant increases in loss allowances expected. Page 18

INTRODUCTION IFRS 9 Financial Instruments Key changes hedge accounting IAS 39 rules based and complex IFRS 9 - Accounting more clearly linked to risk management activities. - More hedging arrangements likely to qualify for hedge accounting. * Less profit or loss volatility - Less complex and onerous ongoing compliance requirements. * 80-125% effectiveness limits eliminated - Ability to hedge components of non-financial items. - Reduced profit or loss volatility from using options. Page 19

INTRODUCTION Who may be most impacted? Banks & Insurance companies Entities that hedge or are planning to take out hedges (foreign exchange, interest rates and commodities) Entities with: Available-for-sale investments Investments in unquoted equity Any financial assets (including loans and receivables) whose return is NOT based solely on principal and interest Non-listed debt investments that are under a held to collect and sale business model Lease/trade receivables Inter-company loan receivables Deferred contingent consideration receivables Page 20

INTRODUCTION Actions that may be required before 2018 Understand the standard Determine impact Decide whether early adoption is beneficial Processes to determine fair value Processes to determine expected credit losses Educate staff Change processes Change systems Change contracts Page 21

Classification and measurement of FINANCIAL assets New member firm training 2010 Page 22

COMPARISON IAS 39 IFRS 9 FVTPL (held for trading) Loans and receivables FVTPL (residual) Amortised cost Held to maturity Available-for-sale (residual) FVTOCI for debt FVTOCI for equities Page 23

COMPARISON IAS 39 AND IFRS 9 (2009,2010 &2013) IAS 39 IFRS 9 (2009, 2010 & 2013) FVTPL (held for trading) FVTPL (residual) Loans and receivables Amortised cost Held to maturity Available-for-sale (residual) FVTOCI for equities Page 24

C&M (2009), (2010), (2013) & (2014) IFRS 9 (2009, 2010 & 2013) IFRS 9 (2014) FVTPL (residual) FVTPL (residual) Amortised cost Amortised cost FVTOCI for debt FVTOCI for equities FVTOCI for equities Page 25

CLASSIFICATION AND MEASUREMENT OF FINANCIAL ASSETS Amortised cost FVTOCI for debt FVTOCI for equities FVTPL Page 26

AMORTISED COST Introduction Common types of financial instruments at amortised cost Trade receivables Loan receivables Intercompany loans and receivables Investments in term deposits Page 27

AMORTISED COST Qualifying criteria for amortised cost To qualify for amortised cost, must meet the following two tests: 1. Contractual cash flow characteristics test 2. Hold to collect business model test Page 28

CONTRACTUAL CASH FLOW CHARACTERISTICS TEST SPPI cash flows Terms of the instrument only provides for cash flows that are Solely Payments of Principal and Interest (SPPI cash flows) Principal: fair value at initial recognition Interest: time value of money and credit risk* Principal *Most significant components, can also contain other components e.g. liquidity risk, profit margin and servicing or administrative costs Page 29 Interest Time value of money Credit risk

SPPI CASH FLOWS Example 1: SPPI cash flows Entity D lends Developer Co CU 500 million for 5 years at 5%. Developer Co will use the funds to buy a piece of land and construct residential apartments for sale. Entity D will be entitled to an additional 10% of the final net profits from the project. Question Does the loan meet the SPPI cash flows test? Page 30

SPPI CASH FLOWS Example 1: SPPI cash flows.cont d Question: Does the loan meet the SPPI cash flows test? Answer: No. Cash flows are not merely SPPI. Also provide for additional profit participation of the business. Loan fails amortised cost and Entity D accounts for the loan at fair value through profit or loss. Page 31

SPPI CASH FLOWS Consequences of failing the SPPI test If the SPPI test is not met, the financial asset cannot be classified at Amortised cost FVTOCI for debt Other possible measurement categories: FVTPL Page 32

AMORTISED COST Qualifying criteria for amortised cost To qualify for amortised cost, must meet the following two tests: 1. Contractual cash flow characteristics test 2. Hold to collect business model test Page 33

HOLD TO COLLECT BUSINESS MODEL Business objective To collect contractual cash flows. Need not hold until maturity. Can have infrequent sales. - Example: selling close to maturity, to realise cash for a liquidity crisis, due to changes in tax laws, significant internal restructuring or business combinations. Key difference between IAS 39 HTM and IFRS 9 amortised cost. - HTM penalises the entity (by prohibiting the entity to use the HTM category for 2 years) if the entity sells the financial asset that it has classified as held to maturity. Page 34

HOLD TO COLLECT BUSINESS MODEL Consequences of failing the hold to collect business model If the hold to collect business model test is not met, the financial asset cannot be classified at Amortised cost Other possible measurement categories if SPPI test is met (but hold to collect business model test not met): FVTOCI for debt FVTPL Page 35

HOLD TO COLLECT BUSINESS MODEL Example 2: Hold to collect business model test Entity A sold one of its diverse business operations and currently has CU10million of cash. It has yet to find another suitable investment opportunity to reinvest, so it buys government bonds to collect interest for 6 months. Once a suitable investment opportunity arises the entity intends to sell the bonds and use the proceeds for the acquisition of a business operation. Management anticipates that it will take at least 6 to 12 months to find a suitable investment. Question: Is the hold to collect business model test met? Page 36

HOLD TO COLLECT BUSINESS MODEL Example 2: Hold to collect business model test Question: Is the hold to collect business model test met? Answer: Consider the likelihood that a suitable investment opportunity will be found within the next 6 months If unlikely then meets the hold to collect business model test. Also need to consider the maturity of bonds if 6-9 months then may still qualify, if (for example ) 10 year maturity bonds, will not meet hold to collect test. Page 37

CLASSIFICATION AND MEASUREMENT OF FINANCIAL ASSETS Page 38 Amortised cost FVTOCI for debt FVTOCI for equities FVTPL

FVTOCI FOR DEBT Qualifying criteria for FVTOCI To qualify for FVTOCI, must meet the following two tests: 1. Contractual cash flow characteristics test 2. Business objective is to both collect the contractual cash flows and sell the financial asset Page 39

FVTOCI FOR DEBT Qualifying criteria for FVTOCI Business objective is to both collect the contractual cash flows and sell the financial asset. - Involve greater frequency and volume of sales than hold to collect business model - Intention is to sell before the investment matures. Page 40

FVTOCI FOR DEBT Common types of debt instruments that may be at FVTOCI Investments in government bonds where the investment period is likely to be shorter than maturity. Investments in corporate bonds where the investment period is likely to be shorter than maturity. Note: This business model would typically not be expected to apply to intercompany loans/trade receivables. Page 41

FVOCI FOR DEBT Example 3 Entity A sold one of its diverse business operations and currently has CU10million of cash. It has yet to find another suitable investment opportunity to reinvest, so it buys government bonds to collect interest. Once a suitable investment opportunity arises the entity intends to sell the bonds and use the proceeds for the acquisition of a business operation. Management anticipates that a suitable investment will be found within the next 3-6 months. Question: How should Entity A classify the investment? Page 42

FVOCI FOR DEBT Example 3.Cont d Question: How should Entity A classify the investment? Answer: Entity A s objective for the asset is to hold the cash flows and sell the asset (before maturity) once a suitable investment is found. Fair value through other comprehensive income. Note: Not classified as at FVPL as the business model is not to manage the asset on a fair value basis. Key difference with IAS 39 where AFS (FVOCI) is the residual category. Page 43

FVTOCI FOR DEBT How it works Balance sheet At fair value Profit or loss Recognise interest revenue using the effective interest rate Impairment losses/reversals in P&L. Apply the same impairment model as for financial assets measured at amortised cost. Other comprehensive income Recognise cumulative FV changes and recycle to P&L on derecognition. Page 44

FVOCI FOR DEBT Example 4 On 1 January 2018 a financial asset is purchased at its face value of CU1,000. Contractual term is 10 years, coupon 5%. Expected credit losses as determined under the impairment model are CU20. Note: the expected loss model will be covered later in this module. Question (a): What is the initial journal entry? Page 45

FVOCI FOR DEBT Example 4 Cont d Question (a): What is the initial journal entry? Answer (a): CU CU DR Financial asset 1,000 CR Cash 1,000 DR Impairment loss (P&L) 20 CR OCI 20 Carrying values CU Financial asset 1,000 OCI 20 Page 46

FVOCI FOR DEBT Example 4.Cont d On 31/12/18 fair value decreased to CU950 Expected losses increased to CU30 A coupon payment is received Question (b): What is the journal entry? On 1/1/19 the financial asset is sold for CU950 Question (c): What is the journal entry? Page 47

FVOCI FOR DEBT Example 4 Cont d Question (b): What is the journal entry? Answer (b): CU CU DR Cash (5%XCU1,000) 50 CR Interest revenue 50 DR Impairment loss (P&L) (CU30-CU20) 10 DR OCI (CU50-CU10) 40 CR Financial asset (CU1,000-CU950) 50 Carrying values CU Financial asset 950 OCI (20) Page 48

FVOCI FOR DEBT Example 4.Cont d On 1/1/19 the financial asset is sold for CU950 Question (c): What is the journal entry? Answer (c): CU CU DR Cash 950 CR Financial asset 950 DR loss on sale (P&L) 20 CR OCI 20 Page 49

CLASSIFICATION AND MEASUREMENT OF FINANCIAL ASSETS Page 50 Amortised cost FVTOCI for debt FVTOCI for equities FVTPL

FVTOCI FOR EQUITIES Key requirements Applies to equity investments that are not held for trading - E.g.: investment in shares in listed and unlisted companies Once off irrevocable election at initial recognition Recognise all fair value changes in OCI - No recognition of impairment loss through profit or loss No recycling - On sale, fair value changes NOT reclassified to profit or loss (may transfer balance within equity) Recognise dividends in profit or loss Common equity instruments at FVTOCI: - Investment in shares in listed and unlisted companies Page 51

EQUITY INVESTMENTS AT FVOCI Example 5 Entity X is an annual reporter On 1 January 2018, Entity X acquires 100 shares of List Co for CU10,000 On 31 December 2018, the fair value of shares in List Co is CU8,000 On 31 March 2019, Entity X received cash dividend of CU500 from its investment in List Co On 31 December 2019, the fair value of shares in List Co is CU13,000 and Entity X decides to dispose of the shares Entity X has a tax rate of 30% Question: What are the journal entries for (a)1 January 2018, (b) 31 December 2018, (c)31 March 2019 and (d) 31 December 2019 Page 52

EQUITY INVESTMENTS AT FVOCI Example 5.Cont d Answer (a): Journal entries on 1 January 2018 DR Equity investment at FVOCI CU10,000 CR Cash CU10,000 Being the purchase of 100 shares in List Co for CU10,000 Page 53

FVTOCI FOR EQUITIES Example 5: Equity investments under IAS 39 and IFRS 9 IAS 39 (AFS) IFRS 9 (FVOCI) IFRS 9 (FVPL) Asset (B/S) CU10,000 CU10,000 CU10,000 Cash (B/S) CU(10,000) CU(10,000) CU(10,000) Page 54

EQUITY INVESTMENTS AT FVOCI Example 5..Cont d Answer (b): Journal entries on 31 December 2018 at reporting date DR Other comprehensive income CR Equity investment at FVOCI DR Deferred tax asset CR Other comprehensive income CU2,000 CU600 CU2,000 CU600 Being the change in fair value (from CU10,000 to CU8,000) of the equity investment and its related tax effects Page 55

FVTOCI FOR EQUITIES Example 5: Equity investments under IAS 39 and IFRS 9 On 31 December 2018 IAS 39: AFS asset impaired IAS 39 (AFS) IFRS 9 (FVOCI) IFRS 9 (FVPL) Asset (B/S) CU8,000 CU8,000 CU8,000 P/L CU(2,000) - CU(2,000) OCI - CU(1,400) - Page 56

EQUITY INVESTMENTS AT FVOCI Example 5.Cont d Answer (c): Journal entries on 31 March 2019 DR Cash CU500 CR Profit or loss CU500 Being the receipt of the cash dividend of CU500 Page 57

EQUITY INVESTMENTS AT FVOCI Example 5.Cont d Answer (d): Journal entries on 31 December 2019 at reporting date DR Equity investment at FVOCI CU5,000 CR Other comprehensive income CU5,000 DR Other comprehensive income CU1,500 CR Deferred tax asset/ liability CU1,500 Being the change in fair value (from CU8,000 to CU13,000) of the equity investments to 31 December 2014 and the related tax effects Page 58

EQUITY INVESTMENTS AT FVOCI Example 5.Cont d Answer (d) (cont): Journal entries on 31 December 2019 DR Cash CU13,000 CR Equity investment at FVOCI DR Deferred tax liability CR Tax office payable CU900 CU13,000 CU900 Being disposal of the equity investment for CU13,0000 and the related tax effects Page 59

CLASSIFICATION AND MEASUREMENT OF FINANCIAL ASSETS Page 60 Amortised cost FVTOCI for debt FVTOCI for equities FVTPL

FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS Common types of financial instruments at FVTPL Investments in shares in listed companies Interest rate swaps Commodity contracts/futures/options Investments in convertible notes Amount receivable based on profits or a market index Contingent consideration receivables Investments in shares in unlisted companies Page 61

FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS Financial assets with embedded derivatives IAS 39 Account for embedded derivative separately if not closely related Or designate the entire contract at FVTPL IFRS 9 Consider the terms of the instrument in its entirety If the terms of the entire contract still meet the SPPI cash flow test then it may still qualify for amortised cost or FVTOCI Page 62

UNQUOTED EQUITY INVESTMENTS IFRS 9 All investments in equity instruments must be measured at fair value. Cost exemption for unquoted equities eliminated. IFRS Foundation educational material on measuring fair value of unquoted equity instruments within the scope of IFRS 9. Change in the boundary between amortised cost and fair value may result in more or fewer assets in the FVTPL category under IFRS 9 Page 63

Classification and measurement of financial liabilities New member firm training 2010 Page 64

CLASSIFICATION AND MEASUREMENT OF FINANCIAL LIABILITIES Examples of common financial liabilities Fair value through profit or loss Interest rate swaps Commodity contracts/futures/options Foreign exchange forward contracts/futures/options Amortised cost Trade payables Loan payables Bank borrowings Page 65

CLASSIFICATION AND MEASUREMENT OF FINANCIAL LIABILITIES What has not changed from IAS 39? Two categories remains for financial liabilities Amortised cost Fair value through profit or loss - Held for trading derivatives - Financial liabilities designated at fair value through profit or loss (fair value option) Bifurcation of embedded derivatives for financial liabilities remains - i.e. account for the embedded derivative separately if it is not closely related to the host financial liability Page contract 66

CLASSIFICATION AND MEASUREMENT OF FINANCIAL LIABILITIES What has changed from IAS 39? Accounting for the changes in own credit for financial liabilities designated at FVTPL under the FVO option Option to early apply this change without applying any other aspects of IFRS 9 NOTE: Could also have an impact on entities that have designated their convertible liabilities at FVTPL Page 67

CLASSIFICATION AND MEASUREMENT OF FINANCIAL LIABILITIES IFRS 9 Example 6: Financial liabilities designated at FVTPL Total FV change of financial liability is ($10) Changes due to own credit is $8 Journals: DR Financial liability at FVTPL $10 CR OCI $8 CR Profit or loss $2 Page 68

CLASSIFICATION AND MEASUREMENT OF FINANCIAL LIABILITIES IFRS 9 Calculation of changes attributable to own credit Assumption: the only significant relevant change in market conditions is the change in an observed (benchmark) interest rate. Step 1 Calculate the IRR of the liability at the start of the period and deduct the benchmark rate to obtain the instrument specific component of IRR Step 2 Calculate the present value of the liability at the end of the period contractual cash flows discounted by the sum of the observed (benchmark) rate and the instrument specific component calculated in step 1 Step 3 Calculate the fair value of the liability. The difference between the fair value and the amount calculated in step 2 is presented in OCI Page 69

Impairment of financial assets New member firm training 2010 Page 70

IMPAIRMENT OF FINANCIAL ASSETS IAS 39 Incurred loss model Recognise impairment based on objective evidence that an impairment of a loan has occurred. Objective evidence or trigger event can include - Borrower has defaulted or experiencing financial difficulty. - Debt has been restructured. - Delinquency in payments. No general provision - general provision in advance of a trigger event is not allowed. Page 71

IMPAIRMENT OF FINANCIAL ASSETS Why is a new impairment model needed? Global Financial Crisis 2007/2008: - Recognising credit losses too little, too late. - Recognise full contractual interest even though losses may be expected (based on past experience). Different entities have assessed same trigger events differently. Page 72

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 IFRS 9 Expected loss model Initial recognition: Recognise impairment based on expected losses arising from default events that are expected to occur over the next 12 months. Significant increase in credit risk: Recognise impairment based on expected losses over the life of the loan. Significant increase in credit risk can arise from Changes in general economic and/or market conditions, e.g. expected increase in unemployment rate, interest rates. Expected or potential breaches of covenants. Expected delay in payment - Actual delinquency in payments may just be too late. Page 73

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 What types of financial instruments will be affected Financial assets at amortised cost (including trade receivables). Debt instruments at fair value through other comprehensive income. Lease receivables. Loan commitments including undrawn amounts (except those at FVTPL) - NEW - Overdraft facility limits - Credit card facility limits - Loan approved but not drawn down (LANA) Financial guarantee contracts (except for those at FVTPL) - NEW Page 74

OVERVIEW OF THE ECL MODEL 3 stage expected credit loss model Stage 1 Credit risk has not increased significantly since initial recognition Recognise 12 month expected losses Stage 2 Credit risk has increased significantly since initial recognition Recognise life time expected losses Interest recognised on a gross basis Stage 3 Credit impaired financial asset (IAS 39 triggers) Recognise lifetime expected losses Interest recognised on a net basis Page 75

OVERVIEW OF THE ECL MODEL 3 stage expected credit loss model Stage 1 2 3 Recognition of impairment Recognition of interest 12 month Lifetime expected credit loss expected credit loss Effective interest on the gross Effective carrying amount interest on the (before deducting expected net (carrying) losses) amount Page 76

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 12 month expected credit losses Probability of event occurring that will result in default over the next 12 months X Expected credit losses from that default = 12- montch expected credit losses Page 77

SIMPLIFIED MODEL Trade receivables Simplified model 12 month practical exemption Trade receivables with maturity <1yr Recognise lifetime expected losses Group trade receivables based on due status or other attributes e.g. geographical region, industry, customer rating etc to improve the accuracy of estimating expected credit losses. Provisional rates to reflect current and forecast credit conditions. Page 78

SIMPLIFIED MODEL Example 7 31/12/18 Company M has trade receivables of CU30million The customer base consists of a large number of small clients Company M estimates the following provision matrix (based on historical observable default rates and adjusted for forward looking estimates) Expected default rate (A) Gross carrying amount (B) Credit loss allowance (A *B) Current 0.3% CU15million CU45,000 1-30 days past due 1.6% CU7.5million CU120,000 31-60 days past due 3.6% CU4million CU144,000 61-90 days past due 6.6% CU2.5million CU165,000 >90 days past due 10.6% CU1million CU106,000 Total CU30million CU580,000 Page 79

SIMPLIFIED MODEL Example 7 (cont d) 31/12/19 Company M has a portfolio of trade receivables of CU34million in 2015 Company M revises its forward looking estimates and expects the general economic condition is performing worse than originally expected Company M estimates the following provision matrix Expected default rate (A) Gross carrying amount (B) Credit loss allowance (A*B) Current 0.5% CU16million CU80,000 1-30 days past due 1.8% CU8million CU144,000 31-60 days past due 3.8% CU5million CU190,000 61-90 days past due 7% CU3.5million CU245,000 >90 days past due 11% CU1.5million CU165,000 Total CU34million CU824,000 Page 80

SIMPLIFIED MODEL Example 7 (cont d) 31/12/19 The credit loss allowance has increased by CU244,000 Credit loss allowance 31/12/14 CU580,000 31/12/15 CU824,000 Increase The journal entry for 31 December 2019 would be DR Expected credit losses CR Credit loss allowance DR CU244,000 CU244,000 CR CU244,000 Page 81

SIMPLIFIED MODEL Trade receivables >12 months Trade receivables with a significant financing components Choice of: Simplified model (lifetime expected credit losses) The 3 stage model Same choice available for lease receivables NOTE: Choice NOT AVAILABLE to intercompany or related party receivables must use 3 stage model. Page 82

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Stage 1 12 month expected credit losses Practical issues 1. What sort of information /data (if any) do entities have to estimate 12 months expected credit losses? How would entities be able to identify the probability of default over the next 12 months for all financial assets? Demographic information age profile? As customer reaches retirement age probability of default will change? How will 12mths of expected credit losses be updated? New customers what sort of demographic/credit data/information is available for new customers? Page 83

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Stage 1 12 month expected credit losses Practical issues.cont d 2. What additional information, systems and processes would need to be in place to estimate 12 month expected credit losses? 3. Should entities be looking at how information/data can be collected and start collecting the information/data Page 84

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Transfer from stage 1 to stage 2 When there is significant increase in credit risk Basing on changes in risk of default over the remaining life of the instrument. Based on changes in risk of default over next 12 months could be a reasonable approximation (may not be appropriate in some circumstances). Use internal definitions of default. Rebuttable presumption that default occurs no later than 90 days past due (unless other reasonable and supportable information supports a more lagging criterion). Page 85

IMPAIRMENT OF FINANCIAL ASSETS Transfer from stage 1 to stage 2.Cont d Factors that can indicate increase in credit risk Changes to contractual terms that would be made if the financial asset was newly originated Existing or forecast adverse changes in business, financial or economic conditions that cause a significant change in a borrower s ability to pay. - E.g. expected increase in interest rates, unemployment rates Significant changes in operating results - E.g. actual or expected decline in revenues or margins, increase in operating risk, working capital deficiencies, decrease in asset quality, increase leverage, liquidity and management problems Credit deterioration on other financial instruments of the borrower Page 86

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Transfer from stage 1 to stage 2 Cont d Factors that can indicate increase in credit risk..(cont d) Significant change in the value of the collateral, quality of third-party guarantees or credit enhancements e.g. decline in house prices. Adverse change in the quality of the guarantee/support by parent. Expected breach of contracts. Increase in the expected number or extent of delayed payments. Changes in credit management approach (i.e. the financial instrument becoming more active or closely monitored). Past due information Page 87

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 (2014) Transfer from stage 1 to stage 2.Cont d 30 days past due rebuttable presumption If payments are more than 30 days past due - Asset is in stage 2 - Recognise lifetime expected credit losses Can be rebutted if (with supportable information) no significant increase in credit risk exists, even if payments are 30 days past due. For example: - Non-payment administrative oversight - No correlation between significant increase in credit risk and when payments are 30 days past due Cannot solely rely on this presumption if more forwardlooking information is available Page 88

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 (2014) Transfer from stage 2 to stage 3 Indicators for moving from stage 2 to stage 3 Significant financial difficulty of the issuer or borrower Breach of contract (e.g. default or delinquency in payments). Granting of a concession to the borrower due to the borrower s financial difficulty. Probable that the borrower will enter bankruptcy or other financial reorganisation. Disappearance of an active market for the financial asset because of financial difficulties. or Purchase of a financial asset at a deep discount that reflects incurred credit losses. Page 89 IAS 39 incurred loss indicators

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 (2014) Measuring expected credit losses Expected credit losses = present value of cash shortfalls Credit loss = delay in payment of contractually required amount Probability weighted average outcome Consider a range of possible outcomes and not the most likely outcome At a minimum consider the probability that - a credit loss occurs and - no credit loss occurs Average credit losses of a large portfolio of financial assets may be a reasonable estimate of the probabilityweighted amount Page 90

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Measuring expected credit losses.cont d Using historical information Adjust historical data to reflect current conditions and forecasts of future conditions Ensure that adjustments to historical data are directly consistent and of similar magnitude with other observable data - Changes in unemployment rates - Changes in property prices - Changes in commodity prices, payment status In some cases, the best reasonable and supportable information could be unadjusted historical information Page 91

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Measuring expected credit losses..cont d Collateralised financial assets Estimated cash flows consider: - Probability of foreclosure - Cash flows that would result from foreclosure (less costs for obtaining and selling the collateral) No change from IAS 39 Page 92

3 STAGE EXPECTED CREDIT LOSS MODEL Intercompany/related party loans Standard does not provide any practical expedients for intercompany/related party loans The 3 stage model applies to related party loans and inter company loans in an entity s standalone accounts This include loans to: - Subsidiaries - Sister subsidiaries - Associates and JVs (including those that form part of the net investment in associates and JVs) Full disclosure under the 3 stage model would also have to be provided Page 93

3 STAGE EXPECTED CREDIT LOSS MODEL Example 8 Company A lends CU100 to Company B (A related party) for 5 years with 10% interest (unsecured) At the end of year 1, there is 0.5% probability the loan defaulting in the next 12months with a 100% loss - Recognise provision of CU0.50 (0.05%XCU100) Stage 1 Stage 3 Page 94

3 STAGE EXPECTED CREDIT LOSS MODEL Example 8.(cont d) Company A lends CU100 to Company B (A related party) for 5 years with 10% interest (unsecured) At the end of year 2. Company B is expected to have cash flow problems due to deterioration in economic conditions and is expected to breach its loan covenants. Probability that the loan will default over the remaining life of the loan is 35%. - Recognises a provision of CU35 (35%XCU100). Stage 2 Page 95

3 STAGE EXPECTED CREDIT LOSS MODEL Example 8 (cont d) Company A lends CU100 to Company B (A related party) for 5 years with 10% interest (unsecured). At the end of year 3 Company B breached its banking covenants Company A estimates that the probability of loan will default over the remaining life the loan is 60% Recognises a provision of CU60 (60%XCU100) Stage 3 Page 96

3 STAGE EXPECTED CREDIT LOSS MODEL Example 8 (cont d) Stage Gross amount Allowance account Interest End of Year 1 1 CU100 CU0.50 CU10 (CU100 x 10%) End of Year 2 2 CU100 CU35 CU10 (CU100 x 10%) End of Year 3 3 CU100 CU60 CU10 (CU100 X 10%) (loan was still in stage 2 during year 3) End of Year 4 3 CU100 CU60 CU4 [(CU100-CU60) X 10%] Page 97

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 (2014) Practical implications IAS 39 current model Two categories of loans good vs bad Provide for incurred credit losses on bad loans Update provision for bad loans each reporting period IFRS 9 new model Three categories of loans (stage 1 vs stage 2 vs stage 3) Provide for 12 months expected losses on initial recognition Update 12 month losses at each reporting date Constant monitoring of whether credit risk has increased significantly Update expected credit losses as the financial asset moves to a different stage Update interest recognition as the financial asset moves to a different stage Page 98

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Detailed and extensive disclosures Quantitative Reconciliation of allowance accounts showing key drivers for change (separately for each stage) Explanation of gross carrying amounts showing key drivers for change (separately for each stage) Gross carrying amount per credit risk grade or past due status (Group by product, loan to value ratios, geographical, industry) Write-offs, recoveries, modifications Qualitative Inputs, assumptions and techniques used to estimate expected credit losses (and changes in techniques) Inputs, assumptions and techniques used to determine significant increase in credit risk and default Inputs, assumptions and techniques used to determine credit-impaired Write off policies, modification policies, collateral Page 99

IMPAIRMENT OF FINANCIAL ASSETS IFRS 9 Carrying amount by days past due if credit risk grades not available IFRS 9 (2014) Financial Instruments Impairment Page 100

AVAILABLE GUIDANCE New member firm training 2010 Page 101

OTHER GUIDANCE Impairment Transition Group (ITG) Set up by the IASB to provide stakeholders a forum to discuss implementation issues. Purpose of ITG. - Solicit, analyse and discuss stakeholder issues arising from implementation of the new impairment requirements, - Inform the IASB about those implementation issues, which will help the IASB determine what, if any, action will be needed to address those issues, and - Provide a public forum for stakeholders to learn about the new impairment requirements from others involved with implementation Conclusions reached by the ITG are not authoritative. However entities should take into careful consideration of the discussions and conclusions reached by the ITG. Page 102

Effective date & transition New member firm training 2010 Page 103

EARLY APPLICATION Options available to early apply different versions IFRS 9 Page 104

TRANSITION TO IFRS 9 Date of initial application (DIA) Date of initial application (DIA) Beginning of the first reporting period when an entity first applies IFRS 9. Question: Can DIA be the beginning of an interim period other than the beginning of an annual period? Answer: Yes, if an entity can adopt IFRS 9 in its interim reports that comply with IAS 34, DIA can be the beginning of an interim period other than the beginning of an annual period Page 105

TRANSITION TO IFRS 9.CONT D Phase Classificat ion and measurem ent Transition requirements Retrospective Summary Determine classification at date of initial application, retrospectively apply that classification Does not apply to items that have already been derecognised at the date of initial application. Not required to restate comparatives (Recognise the difference between the previous carrying amount and the new opening amount in opening retained earnings) - but may restate i.e. choice to restate Must provide the disclosures set out in IFRS 7 Page 106

TRANSITION TO IFRS 9 CONT D Phase Impairmen t Hedge accounting Transition requirements Retrospective Prospective (with certain exceptions) Summary No restatement of comparatives required on initial application (IFRS 7.42Q) restate retained earnings at DIA Disclose reconciliation of ending IAS 39 impairment balance to the IFRS 9 opening loss allowance Complex for financial institutions If qualify under IAS 39 might be able to continue under IFRS 9 without restarting a new hedging relationship Time value of options is to be accounted for retrospectively Page 107

DISCUSSION/QUESTIONS Page 108

Page 109 THANK YOU!!!