Impairment of Financial Assets under IFRS 9: Expected Credit Losses
On 31 December 20X5, Omega Bank has a portfolio of loans receivable with a gross carrying amount of CU10,000,000. The loans are classified at amortized cost. Omega has determined that the loans are not credit-impaired. The bank uses a provision matrix based on historical loss experience adjusted for forward-looking factors. The following information is available:
- Loans that are current (not past due): CU8,000,000, expected loss rate 0.5%
- Loans past due 1-30 days: CU1,500,000, expected loss rate 2%
- Loans past due 31-90 days: CU400,000, expected loss rate 10%
- Loans past due more than 90 days: CU100,000, expected loss rate 30% Additionally, Omega has a portfolio of debt securities measured at fair value through other comprehensive income (FVOCI) with a gross carrying amount of CU2,000,000 and a loss allowance of CU50,000 at 1 January 20X5. During 20X5, Omega purchased additional debt securities for CU500,000. At 31 December 20X5, the fair value of the debt securities is CU2,300,000. The securities are rated investment grade and there has been no significant increase in credit risk. The expected credit loss for these securities at 31 December 20X5 is estimated at CU60,000. Omega uses the general approach for impairment. Ignore tax and interest.
1. Calculate the loss allowance for the loans receivable at 31 December 20X5 using the provision matrix. Prepare the journal entry to recognize the impairment loss, assuming the opening loss allowance was CU120,000.
Read the worked answer
Under IFRS 9, for loans that are not credit-impaired, the loss allowance is measured at an amount equal to 12-month expected credit losses (Stage 1) or lifetime expected credit losses (Stage 2) if there has been a significant increase in credit risk. The provision matrix is used to estimate expected credit losses based on past due status. The loss allowance is calculated as the sum of the expected loss for each category:
- Current: 8,000,000 × 0.5% = 40,000
- Past due 1-30 days: 1,500,000 × 2% = 30,000
- Past due 31-90 days: 400,000 × 10% = 40,000
- Past due >90 days: 100,000 × 30% = 30,000 Total loss allowance = 40,000 + 30,000 + 40,000 + 30,000 = CU140,000.
Opening loss allowance = CU120,000. Increase in loss allowance = 140,000 - 120,000 = CU20,000.
Journal entry: Dr Impairment loss (P&L) 20,000 Cr Loss allowance 20,000
Note: The loss allowance is a contra-asset account. The net carrying amount of loans = 10,000,000 - 140,000 = CU9,860,000.
2. Calculate the loss allowance and the amount recognized in other comprehensive income (OCI) for the debt securities at FVOCI at 31 December 20X5. Prepare the journal entries. Assume the opening fair value of the debt securities was CU1,950,000 and the opening loss allowance was CU50,000.
Read the worked answer
For debt securities measured at FVOCI, the impairment loss is recognized in profit or loss with a corresponding amount in OCI, and the loss allowance is recognized in OCI (not as a reduction of the carrying amount). The carrying amount in the statement of financial position is fair value. The loss allowance is presented in OCI and does not reduce the carrying amount.
At 31 December 20X5, the expected credit loss is CU60,000. The opening loss allowance was CU50,000. So the increase in loss allowance is CU10,000, which is recognized as an impairment loss in profit or loss.
Journal entry: Dr Impairment loss (P&L) 10,000 Cr Loss allowance (OCI) 10,000
Additionally, the debt securities are measured at fair value. The fair value at 31 December 20X5 is CU2,300,000. The gross carrying amount is CU2,000,000 + CU500,000 = CU2,500,000? Wait: The gross carrying amount at 31 Dec 20X5 is the original CU2,000,000 plus the additional CU500,000 purchased during the year = CU2,500,000. But the fair value is CU2,300,000. So there is a fair value loss of CU200,000. However, the impairment loss of CU10,000 is part of that fair value change. Under IFRS 9, for FVOCI debt instruments, the fair value change is split: the portion attributable to credit risk (the impairment) is recognized in P&L, and the remainder is recognized in OCI. But the total fair value change is recognized in OCI, and the impairment is reclassified from OCI to P&L? Actually, the accounting is: the debt instrument is measured at fair value with changes in fair value recognized in OCI. The expected credit loss is recognized in P&L with a corresponding amount in OCI (a separate component of OCI). So the total OCI includes both the fair value change and the impairment allowance.
Let's compute the fair value change: Opening fair value was CU1,950,000. But we also purchased CU500,000 during the year. So we need to consider the purchases. The opening fair value of CU1,950,000 relates to the original securities. The additional securities were purchased for CU500,000, so at purchase date, fair value = cost = CU500,000. At year-end, the total fair value is CU2,300,000. So the fair value change for the year on the original securities is: fair value at year-end of original securities? We don't know the split. Alternatively, we can compute the total fair value change: Opening fair value + purchases - closing fair value = 1,950,000 + 500,000 - 2,300,000 = 150,000 loss. This loss is recognized in OCI. But the impairment loss of 10,000 is also recognized in OCI (as a separate component) and in P&L. So the total OCI effect is a loss of 150,000 + 10,000? No, careful: The impairment loss is recognized in P&L with a corresponding entry in OCI. So OCI is reduced by 10,000 for the impairment. The fair value change is also recognized in OCI. So total OCI loss = 150,000 (fair value change) + 10,000 (impairment allowance) = 160,000? But that would double-count because the impairment is part of the fair value change. Actually, the fair value change includes the effect of credit risk. The impairment loss is a component of the total fair value change. So the total fair value change is 150,000 loss. Of this, 10,000 is attributable to credit risk (impairment) and is recognized in P&L. The remaining 140,000 is recognized in OCI. So the journal entries would be:
To record the fair value change: Dr OCI (fair value) 150,000 Cr Debt securities (FVOCI) 150,000? But the carrying amount is fair value, so we adjust the carrying amount to fair value. The carrying amount before fair value adjustment is the gross carrying amount less loss allowance? Actually, for FVOCI debt, the carrying amount is fair value. The loss allowance is in OCI. So we need to adjust the carrying amount to fair value. The current carrying amount is the amortized cost? No, it's fair value. At 1 Jan 20X5, fair value was 1,950,000. Purchases 500,000. So before fair value adjustment, the carrying amount is 2,450,000? That would be the sum of opening fair value and purchases. But the fair value at year-end is 2,300,000, so we need a fair value loss of 150,000. So: Dr OCI 150,000 Cr Debt securities 150,000
Then, for the impairment: Dr Impairment loss (P&L) 10,000 Cr OCI (impairment allowance) 10,000
So the net OCI effect is a loss of 150,000 + 10,000 = 160,000? But that would mean OCI has a debit of 160,000, which is not correct because the impairment allowance is a credit to OCI? Actually, the entry Dr Impairment loss Cr OCI increases OCI (credit), so it offsets the debit from the fair value loss. So net OCI loss = 150,000 - 10,000 = 140,000. That makes sense: total fair value loss 150,000, of which 10,000 is recognized in P&L, so 140,000 remains in OCI.
Thus, the journal entries are: Dr OCI (fair value) 150,000 Cr Debt securities (FVOCI) 150,000
Dr Impairment loss (P&L) 10,000 Cr OCI (impairment allowance) 10,000
Alternatively, the loss allowance is presented in OCI as a separate component. The net OCI balance related to these securities would be a loss of 140,000.
Note: The loss allowance of CU60,000 is the cumulative expected credit loss. The opening was CU50,000, so the increase is CU10,000. The journal entry for the increase is as above.