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REPARIS – A REGIONAL PROGRAM
THE ROAD TO EUROPE: PROGRAM OF ACCOUNTING REFORM AND INSTITUTIONAL STRENGTHENING (REPARIS)
The Use of IFRS for Prudential and Regulatory Purposes IAS 39 Examples Anna Czarniecka Financial Reporting Consultant [email protected]
! IAS 39.9 has 4 categories of financial assets as follows:
- Loans and receivables - Held-to maturity investments (HTM) - Financial assets ‘at fair value through profit or
loss’ (FVTPL) - Available-for-sale financial assets (AFS) - Disclose categories in balance sheet or notes
IFRS 7.8
Classification of Financial Assets
2
! Loans and receivables are measured at amortised cost
! HTM is measured at amortised cost
! FVTPL is measured at fair value
! AFS is measured at fair value
Measurement
3
! IAS 39.9 measurement at initial recognition minus repayments........using the EIR. EIR is defined as the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument....... to the net carrying amount of the financial asset or liability
! EIR calculation includes all fees and points paid or received that are an integral part of the EIR
Amortised Cost and Effective Interest Rate (EIR)
4
! Example - Fixed interest loan repayable at maturity. No fees or costs.
! At 1.1 X5 lend LCY 1,000 for 5 years at 10%
Loans and Receivables at Amortised Cost
5
Cash inflows Discounted amount
31.12 X5 100 90.91
31.12 X6 100 82.64
31.12 X7 100 75.13
31.12 X8 100 68.30
31.12 X9 1,100 683.02
Carrying amt 1.1 X5 1,000.00
! Example - Accounting entries
Dr Cr Loan at 1.1 X5 1,000 Cash 1,000 Origination of loan ----------------------------------------------------------------- Cash/debtors 100 Interest income 100 Receipt of interest
Loans and Receivables at Amortised Cost
6
! Example – Fixed interest loan repayable at maturity using EIR method of amortisation
! At 1.1 X5 lend LCY 1m for 10 years at 7% ! Origination fee charged LCY 12,500 ! Origination costs incurred LCY 25,000 ! Original EIR 6.823% - Loan Principal 1,000,000 - Origination fee charged (12,500) - Origination costs incurred 25,000 - Initial carrying amount 1,012,500
Loan at Amortised Cost
7
Cash inflows Interest income
Amor5sa5on of net fees
Carrying amount
1.1 X5 70,000 1,012,500
31.12 X5 70,000 69,083 917 1,011,588
31.12 X6 70,000 69,025 975 1,010,613
31.12 X7 70,000 68,959 1,041 1,009,572
31.12 X8 70,000 68,888 1,112 1,008,460
31.12 X9 70,000 68,812 1,188 1,007,272
Carrying Amount of Loan over Period to Maturity
8
Cash inflows Interest income
Amor5sa5on of net fees
Carrying amount
31.12 Y0 70,000 68,731 1,269 1,006,003
31.12 Y1 70,000 68,644 1,356 1,004,647
31.12 Y2 70,000 68,552 1,448 1,003,199
31.12.Y3 70,000 68,453 1,547 1,001,652
31.12 Y4 70,000 68,348 1,652 1,000,000
700,000 687,500 12,500
Repayment of loan (1,000,000)
Carrying Amount of Loan over Period to Maturity (Cont’d)
9
Accounting entries 1.1 X5 Loan account 1,000,000
Cash 1,000,000 Amount lent to borrower ------------------------------------------------------------------------- 1.1.X5 Loan account 25,000
Cash 25,000 Origination costs incurred by lender -------------------------------------------------------------------------
Loan at Amortised Cost
10
1.1.X5 Cash 12,500 Loan account 12,500
Origination Fees charged to borrower ------------------------------------------------------------------------- 31.12 X5 Debtors 70,000
Interest income account 69,083 Loan account 917
Contractual interest accrued at the due date -------------------------------------------------------------------------
Loan at Amortised Cost (Cont’d)
11
2.1 X6 Cash 70,000 Debtors 70,000
Receipt of interest payment -------------------------------------------------------------------------
Loan at Amortised Cost (Cont’d)
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! IAS 39.59 Objective evidence of impairment includes observable data about the following loss events: - Default on payments - Lender grants concession because of borrower’s financial
difficulty - Borrower’s probable bankruptcy or other financial
reorganisation - No active market for that financial asset - Decrease in estimated cash flows from a group of financial
assets indicated by observable data because of: • adverse changes in payment status; or • economic conditions that correlate with defaults on
assets within the group This is an incurred loss model
Impairment of Financial Assets at Amortised Cost
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! Financial assets carried at amortised cost ! Loans and receivables - Amount of the loss is the difference between the
carrying amount and present value of estimated future cash flows using original EIR - Loss is recognised in profit or loss - Interest is recognised on the new carrying amount
using original EIR (discount unwind) - IFRS 7.20 requires disclosure of these amounts
Impairment of Financial Assets at Amortised Cost
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! Basic example - Loan carried at LCY 100 - Collateral of 80 receivable in 1 year - EIR 10%
! Initial allowance - Discounted cash flows 80/1.1 =73 - Carrying value of loan LCY 73 - Allowance account is LCY 27 (100-73) - Interest recognised is LCY 7 (80-73) - Recover collateral of LCY 80 at end of year 1
Loan Impairment
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! IAS 39.65 allows reversal of a loss only if the decrease can be related to an event occurring after the impairment was recognised. For example, an improvement of the borrower’s credit rating.
Reversal of Impairment
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Loan principal at 1.1 X1 1,000 Interest rate 10% Term of loan 5 years At 31.12 X2 the borrower has financial difficulties. The lender agrees to accept two further payments of LCY 400 at the end of years X3 and X4
Impairment of a Fixed Rate Loan
17
Cash flows Present values • Carrying amount of loan at:
– 31.12 X2 1,000 – 31.12 X3 400 363 – 31.12 X4 400 330
• Present value of loan at 31.12 X2 693 • Amount of impairment to profit or loss at 31.12 X2 307 • Gross amount of loan 1,000
Impairment of a Fixed Rate Loan (Cont’d)
18
Interest Income on impaired loan
Cash flows Interest Carrying amount at 10%
1.1.03 693 31.12.03 400 69 362 31.12.04 400 38 -----
Impairment of a Fixed Rate Loan (Cont’d)
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Accounting entries 31.12 X2 Income statement-
credit losses 307 Allowance a/c for credit losses 307
Recognition of impairment -------------------------------------------------------------------------
------
Impairment of a Fixed Rate Loan
20
31.12 X3 Cash 400 Interest income 69 Loan account 331
Receipt of first agreed payment ------------------------------------------------------------------------- 31.12 X4 Cash 400
Interest income 38 Loan account 362
Final payment -------------------------------------------------------------------------
Impairment of a Fixed Rate Loan (Cont’d)
21
31.12 X4 Allowance account 307 Loan account 307
Loan written off -------------------------------------------------------------------------
Impairment of a Fixed Rate Loan (Cont’d)
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! Fair value is the amount at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction – IAS 39.9
Financial Instruments Measured at Fair Value
23
Example 1.1 X1 Purchase of a bond at 98 31.3 X1 Fair value of bond 96 2.4 X1 Sell bond for 95 Accounting entries 1.1 X1 Trading assets –
debt securities 98 Cash 98
Purchase of bond
Held for Trading
24
31.3 X1 Net trading profit 2 Trading assets – debt securities 2
Loss at next reporting date -------------------------------------------------------------------------
----- 2.4 X1 Cash 95
Net trading profit/loss 1 Trading assets – debt securities 96
Sale of bond
Held for Trading (Cont’d)
25
Types of AFS financial assets: ! Equity investments ! Loans and receivables - quoted - designated
! Quoted debt instruments Focus for investments quoted in an active market – should they be classified as fair value through profit or loss or designated as AFS on initial recognition
Available for Sale Financial Assets
26
! Gains or losses on AFS financial assets shall be recognised directly in equity through the statement of changes in equity – IAS 39.55 (b)
! On derecognition the cumulative gain or loss previously recognised in equity shall be recognised in profit or loss
AFS Gains and Losses
27
1.1 X5 Investment in XYZ 500 Cash 500
Acquisition of equity investment -------------------------------------------------------------------------
------ 31.12 X5 Investment in XYZ 20
Statement of changes in equity 20 Change in FV of investment at balance sheet date -------------------------------------------------------------------------
------
Accounting Entries for AFS Equity Investment
28 Anna Czarniecka – Financial ReporOng Consultant – [email protected]
30.6 X6 Cash 530 Investment on XYZ 520 Gain on sale – profit or loss 10
Sale of investment in XYZ ------------------------------------------------------------------------- 30.6X6 Statement of changes
in equity 20 Profit or loss 20
Transfer to profit or loss on sale
Accounting Entries for AFS Equity Investment (Cont’d)
29
! Any decline in fair value due to impairment is moved from equity to profit or loss
! A significant or prolonged decline in fair value of an equity investment below cost is evidence of impairment
! No reversal of impairment losses for equity investments – IAS 39.69
! Reversal allowed for debt securities if it relates to an event occurring after recognition of the impairment – IAS 39.70
AFS – Measurement of Impairment
30
AFS – Measurement of Impairment
31
Example
1.1 X5 Purchase equity investment 500 30.6 X5 FV of equity investment 490 31.12 X5 FV of equity investment 450
The decline in value is significant and falling. At 31.12 X5 impairment of 50 would be charged to profit or loss and there would be no reversal. If the fair value increased to 455 at 30.6 X6, 5 would be debited to the investment and credited to equity.
