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Understanding the basics of IFRS 9; Financial instruments



What is it?

  • IFRS 9 is an International financial reporting standard published by the International Accounting Standards Board (IASB) to address the accounting of financial instruments. It covers 3 areas;
  1. Classification and measurement of financial instruments
  2. Impairment of financial assets and,
  3. Hedge accounting.
  • It came into effect in January 1, 2018 to replace IAS 39 (Financial Instruments – Recognition and Measurement).

A game changer

  • Due to its complex requirement of the impairment model, the standard has been recognized as a very big change in accounting especially for financial institutions.
  • Unlike IAS 39 which was criticized for too complex, inconsistent in risk management and nonrecognition of credit losses until evidence of impairment, the standard introduces the concept of expected credit loss accounting, requiring institutions to predict the future loss of all assets at the point of booking/origination or purchase, and set aside provisions for those assets.
  • The standard assumes a 3-stage impairment model as shown below;
  1.  Stage 1 Assets – These are assets that are performing normally as expected hence no credit deterioration. The standard prescribes a 12-month expected credit loss provisions (losses associated with possibilities that the assets will default in the next 12 months)
  2. Stage 2 assets – Assets whose credit risk has significantly increased since origination and a life time credit loss provision (losses associated with possibilities that the assets will default in their life time).
  3. Stage 3 are assets which have had evidence of impairment and a life time credit loss provisions are required.

Requirements of IFRS 9 Impairment Model;

While the standard doesn’t prescribe a specific method on how to perform the credit risk modelling, it requires a certain level of sophistication whereby institutions will have to determine what methodologies they will use and how advanced the same will be. Institutions will also select macroeconomic factors that are relevant to them at the time of reporting/credit risk assessment.  Some of the requirements of the model are;

  • Forward looking information used must be reasonable and supportable
  • Information must be unbiased
  • Must have different forward-looking scenarios
  • Must be discounted

Myths & Challenges experienced on implementation of IFRS 9

  • Getting the right pieces of information and ensuring that it is compliant with IFRS 9 requirements
  • Building the model is intense
  • Putting an appropriate governance structure in place etc.
  • How many forward-looking scenarios? – the standard requires that the institution calculates different scenarios of the expected credit loss out of the forward-looking information. It however doesn’t specify the number of scenarios to be performed.
  • Key judgement on significant increase in credit risk is a relative test and not an absolute test

What does it benefit a company to adopt and implement IFRS 9?

While IFRS 9 has a direct and quantifiable impact on impairments and provisions into the P&L, it has an indirect but material impact on a wide range of factors contributing to shareholder value. The benefits are:

  • Reduced P&L volatility
  • Enhanced risk management toolbox
  • Competitive advantage
  • Revenue growth etc.
  • Increase liquidity

Join us on 20th to 22nd July at Enashipai Resort & Spa (Naivasha) as we unravel the various myths surrounding the standard and introduce you to our tailored IFRS 9 Impairment solution through the streamlining and automation of processes that combine finance and risk management into one single IFRS 9 Solution covering;

  • Segmentation
  • Expected Credit Loss Calculation
  • Disclosures
  • Stage Accounting

For Comprehensive coverage of the same feel free to reach us.