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International Accounting Standards Board (IASB) disclaimer

Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this webcast are those of the presenter. Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation.

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The IASB proposes a new expected credit loss model: what to expect?

The IASB proposes a new expected credit loss model


What to expect?
30 April 2013

Todays moderator

Wei Li Chan
Ernst & Young Global IFRS Financial Instruments Working Group

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The IASB proposes a new expected credit loss model: what to expect?

Todays agenda
Current

status of the IFRS 9 Financial Instruments project


requirements of the IASBs expected credit loss model with the FASBs proposals

Key

A comparison

Business

impacts and implications

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The IASB proposes a new expected credit loss model: what to expect?

Todays presenters

Sue Lloyd
IASB Senior Director Technical Activities

Steven Robb
Ernst & Young LLP (UK) Financial Accounting and Advisory Services
The IASB proposes a new expected credit loss model: what to expect?

Robert Wadley
Ernst & Young LLP (US) US National Professional Practice Group

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Page 6

Todays agenda
Current

status of the IFRS 9 Financial Instruments project


requirements of the IASBs expected credit loss model with the FASBs proposals

Key

A comparison

Business

impacts and implications

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The IASB proposes a new expected credit loss model: what to expect?

Timeline for financial instruments projects


2009 2010 IFRS 9 Financial instruments (replacement of IAS 39) Classification and measurement IFRS IFRS ED ED ED SD RD ED R R Target IFRS 2015? 2015? ? ? ? 2011 2012 2013 Q1 2013 Q2 2013 Q3 2013 Effective Q4 date

Mandatory effective date and transition disclosures


Classification and measurement (limited amendments) Impairment Comments due 5 July General hedge accounting Macro hedging

Accounting for macro hedging


Note: DP: discussion paper SD: supplementary document
Page 8

Target DP
ED: exposure draft RD: review draft IFRS: final standard

?
R: Redeliberations

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The IASB proposes a new expected credit loss model: what to expect?

Update on IFRS 9 classification and measurement limited amendments


Primary objectives

Application issues raised by constituents Interaction with the insurance contracts project Convergence with US GAAP The introduction of a mandatory fair value through other comprehensive income (FVOCI) category Minor amendments to the contractual cash flow characteristics assessment Clarification of the amortised cost business model assessment Early adoption only if the entire IFRS 9 package is applied But, early adoption of own credit provisions allowed

Key proposals

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The IASB proposes a new expected credit loss model: what to expect?

Overview and timeline of IFRS 9 impairment project


November 2009 ED Lifetime losses built into the effective interest rate January 2011 SD Good book and bad book April 2011 March 2013 ED Expected credit loss model (comments due 5 July)

Three-bucket expected loss model

IASB

FASB

IASB/ FASB

IASB/ FASB

FASB

IASB

May 2010 ED Lifetime expected losses on origination

December 2012 ED Current expected credit loss model (comments due 31 May)
The IASB proposes a new expected credit loss model: what to expect?

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Polling question 1
How much time will your entity require to implement the IASBs proposals?
A.

01 year

B.
C. D. E. F.

12 years
23 years

More than 3 years


Does not apply I do not know
Page 11 The IASB proposes a new expected credit loss model: what to expect?

2013 EYGM Limited. All Rights Reserved.

Todays agenda
Current

status of the IFRS 9 Financial Instruments project


requirements of the IASBs expected credit loss model with the FASBs proposals

Key

A comparison

Business

impacts and implications

2013 EYGM Limited. All Rights Reserved.

Page 12

The IASB proposes a new expected credit loss model: what to expect?

Scope of IASBs Expected Credit Losses ED


Debt instruments measured at amortised cost Debt instruments mandatorily measured at FVOCI Trade receivables and lease receivables Irrevocable loan commitments and financial guarantee contracts not measured at fair value through profit or loss

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The IASB proposes a new expected credit loss model: what to expect?

Summary of the expected credit loss model: general model


Initial recognition
(with exceptions) Performing Under-performing Non-performing

12-month expected Allowance: credit losses


Criterion:

Lifetime expected credit losses


The credit risk has increased significantly since initial recognition + Objective evidence of impairment

Interest revenue based on:

Gross carrying amount

Gross carrying amount

Net carrying amount

Change in credit quality since initial recognition improvement deterioration


2013 EYGM Limited. All Rights Reserved. Page 14 The IASB proposes a new expected credit loss model: what to expect?

Exceptions to the general model: simplified approach


Simplified approach for trade and lease receivables

Recognise lifetime expected credit losses on initial recognition and subsequent reporting periods Required for short-term trade receivables Policy election for long-term trade receivables and lease receivables

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The IASB proposes a new expected credit loss model: what to expect?

Low vs. high credit risk financial instruments: how would the model work?
Threshold S&P
12-mth PD* Allowance 0%

Investment grade
AA+ A
0.08%

Non-investment grade
BB
0.76%

BBB+
0.15%

BBB0.37%

B+
2.50%

B
5.46%

B8.64%

CCC/C
26.82%

D
100%

12-month

12-month or lifetime

Implementation challenges

Tracking credit risk measures from origination Developing practical absolute credit risk thresholds Mapping internal grading to external rating and/or probabilities of default (PD) Using delinquency-based approaches and the more than 30 days past due rebuttable presumption Segmenting the portfolios by shared risk characteristics
Page 16 The IASB proposes a new expected credit loss model: what to expect?

* Probabilities of default are based on S&P Global Corporate Average Cumulative Default Rates By Rating Modifier (1981-2011)
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Polling question 2
Does your entity support the operational simplification of 'investment/non-investment grade' and the rebuttable presumption of 'more than 30 days past due'?
A. B.

Yes to both
Yes to only 'investment/non-investment grade'

C.
D. E.

Yes to only 'more than 30 days past due'


No to both

Does not apply


Page 17 The IASB proposes a new expected credit loss model: what to expect?

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Exceptions to the general model: creditimpaired assets


Financial assets that are credit-impaired on initial recognition

Originated or purchased financial assets Objective evidence of impairment on initial recognition Credit-adjusted effective interest rate (EIR) No Day 1 allowance or credit losses

Allowance based on subsequent changes in lifetime expected losses


Page 18 The IASB proposes a new expected credit loss model: what to expect?

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Estimating expected credit losses (ECL)

Lifetime ECL = present value of all cash shortfalls over the remaining life of the financial instrument 12-month ECL = a portion of the lifetime ECL that is associated with the probability of a default occurring in the next 12 months after the reporting date

A probability-weighted outcome
Best available information
Information about past events
Reasonable and supportable forecasts

Information about current conditions

The time value of money


2013 EYGM Limited. All Rights Reserved. Page 19 The IASB proposes a new expected credit loss model: what to expect?

Estimating expected credit losses (ECL): implementation challenges

Defining default Determining 12-month and lifetime ECL

A probability-weighted outcome No prescribed approaches Not best estimate Best available information Past Current

Future Area of judgement Availability of data Reliability of forecasts

The time value of money Choice of discount rate


Page 20 The IASB proposes a new expected credit loss model: what to expect?

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Polling question 3
Which would be the most challenging aspect of estimating the expected credit losses?
A.

Creating lifetime estimates

B.

Determining a probability-weighted outcome


Incorporating forward looking forecasts Discounting the expected credit losses I do not know

C. D. E.

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The IASB proposes a new expected credit loss model: what to expect?

Illustrative example: PD approach


12-month ECL allowance

PD x LGD x EAD
0.15% x 25% x CU1mn = CU375
Loan

originated at CU1mn, i.e., exposure at default (EAD) 25% gross carrying amount irrecoverable if loan defaults, i.e., loss given default (LGD) 0.15% probability of a default (PD) in the next 12 months

Challenges

Correlating

PD and LGD Relying on rating agencies data Individual vs. collective assessment
Page 22 The IASB proposes a new expected credit loss model: what to expect?

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Illustrative example: provision matrix


Lifetime ECL allowance
Days past due (DPD) Carrying amount Lifetime ECL rate Lifetime ECL
Portfolio

030

3190

Over 90 CU50,000 10% CU5,000

CU800,000 CU200,000 1% CU8,000 5% CU10,000

of trade receivables categorised by common risk characteristics historical loss rates with forwardlooking estimates
The IASB proposes a new expected credit loss model: what to expect?

Challenges

Adjusting

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Disclosures
Objective: Enable users to understand an entitys estimate of expected credit losses and changes in credit risk

Reconciliation of opening and ending gross carrying amount and credit loss allowance or provision

Financial instruments measured at 12-month ECL Financial instruments measured at lifetime ECL Financial instruments with objective evidence of impairment Credit-impaired financial assets

Inputs, assumptions and techniques Collateral information Disaggregation by credit risk rating grades Modified assets Write-off policy Assets evaluated on individual basis
Page 24 The IASB proposes a new expected credit loss model: what to expect?

2013 EYGM Limited. All Rights Reserved.

Transition
Retrospective application is required; however, transition relief is proposed.

Recognise 12-month ECL if credit risk is low; otherwise, lifetime ECL are recognised If determining initial credit risk requires undue cost or effort Except when days-past-due is used as the only borrowerspecific indicator of credit quality deterioration Does not require restatement of comparatives, but permitted to do so unless this requires the use of hindsight Adjust opening retained earnings balance Does not require disclosure of the effect of IFRS 9 on prior period or IAS 39 on current period Reconciliation of IAS 39 and IAS 37 ending balances and IFRS 9 opening balance
Page 25 The IASB proposes a new expected credit loss model: what to expect?

2013 EYGM Limited. All Rights Reserved.

Todays agenda
Current

status of the IFRS 9 Financial Instruments project


requirements of the IASBs expected credit loss model comparison with the FASBs proposals impacts and implications

Key

Business

2013 EYGM Limited. All Rights Reserved.

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The IASB proposes a new expected credit loss model: what to expect?

A comparison with the FASBs proposals: similarities

Single impairment model for debt instruments, trade and lease receivables and loan commitments Change from incurred to expected credit loss model
The same information is used to estimate ECL The measurement of ECL is the same for financial instruments with lifetime ECL

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The IASB proposes a new expected credit loss model: what to expect?

A comparison with the FASBs proposals: key differences


Topic
Measurement bases Simplified approach FVOCI assets Creditimpaired assets

IASB
Dual measurement (12-month and lifetime ECL) Available for trade and lease receivables Investment grade simplifcation
Originated

FASB
Single measurement (current ECL) Not necessary Practical expedient not to recognise ECL Purchased assets with significant deterioration in credit quality since origination
Gross

or purchased assets with objective evidence of impairment allowance on initial recognition

No

Credit-adjusted

Interest income

EIR Based on gross or net carrying amount

up balance sheet with an allowance based on loss expectations at time of purchase

Based
Non

on gross carrying amount

accrual guidance

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The IASB proposes a new expected credit loss model: what to expect?

Polling question 4
Would you prefer an impairment model that is based on:
A.

12-month and lifetime dual measurement ECL approach Other dual measurement ECL approach (e.g., foreseeable future and lifetime)

B.

C.

Single measurement lifetime ECL approach


Existing incurred loss approach None of the above
Page 29 The IASB proposes a new expected credit loss model: what to expect?

D. E.

2013 EYGM Limited. All Rights Reserved.

Todays agenda
Current

status of the IFRS 9 Financial Instruments project


requirements of the IASBs expected credit loss model with the FASBs proposals

Key

A comparison

Business

impacts and implications

2013 EYGM Limited. All Rights Reserved.

Page 30

The IASB proposes a new expected credit loss model: what to expect?

How will the IASBs proposals impact entities?

More judgement and diversity of application


Estimating ECL Assessing when lifetime ECL are required


May increase the credit loss allowance or provision

Likely to result in earlier recognition of credit losses

Depends on duration and quality of financial instruments


Depends on application of the current IAS 39 model

Potential volatility due to change in estimates Cliff effect when financial instruments move between 12-month
ECL and lifetime ECL and vice versa

Modification of current credit risk management and financial reporting systems


Page 31 The IASB proposes a new expected credit loss model: what to expect?

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Next steps: what will entities need to do to implement the IASBs proposals?

Establish governance structure and senior stakeholders involvement Conduct high level impact assessment Define accounting policy and identify areas of judgement Evaluate data availability and reconcile risk and finance data and information sources Examine IT dependencies Leverage existing models (Group vs. legal entities) Assess existing impairment model(s) and develop and validate new impairment model(s) Determine disclosure requirements Consider dependencies with other Groups projects and impacts on capital and budgets Think about communications to users
Page 32 The IASB proposes a new expected credit loss model: what to expect?

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Recap

Oneminute recap
2013 EYGM Limited. All Rights Reserved. Page 33 The IASB proposes a new expected credit loss model: what to expect?

Resources

IFRS Development, Issue 54 (March 2013): IASB proposes new expected credit loss model www.ey.com/ifrs Applying IFRS IFRS Outlook IFRS Practical Matters Core Tools

Good Group Illustrative Financial Statements International GAAP Disclosure Checklist IFRS Update

EY International GAAP IFRS Q&As (internal only)


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The IASB proposes a new expected credit loss model


What to expect?
Tuesday, 30 April 2013

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The IASB proposes a new expected credit loss model: what to expect?

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The IASB proposes a new expected credit loss model: what to expect?

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