REPARIS A REGIONAL PROGRAM The Use of IFRS for Prudential and Regulatory Purposes IAS 39 Examples Anna Czarniecka Financial Reporting Consultant annaczarniecka@tiscali.co.uk THE ROAD TO EUROPE: PROGRAM OF ACCOUNTING REFORM AND INSTITUTIONAL STRENGTHENING (REPARIS)
Classification of Financial Assets! 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 2
Measurement! 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 3
Amortised Cost and Effective Interest Rate (EIR)! 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 4
Loans and Receivables at Amortised Cost! Example - Fixed interest loan repayable at maturity. No fees or costs.! At 1.1 X5 lend LCY 1,000 for 5 years at 10% 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 5
Loans and Receivables at Amortised Cost! Example - Accounting entries Dr Loan at 1.1 X5 1,000 Cash 1,000 Origination of loan Cr ----------------------------------------------------------------- Cash/debtors 100 Interest income 100 Receipt of interest 6
Loan at Amortised Cost! 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 7
Carrying Amount of Loan over Period to Maturity 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 8
Carrying Amount of Loan over Period to Maturity (Cont d) 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) 9
Loan at Amortised Cost 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 ------------------------------------------------------------------------- 10
Loan at Amortised Cost (Cont d) 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 ------------------------------------------------------------------------- 11
Loan at Amortised Cost (Cont d) 2.1 X6 Cash 70,000 Debtors 70,000 Receipt of interest payment ------------------------------------------------------------------------- 12
Impairment of Financial Assets at Amortised Cost! 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 13
Impairment of Financial Assets at Amortised Cost! 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 14
Loan Impairment! 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 15
Reversal of Impairment! 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. 16
Impairment of a Fixed Rate Loan 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 17
Impairment of a Fixed Rate Loan (Cont d) Carrying amount of loan at: 31.12 X2 1,000 31.12 X3 400 363 31.12 X4 400 330 Cash flows Present values 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 18
Impairment of a Fixed Rate Loan (Cont d) 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 ----- 19
Impairment of a Fixed Rate Loan Accounting entries 31.12 X2 Income statement- credit losses 307 Allowance a/c for credit losses 307 Recognition of impairment ------------------------------------------------------------------------- ------ 20
Impairment of a Fixed Rate Loan (Cont d) 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 ------------------------------------------------------------------------- 21
Impairment of a Fixed Rate Loan (Cont d) 31.12 X4 Allowance account 307 Loan account 307 Loan written off ------------------------------------------------------------------------- 22
Financial Instruments Measured at Fair Value! 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 23
Held for Trading 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 24
Held for Trading (Cont d) 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 25
Available for Sale Financial Assets 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 26
AFS Gains and Losses! 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 27
Accounting Entries for AFS Equity Investment 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 ------------------------------------------------------------------------- ------ Anna Czarniecka Financial ReporOng Consultant annaczarniecka@oscali.co.uk 28
Accounting Entries for AFS Equity Investment (Cont d) 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 29
AFS Measurement of Impairment! 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 30
AFS Measurement of Impairment 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. 31