The International Accounting Standards Board (IASB) today published for public comment a revised set of proposals for the impairment of financial instruments. The proposals build upon previous work to develop a more forward-looking provisioning model, which recognises expected credit losses on a more timely basis.
Financial reporting requirements both internationally and in the US currently use an incurred loss model to determine when impairment is recognised on financial instruments. The incurred loss model requires that a loss event occurs before a provision can be made and was introduced to avoid the use of so-called ‘big bath’ general provisions that distorted the accurate reporting of financial performance to investors. However, during the financial crisis the incurred loss model was criticised for delaying the recognition of losses and for not reflecting accurately credit losses that were expected to occur.
Consistent with requests from the G20, the Financial Crisis Advisory Group (FCAG)1 and others, the IASB and the US Financial Accounting Standards Board (FASB) have been working jointly to develop a more forward-looking impairment model that reflects expected credit losses. The proposals published today build upon the expected credit loss model previously agreed between the IASB and the FASB, but it has been simplified to reflect feedback received from interested parties. The FASB has published separately for public comment an alternative expected credit loss model and the two sets of proposals have overlapping comment periods.
The IASB model is designed to recognise credit losses on a more timely basis. Expected credit losses are recognised on all financial instruments within the scope of the proposals from when they are originated or purchased.
Full lifetime expected credit losses are recognised when a financial instrument deteriorates significantly in credit quality. This is a significantly lower threshold than under the incurred loss model today which in practice has resulted in provisioning only when financial assets are close to default.