IFRS 9 Financial Instruments (IFRS 9) introduces major accounting changes for financial assets that are likely to significantly impact the financial statements of credit unions and other lending organizations, such as leasing companies. This article focuses on classification and measurement – including impairment loss provisions – of credit union financial assets. Other significant changes that may impact credit unions (such as the simplification of hedge accounting) are not covered in this article.
Classification of loan to members, term deposit investment, derivative and equity investments
There is now a single classification and measurement approach for all financial assets. A credit union classifies financial assets as subsequently measured at amortized cost, fair value through other comprehensive income (FVTOCI) or fair value through profit or loss (FVTPL) on the basis of both:
- the entity's business model for managing the financial assets and
- the contractual cash flow characteristics of the financial asset
Credit unions will need to perform an analysis of both tests to determine whether they can continue to account for financial assets using the basis currently used (i.e. loans to members at amortized cost). In general, lending by credit unions would be expected to meet the contractual cash flows test, which looks at whether the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal or interest (SPPI). The cash flows received would generally be in the form of principal and interest repayments.
The business model test looks at whether the business objectives are to hold in order to collect contractual cash flows only or to hold in order to collect and sell. If they are held to collect only, a Credit Union would classify member loans and other investments at amortized cost. If they are held to collect and for sale, a Credit Union would classify using FVTOCI. In certain situations, IFRS 9 also permits an election to classify as FVTPL.
Derivatives (futures, options, etc.) and equity instruments will always fail the SPPI test. As a result, all derivatives will be classified as FVTPL. However, for equity investments, a credit union will also need to consider the business model for managing the investment. If the equity investments are held for trading, the instruments are classified and presented as FVTPL, the same as they are under IAS 39. However, if they are not held for trading, the entity has an option to use FVTPL or to elect FVTOCI. This is an irrevocable election.
Note that the accounting for instruments at FVTOCI is not the same as accounting for available sale investments (AFS) under IAS 39. FVTOCI classification does not permit recycling into P&L of any unrealized or realized gains and losses. In addition, IFRS 9 also removed the exemption to recognize equity instruments that do not have a quoted market price in an active market at cost. Credit unions with equity investments that are currently carried at cost (such as Central 1 shares) will need to consider how to classify and measure these equity investments.
Impairment
IFRS 9 introduces a forward-looking expected credit loss impairment model. This is a change from the incurred loss model under IAS 39. For example, under IAS 39, a credit union is looking at the probability that a counterparty has defaulted. In applying IFRS 9, a credit union is looking at the probability that a counterparty will default.
There are three stages to consider (excluding purchased or originated credit impaired instruments):
- Stage 1 - If a financial asset is subject to low credit risk at the reporting date, an amount equal to 12 month expected losses would be recognized.
- Stage 2 - If the credit risk increases significantly from initial recognition, an amount equal to lifetime expected credit losses would be recognized. Interest revenue would be on the gross basis.
- Stage 3 - If the financial asset meets the credit impaired definition, an amount equal to lifetime expected credit losses would be recognized and interest revenue would be on the net basis, rather than on the gross amount.
Credit unions will be faced with challenges in implementing this new impairment model. These include, but are not limited to:
- How to measure or estimate expected
credit losses
- The best available information (historical or forecasts).
- Probability-weighted estimate of cash flows based on a range of possible outcomes from the possibility that a credit loss occurs to the possibility that no credit loss occurs.
- How to define a "significant
increase in credit risk"
- Credit unions may look to apply a default definition that is consistent with internal credit risk management purposes and takes into account qualitative indicators of default when appropriate. Regardless of the way in which a credit union assesses significant increases in credit risk, there is a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due, causing the financial asset to transfer into stage 2 of the impairment model. However, a credit union can rebut this presumption if it has reasonable and supportable information available, without undue cost or effort, that demonstrates that the credit risk has not increased significantly since initial recognition even though the contractual payments are more than 30 days past due.
- What is the impact, if any, of credit enhancements such as CMHC insurance on credit risk and expected loss measurement?
- Are systems in place to track movements in credit risk?
- How are changes in forward looking information determined/managed?
IFRS9 is effective for annual periods beginning on or after January 1, 2018. To determine the best approach to implementing IFRS 9 for your credit union, consult with your local Collins Barrow advisor for assistance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
