THE KOSOVO BANKER | JULY 2017 EXPERTS CORNER 12 IFRS 9 & KEY CHANGES WITH IAS 39 Ms. ARTA LIMANI Mr. ARIAN META SENIOR MANAGER MANAGER DELOITTE KOSOVA DELOITTE KOSOVA SH.P.K. SH.P.K. The introduction of new requirements strong governance and internal controls to in IFRS 9 Financial Instruments will be a give all stakeholders confidence in resulting significant change to the financial reporting financial information. For many banks, the of banks. It will impact many stakeholders adoption of expected credit loss accounting including investors, regulators, analysts and will be the most momentous accounting auditors. Given the importance of banks in change they have experienced, even more the global capital markets and the wider significant than their transition to IFRSs. economy, the effective implementation of the new standard has the potential to The key changes between IFRS 9 and IAS benefit many. Conversely, a low-quality 39 are summarized below. implementation based on approaches that are not fit for purpose has the risk of undermining confidence in the financial Changes in Scope results of the banks. t Financial instruments that are in the The International Accounting Standards scope of IAS 39 are also in the scope Board (IASB) published the final version of of IFRS 9. However, in accordance with IFRS 9 Financial Instruments in July 2014. IFRS 9, an entity can designate certain IFRS 9 replaces IAS 39 Financial Instruments: instruments subject to the own-use Recognition and Measurement, and is exception at fair value through profit or effective for annual periods beginning on loss (FVTPL); hence, IFRS 9 will apply to or after January 1, 2018. Earlier application these instruments. is permitted. The new standard aims t The IFRS 9 impairment requirements to simplify the accounting for financial apply to all loan commitments and instruments and address perceived contract assets in the scope of IFRS 15 deficiencies which were highlighted by the Revenue from Contracts with Customers. recent financial crisis. Time is running out. Banks that report under Changes in Classification and IFRSs must apply IFRS 9 Financial Instruments Measurement in their 2018 financial statements. To be ready, banks must complete a large multi- t The classification categories for disciplinary project combining the skills of financial assets under IAS 39 of held to finance, risk and IT. The project will require maturity, loans and receivables, FVTPL, 13 EXPERTS CORNER THE KOSOVO BANKER | JULY 2017 and available-for-sale determine their FVTPL. In such instances, IFRS 9 requires measurement. These are replaced in the recognition of all changes in fair IFRS 9 with categories that reflect the value in profit or loss. measurement, namely amortized cost, t Reclassification of financial assets fair value through other comprehensive under IFRS 9 is required only when income (FVOCI) and FVTPL. an entity changes its business model t IFRS 9 bases the classification of financial for managing financial assets and is assets on the contractual cash flow prohibited for financial liabilities; hence, characteristics and the entity’s business reclassifications are expected to be vary model for managing the financial asset, rare. whereas IAS 39 bases the classification on specific definitions for each Impairment category. Overall, the IFRS 9 financial asset classification requirements are t IFRS 9 applies a single impairment model considered more principle based than to all financial instruments subject to under IAS 39. impairment testing while IAS 39 has t Under IFRS 9, embedded derivatives are different models for different financial not separated (or bifurcated) if the host instruments. Impairment losses are contract is an asset within the scope of recognized on initial recognition, and at the standard. Rather, the entire hybrid each subsequent reporting period, even contract is assessed for classification if the loss has not yet been incurred. and measurement. This removes the t In addition to past events and current complex IAS 39 bifurcation assessment conditions, reasonable and supportable for financial asset host contracts. forecasts affecting collectability are t Under IAS 39, derivative financial also considered when determining the assets/liabilities that are linked to, amount of impairment in accordance and settled by, delivery of unquoted with IFRS 9 equity instruments, and whose fair value cannot be reliably determined The impairment requirements under IFRS 9 are required to be measured at cost. are significantly different from those under IFRS 9 removes this cost exception for IAS 39. The followings highlights the key derivative financial assets/liabilities; differences between the two standards. therefore, all derivative liabilities will be measured at FVTPL. t IAS 39 allows certain equity investments IAS 39 Incurred Loss Model in private companies for which the fair value is not reliably determinable to be t Delays the recognition of credit losses measured at cost, while under IFRS 9 all until there is objective evidence of equity investments are measured at fair impairment. value t Only past events and current conditions t For certain financial liabilities designated are considered when determining the at FVTPL under IFRS 9, changes in the amount of impairment (i.e., the effects fair value that relate to an entity’s of future credit loss events cannot own credit risk are recognized in other be considered, even when they are comprehensive income (OCI) while expected). the remaining change in fair value is t Different impairment models for recognized in profit or loss. Exceptions to different financial instruments subject this recognition principle include when to impairment testing, including equity this treatment creates, or enlarges, an investments classified as available-for- accounting mismatch and also does not sale. apply to loan commitments or financial guarantee contracts designated as THE KOSOVO BANKER | JULY 2017 EXPERTS CORNER 14 IFRS 9 Expected Credit Loss Model What are ‘credit losses’? t Expected credit losses (ECLs) are Credit losses are defined as the difference recognized at each reporting period, between all the contractual cash flows that even if no actual loss events have taken are due to an entity and the cash flows place. that it actually expects to receive (‘cash t In addition to past events and current shortfalls’). This difference is discounted conditions, reasonable and supportable at the original effective interest rate (or forward-looking information that is credit-adjusted effective interest rate for available without undue cost or effort is purchased or originated credit-impaired considered in determining impairment. financial assets). t The model will be applied to all financial instruments subject to impairment testing. What are ‘12-month expected credit losses’? t 12-month expected credit losses are a The general (or three-stage) portion of the lifetime expected credit impairment approach losses t they are calculated by multiplying the IFRS 9’s general approach to recognizing probability of a default occurring on the impairment is based on a three-stage instrument in the next 12 months by the process which is intended to reflect the total (lifetime) expected credit losses deterioration in credit quality of a financial that would result from that default instrument. t they are not the expected cash shortfalls over the next 12 months. t Stage 1 covers instruments that have not deteriorated significantly in credit They are also not the credit losses on quality since initial recognition or financial instruments that are forecast to (where the optional low credit risk actually default in the next 12 months. simplification is applied) that have low credit risk t Stage 2 covers financial instruments What are ‘lifetime expected credit that have deteriorated significantly in losses’? credit quality since initial recognition (unless the low credit risk simplification Lifetime expected credit losses are the has been applied and is relevant) but expected shortfalls in contractual cash that do not have objective evidence of a flows, taking into account the potential for credit loss event default at any point during the life of the t Stage 3 covers financial assets that have financial instrument. objective evidence of impairment at the reporting date. IFRS 9 draws a distinction between financial instruments that have not deteriorated 12-month expected credit losses are significantly in credit quality since initial recognized in stage 1, while lifetime recognition and those that have. ‘12-month expected credit losses are recognized in expected credit losses’ are recognized for stages 2 and 3. the first of these two categories. ‘Lifetime expected credit losses’ are recognized for the second category. Measurement of the expected credit losses is determined by a probability-weighted estimate of credit losses over the expected life of the 15 EXPERTS CORNER THE KOSOVO BANKER | JULY 2017 financial instrument. An asset moves from about its credit risk, it may not be possible 12-month expected credit losses to lifetime to identify significant changes in credit expected credit losses when there has risk at individual instrument level before been a significant deterioration in credit the financial instrument becomes past quality since initial recognition. Hence the due. It may therefore be necessary to ‘boundary’ between 12-month and lifetime assess significant increases in credit risk losses is based on the change in credit risk on a collective