IASB releases revised proposals on accounting for impairment of loans and other financial assets, moving to an expected loss model

KPMG press release:rnrnIASB releases revised proposals on accounting for impairment of loans and other financial assets, moving to an expected loss modelrnrnThe IASB has issued last week its revised proposals on accounting for impairment of financial assets, long-awaited especially by financial institutions. The proposals aim to address concerns about ‘too little, too late’ provisioning for loan losses and would accelerate recognition of losses by requiring provisions to cover both already-incurred losses and some losses expected in the future. rnrn“The proposals are a steep change in accounting for impairment and are expected to have a significant impact on banks and similar financial institutions” , says Șerban Toader, KPMG in Romania’s Senior Partner.rnAccounting for impairment has been hotly debated by standard setters on both sides of the Atlantic. Regrettably, the initial commitment of the IASB and the FASB to work together on joint proposals ended last year. In December 2012, the FASB issued its own proposals, which are quite different from the IASB’s. rnrnThe IASB proposals introduce a new ‘expected loss’ impairment methodology that would reflect deterioration in the credit quality of financial assets such as loan portfolios. The proposed model would require recognition of lifetime expected credit losses for financial assets whose credit risk has deteriorated significantly since initial recognition and a 12-month expected loss allowance for other financial assets. rnrnCezar Furtună, Financial Services Partner in KPMG Romania, said: “Estimating impairment is an art, rather than a science, involving difficult judgements about whether loans will be paid as due and, if not, how much will be recovered and when. The proposed model widens the scope of these judgements. It introduces a new threshold for determining whether there has been a significant deterioration in credit quality – which in turn is used to assess whether a loan should have an allowance to cover losses in the next 12 months, or to cover all expected losses over its life. These new rules would give rise to challenges for banks, as they would have to make new judgements which have to be reviewed by auditors and understood by financial statement users, including supervisory authorities.” rnrnThe new model would apply to all financial assets that are measured either at amortised cost or at fair value with gains and losses recognised in other comprehensive income, such as loans or government bonds, as well as to certain loan commitments and financial guarantees. The proposals would also introduce extensive new disclosures on impairment of financial assets. rnrnThe revised proposals are expected to have a significant impact on the Romanian banks, which apply IFRS as basis of accounting as of 1 January 2012. In addition to the financial impact, they would be likely to need additional systems in order to collect and process the information required by the new methodology. rnrnAngela Manolache (foto), Advisory Director in KPMG Romania, encouraged companies applying IFRS, in particular banks, not to delay assessing the impact of the proposals on their business: “Credit risk is at the heart of a bank’s business and the proposed model is expected to have far-reaching implications for their credit systems and processes. As a result, banks may face significant implementation issues.” Companies would also be affected, but the impact on short-term trade receivables is likely to be small. rnrnThe proposals are open for comment until 5 July 2013. The IASB will establish the effective date for the revised standard after the public comment period ends. Romanian entities which have a legal requirement to prepare financial statements in accordance with IFRS will apply the new impairment model after endorsement by the European Commission.