At the 2009 G20 summit, world leaders declared that the financial reporting process needed improvements. IAS 39, which came into effect in January 2001, has been widely considered an ‘unfriendly’ standard, due to its complexities and internal inconsistencies. Thus, the International Accounting Standards Board (IASB) decided to significantly accelerate its project to replace this standard. However, replacing IAS 39 has not been an easy task. The IASB divided this project into phases and published various versions of IFRS 9, introducing new classification and measurement requirements (in 2009 and 2010) and a new hedge accounting model (in 2013).
Upon a comparative analysis with IAS 39, we observe that IFRS 9 has adopted:
- A logical principle-based approach towards financial instruments classification and measurement, and removed the restrictive reclassification rules that were mentioned in IAS 39.
- A single forward-looking expected credit loss model applicable to all types of financial instruments that are subject to impairment accounting.
- An improved hedge accounting model to better link the economics of risk management with its accounting treatment.
The new impairment model will have a high impact on banks and financial institutions.
- Now, financial organizations will be required to recognize not only credit losses that have already occurred, but also the ones that are expected in the future, in order to ensure they are appropriately capitalized for the loans they have written Based on our understanding of provisioning for Non-Performing Assets, with our existing banking customers, it can be estimated that implementation of the expected loss model would increase loan loss provision by almost up to 50% percent for banks and financial institutions.
- The new model may introduce a greater degree of subjectivity because it is more forward looking. Banks and financial institutions could have different valuations of collateral and treat trigger events that result in an expected loss differently. This indicates that provisions for bad debts may increase, and will likely be more volatile.
When compared to the restrictive hedge accounting requirements under IAS 39, the new IFRS 9 hedge accounting model will allow entities to better reflect their risk management activities in their financial statements. This model will also enable investors and other stakeholders understand the risks that an entity faces, the action that the management takes to manage those risks, and the effectiveness of those risk management strategies.
Read the detailed white paper on our analysis on the requirements of IFRS 9, in comparison to IAS 39.