Issue 147/April 2019

IFRS Developments

Curing of a credit
impaired financial asset

What you need to know Highlights

• The IFRS IC confirmed its The IFRS Interpretations Committee (the Interpretations Committee or the IFRS IC)
received a request as to how an entity presents unrecognised interest when
previous tentative agenda
decision in March 2019 a credit-impaired financial asset (commonly referred to as a ‘Stage 3’ financial
asset) is subsequently paid in full or is no longer credit-impaired. More specifically,
• When a credit impaired asset the request asked whether an entity can present the reversal related to previously
cures, the interest that was unrecognised interest within interest revenue.
previously unrecognised should
At its March 2019 meeting, the Interpretations Committee published a final agenda
be reported as a credit to
decision concluding that an entity is required to present the difference described in
impairment expense rather
the request as a reversal of impairment losses.
than a credit to interest evenue
Background
IFRS 9 Financial Instruments 1 requires entities to calculate interest revenue on
financial assets that are not credit impaired (i.e., in stages 1 and 2) by applying the
effective interest rate (EIR) to the gross carrying amount of the asset. In contrast,
once an asset is credit impaired (i.e., in stage 3), interest revenue is calculated by
applying the EIR to the amortised cost of the financial asset, i.e., the gross amount
less the expected credit losses (ECLs). This results in a difference between:

• The interest that would be calculated by applying the EIR to the gross carrying
amount of the credit-impaired financial asset
And

• The interest revenue recognised for that asset

If a financial asset ‘cures’, so that it is transferred back to stage 2 or stage 1,
interest revenue would once again be recognised based on the gross carrying
amount. The request to the IFRS IC asked whether, following the curing of the
financial asset, an entity can present the difference as interest revenue or, instead,
it is required to present this as a reversal of impairment losses.
The Committee observed that an entity recognises the adjustment required to
bring the loss allowance to the amount required to be recognised in accordance
with IFRS 9 as a reversal of expected credit losses ECLs in profit or loss. 2 The
allowance would be reversed to zero if the asset is recovered in full. The amount
of this adjustment includes the effect of the unwinding of the discount on the loss
allowance during the period that the financial asset was credit impaired. Ultimately,
the reversal of impairment losses may exceed the impairment losses recognised in
profit or loss over the life of the asset if amounts collected exceed the expected
cash flows.

1
IFRS 9:5.4.1(b)
2
IFRS 9.5.5.8
Committee decision
At its November 2018 meeting, the Interpretations Committee tentatively
concluded that an entity is required to present the difference described in the
request as a reversal of impairment losses following the curing of a credit-impaired
financial asset. It also tentatively concluded that the existing requirements in IFRS
provide an adequate basis to conclude that an entity should recognise and present
the reversal of ECLs following the curing of a credit-impaired financial asset in the
fact pattern described in the request. Consequently, the Interpretations Committee
decided not to add this matter to its agenda.
Following the comment period, the Committee re-convened in March 2019, and
confirmed its previous tentative agenda decision.

Illustrative example

• An existing loan with an effective interest rate of 10% has become credit impaired.
Lifetime expected losses have been recognised on the loan as of 1 January Year N.

• The expected shortfall in cash flows is shown in Table 1 and remain unchanged until
31 December N+3. Discounted at the EIR this gives an ECL as at 1 January of CU59,000,
as shown in Table 1.

• For illustrative purposes, assume that the contractual cash flows (principal + accrued
interest) are fully recovered, unexpectedly, on 31 December N+3.

• For simplification purposes, interest is not accrued on unpaid interest.

Table 1: Contractual & expected cash flows in CU000

Cash flows as at 31 Dec N N+1 N+2 N+3 Total
Contractual cash flows 10 10 10 110 140
Expected cash flows 0 0 0 60 60
Expected shortfall in cash flows 10 10 10 50 80
ECL as at 1 January N (shortfall discounted at EIR) (9) (8) (8) (34) (59)

Table 2: Stage 3 accounting in CU000

Cumulative
31 December P/L effect
N N+1 N+2 N+3
Gross carrying amount: Opening 100 110 120 130
balance
Interest calculated based on 10 10 10 10
gross carrying amount
Settlement 0 0 0 (140)
Gross carrying amount: Closing 110 120 130 0
balance
ECL allowance: Opening balance (59) (65) (70) (75) (59) Initial allowance
Unwinding of discount (6) (5) (5) (5)
Reversal of ECL allowance 0 0 0 80 80 Reversal of
unused allowance
ECL allowance: Closing balance (65) (70) (75) 0 21 Impairment
expense
Amortised cost: Opening balance 41 45 50 55
Interest revenue based on the 4 5 5 5 19 Interest on the
amortised cost amortised cost
Settlement 0 0 0 (60)
Amortised cost: Closing balance 45 50 55 0 19 Interest revenue

As the loan is credit impaired, interest revenue is restricted to the amount derived
from applying the EIR to the amortised cost of the loan. The Interpretations
Committee’s decision clarifies that the reversal of the ECL allowance is recognised
in full in the impairment expense line. The impact of this on a cumulative basis
is that some of the effective interest on the gross carrying amount of the loan
(CU40,000) would not be presented as interest revenue, but rather, as a reversal
of impairment. This is the portion (CU21,000) which represents the unwinding of
discount on the ECL provision while the loan was credit impaired.
 How we see it EY | Assurance | Tax | Transactions | Advisory

While the overall profit or loss before tax figure will not be affected by About EY
the decision, the recognition of the reversal of the ECL allowance in the EY is a global leader in assurance, tax,
impairment losses line instead of interest revenue is likely to affect several transaction and advisory services. The insights
important ratios, especially for financial services entities. These would include and quality services we deliver help build trust
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better working world for our people, for our
The Interpretations Committee’s guidance could present a significant
clients and for our communities.
operational change for entities that previously recognised such reversals in
interest revenue. EY refers to the global organization and may
The Interpretations Committee decided not to add the matter to its agenda. refer to one or more of the member firms of
Therefore, for implementation purposes, entities should refer to the IASB’s Ernst & Young Global Limited, each of which is
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decisions. This publication notes that entities should be allowed sufficient does not provide services to clients. For more
time to implement such changes following publication of the decision. information about our organization, please
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