University of National and World Economy
CRITICAL ANALYSIS OF THE STANDARDIZED MODEL FOR RECOGNIZING IMPAIRMENTS FOR CREDIT LOSSES WITHIN THE MEANING OF IAS 39
The model for recognizing impairment of financial assets rooted in IAS 39 Financial Instruments: Recognition and Measurement – the incurred loss model led to impeding the impairment recognition over time based on the provisions for existence of objective evidence of impairment. The application of a new impairment model – the approach of expected losses (The Expected Loss Model-EL), grounded in IFRS 9 Financial instruments is a fundamental change in the rules on reporting and recognition of financial instruments impairment. It is for the first time that impairment recognition will not be dependent on the existence of identified (incurred losses), instead the commercial banks will apply a new approach, i.e. they will recognize “expected credit losses” of financial instruments.
The aim of the present research work is to make a critical analysis of the currently applicable model of financial assets impairment. This aim is a consequence of the development in the concepts and forms of measurement and management of credit risks arising from financial instruments.
A major methodological aspect for the correct understanding of the issue on the impairment of credits due to uncollectibility or deteriorated financial position of debtors is its treatment in line with the provisions of IAS 39 Financial Instruments: recognition and measurement.
Following the stipulations of the Standard, the focus falls on:
- The existence of objective evidence for impairment. If such objective evidences for impairment exist, the bank recognizes any impairment loss through the profit or loss. The approach rooted in this case - the model of the losses incurred allows the recognition of impairments solely for losses which have occurred (losses actually sustained). The recognition of impairments for presumptive losses is not permitted regardless of how probable is for them to occur, i.e. losses expected as a result of future events are not recognized.
- Discretions of bank’s governing body. The main characteristic of the standard is that it does not set any requirements for a preliminary determined revaluation rate, and it rather relied on the judgment of the banking entity itself.
- The impairment determined is subject to accounting treatment by its recognition through profit or loss (it is treated as an expense) and its amount decreases the value of the financial asset (by crediting the aggregate account for booking the respective credit) or through an allowance account.
Based on the theoretical interpretation of IAS 39 performed, in so far as it refers to impairment for credit losses, it is possible to make a rather negative assessment of the applicable model. The arguments for such an assessment are:
- The model for the recognition of financial assets impairment which is embedded in IAS 39 Financial Instruments: Recognition and Measurement – the model of „incurred loss“, might result in delaying the recognition of impairment in time. It is judged from the presumption that the holders of financial assets have an obligation only with regard to the regular monitoring of historical information, without using any other confirmed information which provides objective grounds for any expected deterioration in the quality of a financial asset.
- The use of accounting discretions of the banking entity itself gives a greater freedom in the process of recognition of impairments for credit losses. The accounting standards provide greater flexibility as when to write off a bad credit, and the decision when exactly to undertake such measures often depends on various factors such as the strategy of the parent bank or simply the postponements in the hope of „better days“.
- Non-accrual of impairments in the balance sheet for the financial assets category of loans and receivables usually results in their overestimation – the prudence concept is violated. At the same time, the concept of matching income and expenses is violated as well – impairment losses are not reported and matched with the resulting effects (income of interest on loans) within the respective reporting period. This leads to the overall distortion of the result of commercial banks’ functioning and casts some suspicion on the quality of the credit portfolio.
- Accountancy Act of Bulgaria, Promulgated, State Gazette No. 95/08.12.2015, effective 1.01.2016.
- IAS 39 Financial instruments: Recognition and Measurement. (2012). ICPA, Sofia.
- IFRS 9 Financial instruments. (2012). ICPA, Sofia.
- Regulation (ЕС) №575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms, OJ L 176.