In Numerology, Number 9 is known as the number of Universal Love, though in the International Financial Reporting Standards, IFRS 9 ‘Financial Instruments’ was certainly not welcomed with much love.

After the financial crisis of 2007 and 2008, the accounting standard bodies were blamed for not adequately catering the impairment provisions of financial assets. The legacy standard was blamed to only recognize the incurred loss and does not look at the events and circumstances that have occurred and will result in the impairment of financial asset. This resulted in the emergence of the new accounting standard for dealing with the complex financial instruments.

IFRS 9 – Timeline

The issuance of IFRS 9 was a lengthy process which started in July 2009 and the final standard was issued in July 2014 with effective date of period beginning on or after January 1, 2018 (i.e. almost 4 years’ time for the corporate and accounting mangers to get ready for the new accounting standard).

Key changes

Some of the key changes brought about by IFRS 9 were as follows:

• The classification categories of financial assets were changed previously we have four classifications i.e. Held to maturity, loans and receivables, fair value through profit and loss (FVTPL) and available for sale these were replaced with categories that reflect measurement, namely amortised cost, fair value through other comprehensive income (FVTOCI) and FVTPL.
• IFRS 9 bases the classification of financial assets on the contractual cash flow characteristics and the entity’s business model for managing the financial asset, whereas IAS 39 bases the classification on specific definitions for each category.
• Under IFRS 9, embedded derivatives are not separated (or bifurcated) if the host contract is an asset within the scope of the standard. Rather, the entire hybrid contract is assessed for classification and measurement. This removes the complex IAS 39 bifurcation assessment for financial asset host contracts.
• IFRS 9 introduced the concept of Expected Credit Loss method for impairment testing of financial assets. In addition to past events and current conditions, reasonable and supportable forecasts affecting collectability are also considered when determining the amount of impairment in accordance with IFRS 9.
• IAS 39 allows certain equity investments in private companies for which the fair value is not reliably determinable to be measured at cost, while under IFRS 9 all equity investments are measured at fair value

Expected Credit Loss (ECL) Model

Among the changes brought about by IFRS 9 the introduction of the ECL model was the most talked about. Under ECL method, an entity always accounts for expected credit losses and changes in those expected credit losses. In other words, an entity does not wait until a credit even has occurred before credit losses (or impairment) are recognized. This exercise of impairment testing has to be conducted at each reporting date.

There are two approaches laid down in IFRS 9 for the assessing impairment using ECL method namely, the general approach and the simplified approach.

General approach – It’s a two-step approach where the entity initially measures the expected losses that make occur in 12 months’ time. However, if the credit risk increases lifetime expected losses are to be recognized.

Simplified approach – This applies to trade receivables and contract assets within the scope of IFRS 15 and lease receivables. Under the simplified approach, the entity at all times must recognize lifetime expected credit losses rather than using the two-step process under the general approach.

How to calculate the ECL / or how to build an ECL model:

IFRS 9 provides the following guidelines on what factors should be accounted for when developing an ECL model:

1. An unbiased and probability-weighted amount that is determined by evaluating the range of possible outcomes
2. Time value of expected recovery (Cashflows)
3. All reasonable and supportable information about past events, current conditions and reasonable and supportable forecasts of future economic conditions when measuring expected credit losses

Example: (ECL calculation using valuation method). An entity has trade receivable of Rs. 100 million from a customer. The company believes that following outcomes are possible along with the expected probability weight-age.

Scenario	Description	Probability weight-age
Scenario 1	All receivable will be received within normal credit period of 60 days	60%
Scenario 2	50% payment will be received within 60 days and remaining 50% after a delay of 1 year	30%
Scenario 3	50% payment will be received after a delay of 1 year and 50% will not be recovered	10%

The relevant discount rate is 10%.

The calculation of expected credit losses will be as follows:

	Expected Cashflows	Probability Weightage Cashflow
Scenario 1	100	100 * 60% = 60
Scenario 2	50 + (50/(1 + 10%))^1 = 95.5	95.5 * 30% = 28.7
Scenario 3	50/(1+10%)^1 + 0 = 45.5	45.5 * 10% = 4.6
	Total	Rs. 93.3 million

Impairment Loss to be recognized:

Rs. 100 million – Rs. 93.3 million = Rs. 6.7 million

Alternatively, a provision matrix approach can also be used where a default rate can be applied to different age brackets of amounts receivable. For e.g. Rs. 100 million in the age bracket of 0-30 days overdue can have a default rate of 1%. ECL calculated will be Rs. 1 million.

Specific Exemption in Pakistan

In Pakistan, the companies suffering from circular debt approached Securities and Exchange Commission of Pakistan (SECP) to exempt these companies from the application of Pakistan. These companies believed that amounts receivable from Government of Pakistan (GoP) being sovereign should not be impaired, further these companies do not have any control on the settlement of these outstanding circular debt hence they should not be penalized for it.

SECP through its SRO 985(I)/2019 granted exemptions to companies holding financial assets due from the GoP, the requirements contained in IFRS 9 with respect to application of Expected Credit Loss Method till June 30, 2021. These companies will follow the relevant requirements of IAS 39 – Financial Instruments: Recognition and Measurement in respect of financial assets due from GoP.