Credit loss, expected credit loss and credit-impaired asset

Learning objectives

• Distinguish a credit loss, 12-month and lifetime expected credit losses, and a credit-impaired financial asset.L1, L2

Normative references

• IFRS 9 §B5.4.7An asset may be credit-impaired on initial recognition because its credit risk is very high (and, for a purchase, it was acquired at a deep discount); the initial expected credit losses are then included in the estimated cash flows used for the credit-adjusted effective interest rate. A high credit risk at initial recognition does not, on its own, justify applying that adjusted rate.
• IFRS 9Appendix A (credit risk terms): a financial asset is credit-impaired when one or more events that have a detrimental impact on its estimated future cash flows have occurred, the definition citing observable data (significant financial difficulty, a breach of contract such as a default or past due event, a concession, probable bankruptcy, disappearance of an active market, purchase at a deep discount); a credit loss is the difference, discounted at the original effective interest rate, between the contractual cash flows due and the cash flows that the entity expects to receive; expected credit losses are the weighted average of credit losses with the respective risks of a default occurring as the weights; 12-month expected credit losses are the portion of lifetime expected credit losses resulting from default events possible within the 12 months after the reporting date. Appendix A does not define default: para. B5.5.37 refers to the entity's internal definition, with a rebuttable presumption that default occurs no later than when a financial asset is 90 days past due.
• IFRS 9 §B5.5.37In assessing the risk of a default, the entity applies a definition of default that is consistent with the definition used for internal credit risk management purposes for the relevant instrument and considers qualitative indicators (for example, financial covenants) when appropriate; there is a rebuttable presumption that default does not occur later than when a financial asset is 90 days past due, unless the entity has reasonable and supportable information to demonstrate that a more lagging default criterion is more appropriate; the definition is applied consistently to all instruments unless information shows that another definition is more appropriate for a particular instrument.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

3 questions

• A financial asset acquired with a high credit risk is, for that reason, a credit-impaired financial asset.L1
• According to the defined terms of IFRS 9, what does the 12-month expected credit loss represent?L1
• An employee summarises in a memo the credit risk terms defined by IFRS 9. Which of these sentences is wrong?L2