Credit-impaired assets and interest on the net amount

Learning objectives

• Calculate the interest revenue of a credit-impaired asset (stage 3) by applying the effective interest rate to the amortised cost net of the loss allowance.L2, L3
• Record the journal entries for credit-impaired assets and interest on the net amount and measure their effect on the financial position, profit or loss and other comprehensive income.L2, L3
• Prepare a workpaper documenting credit-impaired assets and interest on the net amount.L2, L3

Normative references

• IFRS 9 §5.4.1Interest revenue: effective interest method applied to the gross carrying amount, except (a) for purchased or originated credit-impaired financial assets, to which the credit-adjusted effective interest rate is applied to the amortised cost from initial recognition, and (b) for assets that subsequently became credit-impaired, to which the effective interest rate is applied to the amortised cost (net of the loss allowance) in subsequent reporting periods. The return to the gross basis is governed by para. 5.4.2.
• IFRS 9 §5.4.2When the entity was calculating interest revenue on the amortised cost under para. 5.4.1(b), it reverts, in subsequent reporting periods, to applying the effective interest rate to the gross carrying amount if the credit risk improves so that the asset is no longer credit-impaired and the improvement can be related objectively to an event occurring after para. 5.4.1(b) was applied, such as an improvement in the borrower's credit rating.
• 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.
• IFRS 9 §B5.5.33For a financial asset that is credit-impaired at the reporting date but is not a purchased or originated credit-impaired financial asset, expected credit losses are measured as the difference between the gross carrying amount and the present value of estimated future cash flows discounted at the original effective interest rate; any adjustment is recognised in profit or loss as an impairment gain or loss.

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

4 questions

• Which statements about a credit-impaired financial asset are accurate? More than one answer is possible.L2
• Alba SA holds a credit-impaired loan (stage 3) whose gross carrying amount is {gross_amount} and whose loss allowance is {loss_allowance}. The annual effective interest rate given by the case is {effective_rate}. Calculate the net amortised cost and the interest income for the period.L3
• Cobalt SA holds a credit-impaired loan (stage 3), measured at amortised cost, whose gross carrying amount is {gross_amount} and whose loss allowance is {loss_allowance}. The annual effective interest rate given by the case is {effective_rate}. Case convention: the interest of the period is added to the carrying amount of the loan. Record the entry for the interest income of the period.L3
• Tilia SA holds a loan measured at amortised cost that became credit-impaired after origination (it was not credit-impaired at origination). Which statements are correct? Several answers are possible.L3