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IASB ditches ‘incurred loss’ model

The International Accounting Standards Board (IASB) has abandoned the “incurred loss” model for loan provisioning to create a more accurate picture of company accounts.

It has unveiled a series of amendments to IFRS 9, Financial Instruments, which introduce a more forward-looking “expected loss” approach, forcing banks to ensure their balance sheets reflect financial losses they expect to incur.

The changes will affect banks, insurance companies and users of financial statements. It will mean these financial institutions must recognise credit losses expected in the future as well as those that have already occurred.

IASB chairman Hans Hoogervorst commented: “The reforms introduced by IFRS 9 are much needed improvements to the reporting of financial instruments and are consistent with requests from the G20, the Financial Stability Board and others for a forward-looking approach to loan-loss provisioning.

“The new standard will enhance investor confidence in banks’ balance sheets and the financial system as a whole.”

IFRS 9 also introduces a “logical approach” for the classification of financial assets that will be driven by cash flow characteristics and the business model in which an asset is held.  A “single, principle-based approach” replaces the existing rule-based requirements that many see as overly complex and difficult to apply. “The new model also results in a single impairment model being applied to all financial instruments, thereby removing a source of complexity associated with previous accounting requirements,” says the IASB.

Another change see the removal of volatility in profit or loss that was caused by changes in the credit risk of liabilities elected to be measured at fair value. This accounting change  “means that gains caused by the deterioration of an entity’s own credit risk on such liabilities are no longer recognised in profit or loss”, says the standards setting body in its summary of IFRS 9.

The standard, which also introduces a substantially-reformed approach to hedge accounting, will come into effect on January 1st 2018.

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