Measurement of credit loses on credit impaired assets

Ultimate Sacco, well-governed microfinance adopted IFRS 9 at the start of 2019 to align her provisioning to best industry practices. At the time of adoption, Sacco’s loan book was performing well indicated by the few days in arrears on most clients.

By the close of the third quarter of 2019, loan performance deteriorated. The Sacco had registered many nonperforming loans. A big section of the clientele had accumulated many days in arrears, beyond 90. When the CEO asked for a report on the state of implementation of the standard, the CFO was all over the place in a panic. The provisions had surged by over 85% over the nine months into 2019.

“So, given the fact that our loan book is going bad, how do we measure impairment on such financial instruments?” asked the CEO. For financial assets that are not purchased or originated credit-impaired financial assets, but subsequently have become credit-impaired financial assets (stage 3 in the general ECL model), interest is recognized by application of original EIR to the amortized cost of the asset, i.e. after deducting ECL from the gross amount. See example 1:

Example: an asset that has become credit-impaired after initial recognition

On 1 January 2016, Ultimate Sacco lent Ugx1,000,000 to Ssenyonga, and he has to repay the loan on 31 December 2019 by paying Ugx1,400,000. There are no payments required between these dates, which gives the effective interest rate (EIR) at 10.7%. Ultimate Sacco estimates the 12-month ECL at initial recognition at Ugx200,000.

On 1 January 2019, the financial situation of Ssenyonga deteriorated significantly and Ultimate Sacco considers its loan to Ssenyonga as credit-impaired (stage 3). As of 31 December 2019 impairment, Ultimate Sacco now estimates to receive only Ugx596,398. The estimated credit loss (ECL) at the repayment date is, therefore, Ugx903,602 which, discounted using the original EIR of 10.7%, gives a present value of ECL at Ugx735,654 as of 1 January 2020. See excel format:

ifrs_9_example_credit_impaired_asset_after_initial_recognition_original_EIR.xlsx (2 downloads)
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