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ABOUT M/s. STUART & HAMLYN


Stuart & Hamlyn, Chartered Accountants, is a professional audit firm registered with The
Institute of Chartered Accountants of Australia & New Zealand with worldwide offices in
USA, UAE and India.

Our operations in the UAE are based out of Dubai, Sharjah and Ras-Al Khaimah. We
offer comprehensive range of services custom made to the individual needs of our
clients.

Sincerity, commitment, confidentiality and professional ethics are the corner stones of
our success. Our focus on such values ensures our continued growth. We are fully
committed to deliver the assignments in a highly professional and efficient manner.

Our partners are well qualified and each one of them has more than two decade’s
experience in audit and related areas.

Our partners have authored or co-authored books and articles related to tax (VAT) and
finance , risk (credit risk) and related topics.

Our partners are also visiting faculty to prestigious institutes and universities in the
region and are members of select Committees.
IFRS 9
Application Guidance
Jan – 2019

By CA. Ciby Joseph


Partner – Stuart & Hamlyn
055 8862176
ciby@stuaham.com
INTRODUCTION
1. IFRS 9- IMPORTANT FOR CORPORATES
o Many assume that the IFRS 9 and the related accounting
guideline for financial instruments is applicable only for large
financial institutions and banks.
o However, this is not the case. Almost every entity that has
financial instruments or assets have to apply IFRS 9.
o Every entity that has trade receivables must think about
impairment as per IFRS 9, which is based on ‘forward looking’
information and not on ‘incurred or past’ information.

MAJOR CHANGES

o IFRS 9 replaces IAS 39. In the past, as per the requirements of IAS
39, impairment losses on financial assets were recognized only to
the extent that there was objective evidence of impairment. In
other words, a credit loss event was needed to book an
impairment loss.
o IFRS 9 introduces a new impairment model . It does not wait a
credit loss event to book impairment. It requires recognition of a
loss allowance before the credit loss is incurred. We will discuss,
more on this later.

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2. SCOPE OF IFRS 9
Reasons for replacing IAS 39
o IAS 39 is too complex, inconsistent with the way entities manage their risks
o defers the recognition of credit losses on loans and receivables until too late
o 2008 financial crisis made this a priority.
IFRS 9 in Banks
Banks and FI (Financial Assets, Instruments & Liabilities)
 Loans, Overdraft & other products with credit risk
 Equity and Embedded Securities
 Derivatives
 Impairment – General Approach
IFRS 9 in Corporate Sector
 All of the above
 Trade Receivables
 Due from related parties
 Impairment – Simplified Approach (subject to some criterion)

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3. PD, LGD & EAD
Going forward, corporates will have to calculate PD, LGD and EAD for arriving at impairment
provisions. Impairment provisions will also be known as ECL.
What is meant by PD, LGD, EAD and ECL?
 Probability of Default (PD) is an estimate of the likelihood of a default over a given time
horizon. For example, a 10% PD implies that there is a 10% probability that the trade
debtors will default.
 Loss given Default (LGD) is the amount that would be lost in the event of a default. For
example, a 30% LGD implies that if a debtor defaults only 30% of the amount outstanding
at the point of default will be lost and the remaining 70% can be recovered.
 Exposure at Default (EAD) is the expected outstanding balance of the receivable at the
time of default.
 Expected Credit Loss (ECL) = PD x LGD x EAD
Note: What constitutes a default is to be defined by the management, based on historical
experience.

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CLASSIFICATION OF FINANCIAL
ASSETS/INSTRUMENTS – IFRS 9
4. CLASSIFICATION OF FIN ASSETS & LIABILITIES
Financial asset or a financial liability has to accounted and presented in the Financial
Statements. The ways in which it can be done is dependent upon certain classification of
Financial Instruments.

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5. CLASSIFICATION : APPLICATION IN BANKS/FI

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6. SPPI TEST
SPPI – stands for Solely Payments of Principal and Interest

EXAMPLE
XYZ LLC lends $15 million to PQR LLC, for a period of 3 years. The interest rate
on the loan is based on LIBOR plus 2% on $15 million payable per annum.
The principle to be repaid after 3 years.

The rate of LIBOR is determined as the average of the LIBOR rate at the start
and end of each annual period.

Since LIBOR is fluctuating, it creates variability in the interest payments.


Except for LIBOR fluctuations, there no other features in the contractual
terms that result in any variability in the contractual cash flows.

QUESTION

Determine whether the loan’s contractual cash flows (a) fails SPPI test or (b)
meets SPPI test (Ans: b)

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7. BUSINESS MODEL TEST
The assessment of a business model is based on how key personnel
actually manage the business, rather than management's theoretical intent
for specific financial assets.
EXAMPLE
Bank ABC lends $100 million to DEF Ltd. The terms of the loan require DEF Ltd to
repay $100 million in 5 years. The management decides to sell the asset in the
secondary market, to get rid of the risk and improve the liquidity of the Bank.
The interest rate on the loan is based on LIBOR plus 3% and the interest is
payable on a quarterly basis.

QUESTION

Determine whether the loan is held to collect (a) contractual cash flows only? or
(b) contractual cash flows & sale?

(Ans: b)

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8. Financial Assets at FVTPL *
1. Financial assets that do not meet the
amortized cost criteria
2. Financial assets of nature of equity &
derivatives

Critical judgment criteria: whether the


business model is for sale in the short term ;
if so the fair value changes shall be reflected
in the P&L.

For example:
• Investing in Shares/bonds held for
trading.
• Positions in derivatives – calls and puts

FVTPL. Fair Value Through Profit or Loss


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9. FINANCIAL ASSETS AT FVOCI *
1. Available only for investments (AFS) in equity instruments that
are not held for trading.
2. For debt instruments, they shall meet the SPPI contractual
cash flow characteristics test. The entity shall hold the debt
instrument to collect contractual cash flows and not held for
trading, although the debt instrument can be sold, before
maturity.
3. In such cases, changes in the fair value of the financial
instruments designated as FVOCI shall be transferred directly
to the equity (and not profit & loss) through other
comprehensive income.

Example
• Investments in shares and bonds with a long term dimension

*FVOCI. Fair Value Through Other Comprehensive Income


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10. FINANCIAL LIABILITIES
1. Financial Liabilities at FVTPL

 Financial liabilities held for trading


 Financial liabilities from derivative positions

Examples
• A company issues a bond i.e. borrows and the bond is
trading on a stock market with intention to buy back.
• Derivatives positions, that results in a liability.

2. Financial Liabilities at Amortized Cost


 All other financial liabilities. These include trade payables
and loans.

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IMPAIRMENT OF FINANCIAL
ASSETS/INSTRUMENTS – IFRS 9
11. IMPAIRMENT
Usual financial assets/instruments covered by the impairment guideline of
IFRS 9 are as follows:

• Financial assets at amortised cost


• Financial assets (debt instruments)
• Loan commitments
• Financial guarantee contracts
• Lease receivables
• Trade receivables
• Contract assets

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12. IMPAIRMENT – FOR CORPORATES
IFRS 9 recommends two approaches to recognize the impairment of financial
assets :

General approach (mostly for banks and financial institutions)


In this case, there are 3 stages of a financial asset and the bank may recognize
the impairment loss depending on the stage of a financial asset in question.
- In the first stage, for good loans, 12 month ECL is calculated
- In the second stage, for deteriorating loans, Life Time ECL is calculated
- In the third stage, for uncollectable loans, loss allowance is calculated.
Simplified approach (mostly for corporates)
In fact this approach is not that simple. It needs to be applied for the
following:
- Trade receivables without significant financing component, and
- Contract assets under IFRS 15 without significant financing component
If there is significant financing component, then General approach to be
followed.

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13. TRADE RECEIVABLES - Impairment
• Pre – IFRS 9 : Incurred Credit Loss Model. An
incurred loss model assumes that all loans will be
repaid until evidence to the contrary (known as a
loss or trigger event) is identified. Only at that
point is the impaired loan (or portfolio of loans)
written down to a lower value.

• IFRS 9 : Expected Credit Loss (ECL)


Model. Under this model, impairment does not
wait for a ‘Credit Event’ to trigger. Based on the
history, current market conditions and macro
economic environment, the Probability of Default
of each Customer (or) Category of Customers is
calculated and provided for.

• While Incurred Loss Model was reactive, Expected


Loss Model is proactive.

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14. Expected Credit Loss Calculation - Impairment

= Probability Loss that will Potential


Expected
of defaulting be suffered exposure at
Credit
at point of in the case of the time of
Loss
time t default default
(ECL)
(PD) (LGD) (EAD)

To compute ECL, following are to be calculated:


• PD
• LGD
• EAD
PD and LGD are to be adjusted to the macro-economic variables forecast, if
necessary.

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15. Publically Available Default Rates
Standard & Poors (S&P) is one of the top three Global Credit Rating agencies.
They publish the historical default rates (i.e. PD), based on their ratings. As
evident from the table below, higher rated entities (AAA, AA etc) has lower
default probability than the relatively lower rated entities such as BB, etc.

There are a few situations, when you may use the PD by rating agencies such
as S&P, Moodys, Fitch etc.
• If the trade debtor is rated by is S&P, Moodys, Fitch etc., and the past
behaviour of the trade debtor is in line with such ratings.
• If the trade receivable or contract asset or the financial instrument is
guaranteed by a Bank or Financial Institution rated by S&P, Moodys, Fitch
etc.

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16. A/R – Impairment Steps
When applying the ‘simplified approach’ to, for example, trade receivables with
no significant financing component, a Provision Matrix can be applied.

Following are the steps to arrive at a Provision Matrix and ECL.


• Step 1 : Groupings of receivables into different categories.
• Step 2 : Develop ‘Probability of Default’ from the above data
• Step 3 : Understand the historical loss rates to arrive a LGD.
• Step 4 : Factor in forward looking macro-economic information.
• Step 5 : Calculate Provision Matrix.
• Step 6 : Calculate ECL.

 In case of collateral is available, and it has value, such collateral value shall be
netted off while arriving at the ECL i.e. expected credit loss.
 In case there is bank guarantee etc., the PD of the bank shall be substituted.
 Ideally historical data of 3-5 years to be mined and studied.

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17. Example –Provision Matrix
IFRS 9 provides the following as a sample Provision Matrix

o Each entity shall arrive its own Provision Matrix, based on the steps
mentioned earlier in this presentation.
o Naturally, aging of the trade receivable is an important factor in arriving at the
provision matrix.
o The provision rates shall be arrived at based on historical information and
data.
o The provision rates, once arrived at, shall be reviewed and monitored on a
periodical basis.

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18. WHAT WE CAN DO FOR YOU
o Do you have any doubts on IFRS 9 ?
o Please contact CA. Ciby Joseph at ciby@stuaham.com /
055-8862176 a for FREE CONSULTATION. He is an expert
on the topic and authored a book on credit risk published
by M/s. John Wiley & Sons, London, UK.

o Our offices in the UAE are as follows:

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THANK YOU

Stuart & Hamlyn is an Australia based chartered accountancy and business consulting
firm, with offices in the UAE positioned to serve you better. Working with expert team
members, you have access to our global network of professionals to help you meet the
requirements and challenges that you face every day in the business.

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