Last update 21/08/2019
Purchased or originated financial asset(s) that are credit-impaired on initial recognition.
For purchased or originated credit-impaired financial assets it is clear for the owner that the value of these financial assets is lower than their nominal or initial value. Also it was clear the interest revenue is not the full interest promoted at initial placement. For purchased and originated credit-impaired financial assets, a ‘day 1 loss’ is not recognised. Instead interest revenue is calculated on the impaired value of the purchased or originated loan as follows:
- Lifetime expected credit losses would be included in the estimated cash flows for the purposes of calculating the effective interest rate – resulting in a credit-adjusted effective interest rate
- Interest revenue would be calculated on the net carrying amount at the credit-adjusted effective interest rate i.e. including expected credit losses
- Expected credit losses would be discounted using the credit-adjusted effective interest rate
- Any subsequent changes (favourable or unfavourable) from the initial expected credit losses would be recognised immediately in profit or loss.
Purchased credit-impaired financial assets are recorded on initial recognition at the transaction price (which is already a downgraded value) without presentation of an allowance for expected contractual cash shortfalls that are implicit in the purchase price, but disclosures are required of contractual cash shortfalls that are implicit in the purchase price.
Policies and internal procedures enable appropriate identification and accounting for purchased or originated credit-impaired lending. The cash flow estimates for these lending exposures should be reviewed each reporting period and updated as necessary. Such updates should be properly supported and documented, and approved by senior management.
A calculation example of a credit-impaired financial asset is provided here….
Definition or recognition issues in respect of credit-impaired financial asset
A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred.
Informally credit-impaired assets are also denoted Stage 3 Assets
Evidence of Impairment
Evidence that a financial asset is credit-impaired include observable data about the following events[1]:
- Significant Financial Difficulty of the issuer or the borrower
- A Breach of Contract, such as a default or Past Due event
- The lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider
- It is becoming probable that the borrower will enter Bankruptcy or other financial reorganisation
- The disappearance of an active market for that financial asset because of financial difficulties
- The purchase or origination of a financial asset at a deep discount that reflects the incurred Credit Loss
It may not be possible to identify a single discrete event—instead, the combined effect of several events may have caused financial assets to become credit-impaired.
Purchased or originated credit-impaired financial asset
Purchased or originated credit-impaired financial asset
Purchased or originated credit-impaired financial asset Purchased or originated credit-impaired financial asset Purchased or originated credit-impaired financial asset