BDO recently issued an update regarding AASB 9 Financial Instruments, which is effective for years beginning on or after 1 January, 2018.
BDO partner Aletta Boshoff said AASB 9 fundamentally shifts the approach entities must take when analysing loans for impairment.
It also changes how that impairment is measured by shifting from an ‘incurred loss’ model under AASB 139 to an expected credit loss (ECL) model under AASB 9.
“AASB 9 Financial Instruments is making waves across the financial sector, with particular impact on entities with significant loan portfolios, such as credit unions, banks and private lenders, like mortgage investment companies and schemes,” Ms Boshoff said.
“The ECL model requires entities to estimate future losses on loans, regardless of whether a loss event has occurred. This is inherently complex in that it requires entities to make estimates concerning future, uncertain events.”
Ms Boshoff said there a five processes and system issues that entities must address to successfully adopt an ECL model of impairment to be compliant under the new standard.
Firstly, Ms Boshoff said entities need to ensure historical data is up-to-date.
“Many entities may start measuring ECL using historical data as a starting point, and then updating them with forward-looking information. As the saying goes, the best predictor of future behaviour is past behaviour,” she said.
Secondly, Ms Boshoff explained that a fundamental difference between AASB 139 and AASB 9 is the requirement to make estimations of future losses, despite the triggering event leading to those losses not necessarily having occurred yet.
“Forecasts of future events are inherently uncertain, and will require entities to develop methodology that complies with the requirements of AASB 9,” she said.
“Even if an entity starts estimating ECL based on historical data, these figures have to incorporate estimates of future events that impact ECL.”
The third point Ms Boshoff raised is the need to segment and stratify the entities’ loan portfolio accurately.
“In order to make the measurement of ECL meaningful, the data used to calculate it needs to be segmented in such a way that groups of loans that share common risk characteristics are analysed together,” Ms Boshoff said.
“Segmentation to an appropriate level of granularity is key when incorporating forward-looking information, as using too heterogeneous a population would not provide ECL that is responsive to particular risks.”
The fourth point Ms Boshoff made was that once an entity becomes compliant with the ECL methodology under AASB 9, ongoing monitoring is required.
“Data must continue to be validated, especially when systems are updated or new products are introduced, or the sensitivity to risks changes.”
Lastly Ms Boshoff said that more cross-department collaboration will be required for AAASB 9 compared to past accounting standards.
“The adoption of AASB 9 is likely to have a more significant impact on ongoing processes and systems,” she said.
“Even if the financial reporting department is driving the process, a significant component of its work effort will be in managing the change process for the IT and credit departments, as all parties work towards a common goal of compliance, as well as improving overall credit risk management.”
ASIC recently issued a harsh reminder about AASB 9 Financial Instruments, AASB 15 Revenue from Contracts with Customers and AASB 16 Leases, which will all significantly affect the reporting of revenue, the values of financial instruments, loan loss provisions and the impact of lease arrangements.