The International Accounting Standards Board (IASB) released a standard for financial instruments, including a single, forward-looking ‘expected loss’ impairment model. In a private fund context, the accounting rules are used when reporting expected losses incurred by a LP failing to pay a capital call notice or when writing down the value of a portfolio company debt investment, among other areas.
The package of reforms in IFRS 9 “Financial Instruments” addresses the delayed recognition of credit losses on loans (and other financial instruments) which had been criticized by accountants.
The new standard requires a portion of the expected credit losses to be reported every period until “significant credit deterioration” has occurred, at which time the full estimate of expected losses would need to be reported.
The IASB was unable to reach an agreement with the US standard setter, the Financial Accounting Standards Board (FASB), on how to address credit losses in accounting standards as the two boards had planned under the 2002 Norwalk Agreement.
“Work on IFRS 9 was accelerated in response to the financial crisis,” said the IASB in a project summary. “Although every effort has been made to come to a converged solution, ultimately these efforts have been unsuccessful. Throughout the lifecycle of the project the IASB has consulted widely with constituents and stakeholders on the development of the new standard.”
FASB is currently working on its own financial instruments standard which is expected to be complete by end of year. FASB’s model would require companies estimate expected losses on loans and other financial assets based on past events, current conditions and forecasts. The updated loss estimate would be neither a “worst case” nor a “best case” scenario, but what contractual cash flows management does not expect to collect. The estimate would also factor in changes in the credit risk of assets held by the organization. Any loss, or gain, would then need to be reported every period.
The new IASB standard will take effect on January 1, 2018.