Public Benefit Entities: Impairment of financial assets under PBE IPSAS 41
In the February 2021 edition of Accounting Alert we noted that public benefit entities face substantial changes to accounting for financial instruments, due to PBE IPSAS 41 Financial Instruments (“PBE IPSAS 41”) replacing PBE IPSAS 29 Financial Instruments: Recognition and Measurement (“PBE IPSAS 29”) for financial reporting periods beginning on or after 1 January 2022.
In the March 2021 edition of Accounting Alert and the April 2021 edition of Accounting Alert we discussed various aspects of the classification of financial assets under PBE IPSAS 41 and in the May 2021 edition of Accounting Alert we examined the measurement of financial assets under PBE IPSAS 41.
In this edition of Accounting Alert, we turn our attention to the impairment of financial assets under PBE IPSAS 41.
Impairment of financial assets
One of the major changes introduced by PBE IPSAS 41 relates to the impairment of financial assets.
Currently, the incurred loss impairment model for financial assets under PBE IPSAS 29 recognises impairment losses on financial assets only when there is objective evidence of impairment as a result of a past event that occurred subsequent to the initial recognition of the financial asset.
In contrast, PBE IPSAS 41 uses an expected loss model to determine the impairment of financial assets.
The PBE IPSAS 41 expected loss model is a three stage model that recognises impairment based on whether there has been a significant deterioration in the credit risk of a financial asset. The stage that the asset is in determines the amount of impairment to be recognised (as well as the amount of interest revenue).
Under PBE IPSAS 41, at each reporting date the three stage approach to impairment is applied as follows:
| Stage | Impairment | Interest Revenue |
| One: Credit risk has not increased significantly since initial recognition |
Recognise 12 month expected credit losses | Calculated based on the gross amount of the asset (i.e. before credit losses are taken into account) |
| Two: Credit risk has increased significantly since initial recognition |
Recognise lifetime expected losses | Calculated based on the gross amount of the asset (i.e. before credit losses are taken into account) |
| Three: There is objective evidence of impairment as at the reporting date |
Recognise lifetime expected losses | Based on the net amount of the asset (i.e. after credit losses are taken into account) |
The recognition pattern for impairment and interest is thus:
| Stage | 1 | 2 | 3 |
| Impairment recognition: | 12 month expected credit loss | Lifetime expected credit loss | |
| Interest recognition: | On the gross (i.e. unimpaired) amount | On the net (i.e. impaired) amount | |
Example
As an example, Entity A lends $100 to Entity Z for five years at 10% interest; the loan is unsecured.
At the end of:
- Year one, there is 0.5% probability of the loan defaulting in the next 12 months with a 100% loss
- Year two, Entity Z is expected to have cash flow problems due to a deterioration in economic conditions and is expected to breach its loan covenants; the probability that the loan will default over the remaining life of the loan is 35%
- Year three, Entity Z breaches its banking covenants; Entity A estimates that the probability that the loan will default over the remaining life of the loan is 60%.
The following table shows Entity A’s calculation of impairment and interest revenue on the loan, and the impairment journal entries, at the end of each of the first three years of the loan period:
| Period | Stage | Impairment | Impairment journal entry | Interest |
| End of year 1: | Stage one | $0.50 ($100 x 0.5%) |
Dr Profit or loss $0.50 Cr Impairment allowance $0.50 |
$10 ($100 x 10%) |
| End of year 2: | Stage two | $35 ($100 x 35%) |
Dr Profit or loss $34.50 Cr Impairment allowance $34.50 |
$10 ($100 x 10%) |
| End of year 3: | Stage three | $60 ($100 x 60%) |
Dr Profit or loss $25 Cr Impairment allowance $25 |
$4 ([$100 - $60] x 10%) |
Different requirements apply to receivables
There is one exception to the PBE IPSAS 41 requirement to apply the three stage impairment model outlined above.
That exception relates to receivables that result from exchange transactions within the scope of PBE IPSAS 9 Revenue from Exchange Transactions and non-exchange transactions within the scope of PBE IPSAS 23 Revenue from Non-Exchange Transactions, the loss allowance for which is required to be measured at an amount equal to lifetime expected credit losses. Lifetime expected credit losses are the present value of expected credit losses that arise if a borrower defaults on its obligation at any point throughout the term.
To determine the impairment to recognise, receivables are grouped based on their due status or other attributes (e.g. geographical location, counterparty credit rating etc). Impairment losses are calculated based on a weighted average of expected credit losses, with the weightings being based on the respective probabilities of default – these probabilities must reflect both historical and forecast credit conditions.
The table below sets out the impairment of a receivables portfolio of $30 million:
| Due status | Expected default rate | Gross carrying amount | Credit loss allowance |
| Current | 0.3% | $15 million | $45,000 |
| 1-30 days past due | 1.6% | $7.5 million | $120,000 |
| 31-60 days past due | 3.6% | $4 million | $144,000 |
| 61-90 days past due | 6.6% | $2.5 million | $165,000 |
| > 90 days past due | 10.6% | $1 million | $106,000 |
| Total | $30 million | $580,000 |
In this instance, impairment of $580,000 would be recognised on the portfolio of receivables.
Concluding thoughts
Changing from the PBE IPSAS 29 incurred loss model to the PBE IPSAS 41 expected loss model will likely result in earlier impairment recognition and the recognition of greater levels of impairment.
In preparation for the implementation of PBE IPSAS 41, accounting teams will need to ensure that their financial reporting systems and processes are equipped to calculate impairment based on the new requirements.
For more on the above, please contact your local BDO Representative.
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