In July 2014, the International Accounting Standards Board (IASB) issued the final version of IFRS 9 – ‘Financial Instruments’ effective for annual periods beginning on or after 1 January 2018. The Securities and Exchange Commission of Pakistan (SECP) vide SRO 1007(I)/2017 dated 04 October 2017, adopted the standard and declared it effective for annual reporting periods beginning on or after July 01, 2018. Application of IFRS 9 was deferred on the request of different Entities and the same become applicable for the accounting periods ending on or after June 30, 2019.
One of the significant changes from the IAS 39 was related to impairment testing of financial assets where old ‘incurred loss’ model is changed with an ‘expected credit loss’ (ECL) model. Under this method, 12-month expected credit losses are required to be assessed and recognized in profit or loss as soon as a financial instrument is originated or purchased. Where there is a Significant Increase in Credit Risk (SICR), IFRS 9 requires that lifetime ECLs be assessed and recognized in the financial statements.
The coronavirus pandemic has affected the businesses adversely due to the lock down imposed by the Government to control or minimize the risk of / spread of corona virus. The purpose of this document is to provide guidance to our worthy clients for the implementation of IFRS 9 under the current abnormal circumstances in the light of guidance provided by IASB in its document IFRS 9 and Covid 19 and relief provided by SECP vide its S.R.O. 278 (I)/2020 dated April 1, 2020 for the financial statements of the Entities for the period / year ended on March 31, 2020. These can be accessed through the following links:
Assessment of impairment loss under expected credit losses (ECL) model
The Corona Virus (Covid 19) has forced the countries to lock down in order to reduce / minimize the risk of its spread, resulting in SICR. IFRS 9 requires the Entities to assess and account for life time expected credit loss on specific financial instruments in case of SICR. However, the extension of payment period under the current circumstance caused by Covid 19 pandemic should not be considered to have automatically resulted in SICR for the purpose of application of IFRS 9.
IFRS 9 requires the application of judgement and allows entities to adjust their approach to determining ECLs in different circumstances. A number of assumptions and linkages previously used in the ECLs may no longer be appropriate under the current circumstances and, therefore, Entities should not continue to apply their existing ECL methodology mechanically. Entities need to assess whether the extension in period of payment in case of any specific financial instrument results in SICR for that specific instrument or not. To assess SICR IFRS 9 requires the Entities to assess changes in the risk of a default occurring over the expected life of a financial instrument. Both the assessment of SICRs and the measurement of ECLs are required to be based on reasonable and supportable information that is available to an entity without undue cost or effort.
Entities are required to develop estimates based on the best available information about past events, current conditions and forecasts of economic conditions. In assessing forecast conditions, consideration should be given to the effects of covid-19 and the significant government support measures being undertaken. It is likely to be difficult at this time to incorporate the specific effects of Covid-19 and government support measures on a reasonable and supportable basis. However, changes in economic conditions should be reflected in macroeconomic scenarios applied by entities and in their weightings. If the effects of Covid-19 cannot be reflected in models or post-model overlays, adjustments will need to be considered. The environment is subject to rapid change and updated facts and circumstances should continue to be monitored as new information becomes available and their effect of ECL should be considered. Appropriate disclosers in the financial statements with respect to the current stressed environment and reasonable and supportable information on which ECL is based will provide much needed transparency to users of financial statements.
Relief provided by SECP
Covid 19 has also resulted in crash of the stock exchanges worldwide. Fair values of different quoted instruments had significantly reduced due to this Covid 19 pandemic, which will result in huge fair value loss on the financial instruments that are categorized as at Fair Value through Profit or Loss (FVPL). Recognition of these huge fair value losses in the profit or loss will create lot of problems for the Entities. SECP vide its S.R.O. 278 (I)/2020 dated April 1, 2020 has granted temporary relief to the Entities who are preparing financial statements for the year / period ended March 31, 2020 by giving them an option to park of such a fair value loss in the statement of changes in Equity till June 30, 2020. In the financial statements of the Entities for the year / period ended June 30, 2020, the fair value loss which is parked in equity by exercising the option under this SRO will be reclassified to profit or loss.
In case payment of any dividend for the year / period ended March 31, 2020 is under consideration, the Entities are required to calculate the profits available for appropriation after deducting the fair value loss parked in equity under the said SRO. Summary of the SRO is as under;
1. Option to temporarily park / record any fair value loss on financial instruments in equity is available to the Entities for the financial statements for the year / period ended March 31, 2020.
2.This is not mandatory for all such entities. If any Entities are willing to recognize such fair value losses in the statement of profit or loss, they are encouraged to do so.
3.The fair value losses recognized in equity under this SRO will be reclassified in the statement of profit or loss in the financial statements of the Entities for the next period ending on June 30, 2020.
4.If any entity is availing the relaxation under this SRO, it will disclose this fact in the statement of financial position, statement of profit or loss and its directors’ report along-with the impact of the option on the line items of the financial statements to meet the disclosure requirements of IAS-1 with respect to departure from the requirements of any standard. This can be achieved by adding a foot note / section in the above referred documents such as the following;
“ The Company has recognized the fair value loss of Rs. ____ million on the financial instruments categorized as at Fair Value Through Profit or Loss in the statement of changes in equity as ‘fair value reserve’ as allowed under SECP’s S.R.O. 278 (I)/2020 dated April 1, 2020. Had the fair value loss been recognized in the statement of profit or loss as required under IFRS 9, profit for the year / period, equity and fair value reserve would have been decreased by Rs. _____ million or loss for the year / period would have been increased by Rs. ____ million and equity and fair value reserve would have been decreased by Rs. _____ million.