IMPAIRMENT OF FINANCIAL ASSETS

An impairment occurs when the carrying amount of an asset exceeds its recoverable amount. IAS 39 Financial instruments: Recognition and measurement requires an entity to assess at the end of each reporting period whether there is any objective evidence that financial assets are impaired and whether the impairment impacts on future cash flows.



Objective evidence of impairment includes the following:

• significant financial difficulties of the issuer;
• probability that the borrower will enter bankruptcy; and
• the disappearance of an active market for the financial asset because of financial difficulties.

If any objective evidence of impairment exists, the entity recognises any associated impairment loss in profit or loss. Only losses that have been incurred can be reported as impairment losses. This means that losses expected from future events, no matter how likely, are not recognised.

The impairment review requirements only apply to financial assets measured at amortised cost and investments in unquoted equity instruments that cannot be reliably measured at fair value.

Financial assets measured at amortised cost

The financial asset's recoverable amount is measured at the present value of the estimated future cash flows discounted using the original effective interest rate of the financial assets (i.e. the effective interest rate that is used to determine amortised cost).

The impairment review is as follows:

									$
Carrying amount of financial asset (at amortised cost)									XXX
Present value of estimated future cash flows discounted at the original effective interest rate									(XXX)
Impairment loss (recognised in profit or loss)									XXX

Such impairment losses can be reversed if the impairment losses subsequently decrease due to an event occurring after the impairment was recognised (such as an improvement in the debtor’s credit rating). The reversal is recognised in profit or loss and must not exceed the original amortised cost.

Investments in unquoted equity instruments that cannot be reliably measured at fair value

The financial asset's recoverable amount is measured at the present value of the estimated future cash flows discounted using the current market rate of return for a similar financial asset.

The impairment review is as follows:

									$
Carrying amount of financial asset (at cost)									XXX
Present value of estimated future cash flows discounted at the current market rate									(XXX)
Impairment loss (recognised in profit or loss)									XXX

Such impairment losses cannot be reversed.

Note:

The impairment review requirement is required for the two category of financial assets above. However, this does not mean that financial assets measured at fair value cannot be impaired.

Impairment of financial assets measured at FVTPL and FVTOCI is recognised in profit or loss.

In addition, when a financial asset measured at FVTOCI is impaired, any gains or losses previously recognised in OCI must be reclassified to profit or loss. As explained in Financial Instruments: Measurement, gains or losses previously recognised in OCI must be reclassified to profit or loss on disposal of those financial assets. Therefore, there are two instances in which such a reclassification is made, i.e. on disposal and on impairment of financial assets measured at FVTOCI.

Let's look at the following illustrations.

Illustration 1

James made a loan of $12,000 to its customer.

The loan has four years to run with a coupon rate of 3%. The loan runs as expected for the first two years, but at the end of the second year just as the second interest payment is received, James receives information that the customer is going through a financial reorganisation. Further investigation reveals that the customer is unlikely to pay any further interest instalments and is estimated to pay only $5,000 of the nominal value of the loan at the end of the fourth year.

The effective interest of the loan is 8%.

Required:

Show how the financial asset would be accounted for in the financial statements of James over the four years.

Solution

The loan is a financial asset measured at amortised cost as it is held to collect contractual cash flows over the four year period. The carrying amount of the loan asset (at amortised cost) at the end of Year Two is determined as follows:

End of Year	Opening	Effective	Cash	Closing
	balance	interest at 8%	received	balance
	$	$	$	$
One	12,000	960	(360)	12,600
Two	12,600	1,008	(360)	13,248

The financial reorganisation of the customer is objective evidence of impairment. The impairment review is as follows:

									$
Carrying amount of loan asset									13,248
Present value of estimated future cash flows (5,000 x 1/1.082)									(4,287)
Impairment loss									8,961

Therefore, an impairment loss of $8,961 will be recognised in profit or loss.

The financial asset will continue to be accounted for at amortised cost, based on the revised carrying amount of the loan as follows:

End of Year	Opening	Effective	Cash	Closing
	balance	interest at 8%	received	balance
	$	$	$	$
Three	4,287	343	-	4,630
Four	4,630	370	-	5,000

Illustration 2

On 1 January 20X1, Jonas purchased 10,000 shares in an unquoted company for $100,000. The fair value of the shares cannot be reliably measured as the company does not have an active market for its business. On 31 December 20X2, the company enters into liquidation and it is estimated that Jonas will only be able to recover $60,000 for its investments when the liquidation completes on 31 December 20X4. The current market interest rate for an investment similar to those of Jonas' on 31 December 20X2 is 8%.

Required:

How should this investment be accounted for in the financial statements of Jonas?

Solution

As the investment is in unquoted equity instruments that cannot be reliably measured at fair value, it will be measured and carried at its cost of $100,000.

The impairment review is as follows:

									$
Carrying amount of financial asset									100,000
Present value of estimated future cash flows (60,000 x 1/1.082)									(51,440)
Impairment loss									48,560

An impairment loss of $48,560 is therefore recognised in profit or loss.

After the impairment, Jonas should recognise the unwinding of discount on the investment as finance income for the remaining two years as follows:

End of Year	Opening	Effective	Cash	Closing
	balance	interest at 8%	received	balance
	$	$	$	$
31 December 20X3	51,440	4,115		55,555
31 December 20X4	55,555	4,445		60,000

Illustration 3

Johnson purchased shares in a company for $100,000 and classified them as measured at fair value through other comprehensive income (FVTOCI). At the end of Year One, the shares have a fair value of $120,000. At the end of Year Two, the fair value of the shares had fallen to $90,000. Johnson found out that the fall in value was caused by the company entering into a restructuring scheme, as the company was having some financial difficulties.

Required:

How should this financial asset be accounted for in the financial statements of Johnson?

Solution

On initial recognition, the shares should be measured at the fair value of consideration paid, i.e. $100,000.

	Dr	Investments in equity instruments	$100,000
	Cr	Cash	$100,000

At the end of Year One, the financial asset is remeasured to its fair value of $120,000, giving a gain of $20,000 which should be recognised in other comprehensive income (OCI).

	Dr	Investments in equity instruments	$20,000
	Cr	Other comprehensive income	$20,000

At the end of Year Two, the financial asset is again remeasured to its fair value, i.e. $90,000. As the fall in fair value was caused by impairment, the resulting loss of $30,000 would be recognised in profit or loss instead of OCI. In addition, the gain of $20,000 previously recognised in OCI would be reclassified to profit or loss.

	Dr	Profit or loss	$30,000
	Cr	Investments in equity instruments	$30,000

	Dr	Other comprehensive income	$20,000
	Cr	Profit or loss	$20,000