Financial Assets Impairment Loss Model For Evolution

During the current financial crisis, criticisms were raised against the current IFRS impairment model for financial assets (the incurred loss mode). The issue with the incurred loss model is that impairment losses and resulting write-downs in the reported value of financial assets can only be recognized when there is evidence that they exist. This creates a systematic bias towards late recognition of credit losses that is inconsistent with the cash flow expectations in relation to the financial asset. Once the recognition threshold is crossed the incurred loss model results in a’cliff effect’ In the report issued by the Financial Crisis Advisory Group, it claimed that delayed recognition of losses associated with loans (and other financial instruments) and the complexity of multiple impairment approaches are the primary weaknesses in accounting standards and their application. The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have been urged by many to develop new impairment model for financial instruments which use more forward-looking information.In the light of the criticisms of the incurred loss model, IASB and FASB decided to propose an expected loss approach to determining impairment. Both the IASB and the FASB developed their original proposals on credit impairment in contemplation of their respective decisions on the classification and measurement of financial instruments. The IASB’s primary objective in the exposure draft Financial Instruments:Amortized Cost and Impairment was to reflect initial expected credit losses as part of determining the effective interest rate, as the IASB believed that this was more reflective of the economic substance of lending transactions. The approach originally proposed by the IASB required an entity to estimate expected cash flows over the life of instruments. The FASB’s objective in its originally proposed approach was to ensure that the allowance balance was sufficient to cover all estimated credit losses for the remaining life of an instrument. Therefore, the approach originally proposed by the FASB would require an entity to estimate cash flows not expected to be collected over the life of the instruments and recognize a related amount immediately in the period of estimate. Furthermore, the FASB believed that it would be inappropriate to allocate an impairment loss over the life of a financial asset. In other words, if an entity expects not to collect all amounts, a loss exists and should be recognized immediately. However, the importance of achieving a common solution to this particular issue has been stressed by the boards’constituents. The IASB and the FASB are committed to enhancing comparability internationally in the accounting for financial instruments. In particular, they are committed to seeking a common solution to the accounting for the impairment of financial assets. A new impairment model that the boards believe will enable them to satisfy at least part of their individual objectives for impairment accounting while achieving a common solution to impairment. The impact of the new model related to impairment of financial instrument should be analyzed carefully. The accurate measurement and disclosure of financial instruments is directly related to the healthy development of the entire financial system.This paper includes five parts. The first part is the introduction part. It introduces the research background, the significance of such research, the framework of the research methodology. This part also point out innovation points and deficiencies and other problems. The second part focus on the developments in the recognition and measurement of financial assets based on the latest IFRS, discussing the origin and development of the impairment of financial assets, scope of application, this part summarized in the theoretical and practical aspects of the current model. The third part proceeds on the goals of the IASB and FASB. The objective of IASB is to reflect initial expected credit losses as part of determining the effective interest rate, as the IASB believed that this was more reflective of the economic substance of lending transactions. The FASB’s objective in its originally proposed approach was to ensure that the allowance balance was sufficient to cover all estimated credit losses for the remaining life of an instrument. This part focuses on the IASB and FASB respective view on the impairment model. Analyzed and compared the issues on data, the confirmation of the credit losses and the presentation. Finally, the IASB and FASB proposed alternative A and alternative B, alternative A and alternative B is the model of the IASB and FASB proposed to achieving a common solution to impairment. The third part establishes a basis for model development and application in Part IV. The Fourth part continued the issue discussed in the third part. This part focused on the application and impact of the IASB and FASB initial impairment model. This part presents an impairment model that the boards believe will satisfy part of their individual objectives for impairment accounting while achieving a common solution to impairment. The final part summed up the issue prescribed in the previous parts and pointed out the important issues of the expected loss model:which expected losses? When are initial loss expectations recognized? How are changes in loss estimates treated? Allowance account floor etc. At last, based on the comprehensive analysis in the above sections, this part brought forward recommendations and amendment to standards.