Analysis On The Expected Loss Model’s Development And Application

In2008, the outbreak of the financial crisis has brought the Incurred Loss Model into criticism. The Financial Crisis Advisory Group in its report claimed that the delayed recognition of losses associated with financial instruments and multiple approaches to recognizing asset impairment are the weakness and the primary cause of the economic disaster. It also proposed to use more forward-looking information such as the potential risk of the financial assets for the impairment. Among the projects of The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB), impairment is one of the most important issues. They tried to sort out the method of impairment for financial assets, and put forward an expected loss model which considered future credit losses instead of the Incurred Loss Model. In order to improve the practical feasibility of the model, IASB and FASB have been committed to revising it. They have successively raised different approaches, submitted to public for discussion.Based on the concept of expected losses, IASB and FASB jointly improved the Expected Loss Model, sequentially proposed the expected cash flow, two group approach and three-bucket model. Due to the inconsistent objectives and different concerns received from the feedback of previous drafts, the IASB developed its impairment model and made differentiates between financial instruments that have suffered a significant deterioration in credit quality since initial recognition and financial instruments that have not. The FASB put forward a single measurement model that recognizes loss allowance for all expected credit losses on financial instruments. Now the IASB and the FASB have agreed on the necessity of the Expected Loss Model. But the IASB sought to reflect the relationship between initial estimates of credit losses and pricing and recognize the real yield on the financial assets. The FASB insisted on that the impairment loss should cover its lifetime expected credit losses. Although both boards have been urged to work together to develop a converged impairment model, they have not yet got consensus about the way of model works on. This article uses normative method to discuss the origin and development of the Expected Loss Model, and make reasonable analysis on each approach of the model. Then this paper compares the models proposed by the IASB and FASB with the Incurred Loss Model on the aspects of the accounting recognition, measurement, presentation and disclosure, makes focus on the reasons of differences between models. Based on the pros and cons of the model, the paper suggests that we should deepen understanding in terms of accounting theory and reduce the complexity of the model from the concrete operational aspect.With the work to international convergence of accounting standards, the application of the Expected Loss Model has become an inevitable trend in China. It will have a significant impact on China’s banking industry as financial assets cover a large proportion of our banking assets. It will reduce public’s doubt on the rate of non-performing loans. Since China’s commercial banks adopt the five-category loan quality classification method combined with incurred loss model, the internal accounting system and current risk management mechanism are difficult to support the model. What’s more, the coordination with regulation and tax policy is an important problem. Therefore, this paper suggests that our country should clear the accounting objectives to revise the financial instrument accounting standards according to the special situation of our banks and other financial institutions. We may retain appropriate flexibility of the Expected Loss Model for specific regulations under the premise of maintaining unity to ensure operability. Furthermore, to cope with the model, our banks should strengthen the consciousness of venture management, adequate internal system, improve data mining technology.