IASB Staff Examples
On 5 November 2009, the IASB published the exposure draft Financial Instruments: Amortised Cost and Impairment (ED).
In order to promote discussion of the proposals, the IASB staff has prepared the following numerical examples of the calculation mechanics of the expected cash flow approach.
- are prepared by the IASB staff and are for education purposes only;
- demonstrate only the calculation mechanics, and do not illustrate how the ED proposals should or could be applied by an entity; and
- do not form part of the exposure draft. The IASB is not asking respondents to the ED to comment on these examples.
Example 1: Fixed rate financial instruments
Example 1 demonstrates the calculation mechanics of the expected cash flow approach for fixed rate financial instruments. This example illustrates a pool of 100 loans with nominal amount of 10,000 per loan, a contractual interest rate of 10% and a maturity of 5 years. At the end of period 2, the originally expected cash flows were revised in order to reflect higher per annum defaults than originally expected. As a consequence, the carrying amount is adjusted against profit or loss at the end of period 2 in order to reflect the revised cash flow estimate.
The amount of the adjustment is the difference between:
(a) the carrying amount at the end of period 2 that would have resulted without a revision of cash flow estimates; and
(b) the present value of the expected cash flows (after revising the estimates) over periods 3 to 5 discounted at the originally expected effective interest rate (EIR).
No further adjustments are made in periods 3 to 5 as there are no further revisions of estimates.
Example 2: Short-term trade receivables
Example 2 demonstrates the calculation mechanics of the expected cash flow approach for trade receivables where the effect of discounting is immaterial. (Refer to paragraph B16 of the ED.) This example illustrates sales with a total invoice amount of 100,000 and an estimated loss rate on receivables of 2% at initial recognition. The estimated loss rate is then subsequently revised to 1.5% as a result of improvements in credit conditions. The overdue receivables are determined as uncollectible one year after they were due, which is when they are written off.
Example 3: Floating rate financial instruments
Example 3 demonstrates the calculation mechanics of the expected cash flow approach for floating rate financial instruments.
For floating rate financial instruments if the carrying amount differs from the nominal amount (for example due to transaction costs, a premium or discount, or as the carrying amount of a financial asset is reduced over time by the allocation of the initial expected credit losses), updating the benchmark interest rate (in accordance with paragraph B12 of the ED) will result in a situation where the carrying amount will no longer (automatically) unwind to the expected principal cash flow at maturity.
An adjustment (against profit or loss) is used in order to reset the carrying amount to the present value of the expected cash flows (discounted based on the expected EIR using the initial expected credit spread).
Example 3 illustrates the mechanics of the adjustment. The basic design of the workbook is as follows:
- The example covers five periods using different tabs for different points in time (from t0 to t4 starting with the tab to the right and moving towards the left as time progresses).
- Adjustments are required to ensure that the carrying amount unwinds to the expected remaining cash flows where there is a change in the interest rate curve as shown in t2 and t3).
Example 3 uses three sets of forward rates and corresponding spot (zero coupon) curves for:
- benchmark interest rates;
- the contractual interest rates (ie benchmark plus contractual spread); and
- benchmark interest rates plus expected spread.
The spreadsheets include comments with more detailed remarks on the calculations.