A CRITICAL ANALYSIS OF CALCULATIONS OF CURRENT EXPECTED CREDIT LOSSES (CECL) AT DYNAMIC CORPORATION

In 2016, the Financial Accounting Standards Board (FASB) issued a standards update on current expected credit losses (Accounting Standards Update 2016-13; FASB Codification® Topic 326). While the update does not change the debits and credits associated with current expected credit losses (CECL), it does significantly change the calculations associated with estimates of current expected credit losses. Additionally, given that most textbooks simply provide inputs for the calculations associated with estimates of current expected credit losses, most accounting curricula does not cover the most important changes found in the update. This case provides students with a hypothetical situation in which to analyze and understand these issues. Specifically, the case requires students to critically analyze a series of current expected credit loss calculations, research authoritative guidance, and conclude regarding the appropriateness of the calculations of the actors in the case. Results indicate that students perceive significant practical learning opportunities from the case.

IFRS9 e le sfide di contesto

Under IFRS9, Financial Institutions are required to implement impairment frameworks to determine the expected losses on their credit portfolio taking into account the current (so called “point in time”) and the prospective (so called “forward looking”) economic cycle. The Covid-19 pandemic, which began in early 2020, has posed significant challenges for Financial Institutions in their ability to manage credit risk. Despite numerous guidelines given by regulators, estimating IFRS9 expected loss continues to be a considerable challenge. The challenge partly stems from the relationship between macro-economic scenarios and credit losses, the treatment of moratoriums inside the historical series for development and calibration of IFRS9 risk parameters, and the management of support measures defined at National and European levels (e.g. Next Generation EU) for the forward looking estimations.

Empirical results for expected credit losses of G-SIBs during COVID-19. The proof of the pudding is in the eating

This study examines the provision for credit losses and its disclosures for Global Systemically Important Banks (G-SIBs) in connection to the COVID-19 crisis. We find a profound difference in the increase of the provision for credit losses between banks that report under IFRS and US GAAP. For banks that report under US GAAP, the provision for credit losses more than doubles, while it increases by only 32 percent for banks that report under IFRS. This difference becomes even more striking when considering that the increase for IFRS-reporting banks is partly attributable to increased lending activities. This study further finds that European auditors are more likely to issue a Key Audit Matter (KAM), than auditors of US banks, and that these KAMs specifically relate to COVID-19 in the financial year 2020. Furthermore, IFRS-reporting banks disclose more information on expected credit losses than banks that report under US GAAP. Moreover, we find that European banks disclose relatively more information regarding the impact of COVID-19 than banks reporting under US GAAP.

MODELING LIFETIME EXPECTED CREDIT LOSSES ON BANK LOANS

The guidelines of various Accounting Standards require every financial institution to measure lifetime expected credit losses (LECLs) on every instrument, and to determine at each reporting date if there has been a significant increase in credit risk since its inception. This paper models LECLs on bank loans given to a firm that has promised to repay debt at multiple points over the lifetime of the contract. The LECL can be written as a sum of ECLs (estimated at reporting date) incurred at debt repayment times. The ECL at any debt repayment time can be written as a product of the probability of default (PD), the expected value of loss given default and the exposure at default. We derive a stochastic dynamical equation for the value of the firm’s asset by incorporating the dynamics of the factors. Also, we show how the LECL and the term structure of the PD can be estimated by solving a Black–Scholes–Merton like partial differential equation. As an illustration, we present the numerical results for the various credit loss indicators of a fictitious firm when the dynamics of the short-term interest rate is characterized by a Cox–Ingersoll–Ross mean-reverting process.

New Accounting Framework Faces Its First Test: CECL During the Pandemic

On January 1, 2020, most large and mid-sized U.S. banks adopted Current Expected Credit Losses (CECL), a new accounting standard for estimating allowances. Allowance for credit losses is an estimate of the amount that a bank is unlikely to recover from a financial asset.

Impact of COVID-19 pandemic on assessment of companies activity within international standards of financial reporting

Introduction. During crises like the current one, induced by a global pandemic of the COVID-19, the most relevant aspects for the majority of businesses are a continuity of their operating, assessment for impairment and assessment of expected credit losses. These factors impact accounting and financial reporting which, in turn, impact decision-making. A business survival in such conditions is highly dependent on how efficiently managers assess these aspects. The purpose of the paper is to determine particular actions management should undertake in order to prevent business bankruptcy as a result of the pandemic and the pandemic-related restrictions. Results. It terms of assessment of continuity of business operating, the main issue is the fact that the budgets approved in 2019 for the year 2020 turned to be irrelevant in the context of expected prices, sales volumes, total net profit, working capital and the effects of exchange difference, whereas the key solution is an estimation of a company’s liquidity to be able to cover liabilities within the deadlines. In terms of assessment for impairment, there two indicators of the impairment: external changes with significant impact on a company or its environment and a situation when a book value of net assets exceeds company’s market capitalization whereas a solution is to determine amount of expected compensation either with a traditional approach or with an approach based on expected cash flows. In terms of credit losses assessment, among the factors that should be accounted there are, for instance, additional economic scenarios that address high uncertainty, an impact on particular groups of clients, industries or regions and actions taken by governments and central banks whereas among the targets of the assessment there are, for instance, an ability to include changes of a default risk into evaluation of default probability in time. Conclusions. COVID-19 pandemic and the risks related to it caused a significant impact on accounting and financial reporting, regardless of a company’s industry, size and region where it is located which is expressed in the dynamic of the Global SEMs bankruptcy index and PMI.

IFRS 9 Single Impairment Model: Semantics and Circularity? A Study in the Airline Industry

This paper studies a sample of airlines reporting under International Financial Reporting Standards (IFRS) about three specific challenges in implementing International Accounting Standards Board (IASB) (2019), IFRS 9 requirements for impairment versus IASB, 2014, IAS 39: 1) expected versus incurred credit losses; 2) impairment scoping and elective simplifications; and 3) definition and use of default. First, there appears to be a strong indicator that the way airline companies have drawn the line between what future conditions should or should not be considered in estimating expected versus incurred credit losses has maintained the fundamental tenet in IFRS of representing the condition existing as of the end of the reporting period. Second, evidence of companies quests for IASB (2019), IFRS 9 impairment simplifications attests to the criticism that the alleged single model of impairment is in effect a complex collection of different techniques. Finally, the degree of specific application that IASB (2019), IFRS 9 requires for the definition and use of default, as well as the customization of what triggers a significant change in the risk of default since initial recognition, does not appear to have been fully received, and sufficiently disclosed in the financial statements.

Expected credit losses and managerial discretion. Current practices and future challenges

This paper examines the loan loss provisioning behaviour during the transition from IAS 39 to IFRS 9 for a sample of 403 banks in 27 countries in European Union. The objective of the study is to investigate whether during the first years of adoption of the new expected credit loss (ECL) impairment model banks are more en-couraged to smooth earnings and manage capital, compared to the previous in-curred loss (ICL) model. Results show that under ECL, banks adopt a more ag-gressive opportunistic behaviour in accordance with the income-smoothing and capital management approach. Management should be aware of this to implement monitoring and control systems, increasing trustworthiness of financial in-formation for investors' expectations.