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This article was first published in the April 2011 UK edition of Accounting and Business magazine.

Current accounting requirements for the impairment of financial assets under both International Financial Reporting Standards (IFRS), and US generally accepted accounting principles (US GAAP), require evidence of a loss before an impairment is recognised – an incurred loss model.

The incurred loss model was the subject of criticism during the financial crisis, with some commentators saying it resulted in the losses that were being recognised being ‘too little, too late’. As a result, the International Accounting Standards Board (IASB) and US standard-setter the FASB, published separate exposure drafts in September 2009 and May 2010 respectively, proposing a new, expected loss model. The two exposure drafts did, however, differ in the detail of the methods of accounting for impairment and, subsequent to the exposure drafts, both the IASB and FASB have been working together to try and align their approaches.

Commentators on the exposure drafts have highlighted a number of concerns and one of these has been addressed by the recent issue of a supplement to both the drafts, dealing with the accounting for impairment of financial assets managed in an open portfolio. While the amendment is reasonably narrow in its scope, it is important for financial institutions that had identified practical issues in applying the model set out in the original draft.

Many financial institutions have two broad groups of financial assets – the ‘bad book’ which comprises loans that are considered problematic, and the ‘good book’ which comprises the remaining financial assets. While assets in the bad book are monitored closely, those in the good book are monitored on a portfolio basis.

The supplementary document proposes that for good book assets, losses would be recognised over time using a ‘time-proportional’ approach, and for bad book assets, expected losses would be recognised immediately.

Yvonne Lang, director, and Kern Roberts, associate director, Smith & Williamson

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Last updated: 1 Apr 2014