12-month ECLs

Definition

12-month Expected Credit Losses (ECLs) refer to the estimate of credit losses on financial instruments over the next 12 months. This concept is crucial under IFRS 9, as it replaces the incurred loss model from IAS 39, emphasizing a forward-looking approach to assessing credit risk. The recognition of 12-month ECLs allows entities to better anticipate potential losses from default events, reflecting changes in credit risk more effectively.

5 Must Know Facts For Your Next Test

1. Under IFRS 9, the 12-month ECL model applies to financial assets that have not experienced a significant increase in credit risk since initial recognition.
2. The estimation of 12-month ECLs involves considering historical data, current conditions, and reasonable forecasts about future economic conditions.
3. Entities must recognize a loss allowance for 12-month ECLs on an asset-by-asset basis or collectively for groups of similar financial instruments.
4. The transition from IAS 39 to IFRS 9 introduced the need for companies to adjust their impairment models, moving towards a more proactive approach in recognizing credit losses.
5. Entities are required to disclose information about their ECL calculations and the factors influencing credit risk assessments in their financial statements.

Review Questions

• How do 12-month ECLs differ from lifetime ECLs in terms of recognition and measurement?
  • 12-month ECLs are recognized for financial assets that have not seen a significant increase in credit risk since they were initially recognized. In contrast, lifetime ECLs are applicable when there has been a significant increase in credit risk. The measurement of 12-month ECLs focuses on estimating losses that could occur within the next year, while lifetime ECLs require an estimation of potential losses over the entire duration of the financial instrument.
• Discuss the implications of moving from the incurred loss model under IAS 39 to the expected loss model under IFRS 9, specifically focusing on 12-month ECLs.
  • The shift from the incurred loss model to the expected loss model under IFRS 9 represents a significant change in how financial institutions assess credit risk. With 12-month ECLs, entities are required to recognize expected losses earlier, thereby enhancing transparency and enabling better risk management. This proactive approach aims to ensure that entities are prepared for potential credit losses before they occur, as opposed to waiting until there is concrete evidence of default.
• Evaluate how the concept of 12-month ECLs contributes to more accurate financial reporting and risk assessment for financial institutions.
  • The introduction of 12-month ECLs enhances financial reporting by promoting a forward-looking perspective on credit risk. This methodology encourages institutions to incorporate a wider range of data when assessing potential credit losses, leading to more accurate and timely recognition of risks. By ensuring that entities account for expected losses early on, stakeholders can have greater confidence in the reported financial position and performance of institutions, ultimately fostering stability and trust within the financial system.

Related terms

Lifetime ECLs:

Lifetime Expected Credit Losses are estimates of losses over the entire life of a financial instrument, recognized when there is a significant increase in credit risk since initial recognition.

Impairment:

Impairment refers to the reduction in the recoverable amount of a financial asset below its carrying amount, leading to a loss being recognized.

Credit Risk:

Credit risk is the possibility of loss resulting from a borrower's failure to repay a loan or meet contractual obligations.