WILL THE INTERNATIONAL ACCOUNTING STANDARDS BOARD’S DECISION TO INTRODUCE ‘THE EXPECTED LOSS MODEL’ UNDER IFRS 9 CONTRIBUTE TO GREATER TRANSPARENCY OF FINANCIAL STATEMENTS INFORMATION? IS IT TRUE OR IS IT TOO EARLY TO ADDRESS THE QUESTION?

Hristina Oreshkova
University of National and World Economy (UNWE), Faculty of Finance and Accounting Sofia, Bulgaria
DOI: https://doi.org/10.31410/eraz.2018.195

​​ ​​

4th International Conference – ERAZ 2018 – KNOWLEDGE BASED SUSTAINABLE ECONOMIC DEVELOPMENT, Sofia- Bulgaria, June 7, 2018, CONFERENCE PROCEEDINGS published by: Association of Economists and Managers of the Balkans, Belgrade, Serbia;  Faculty of Business Studies, Mediterranean University – Podgorica, Montenegro; University of National and World Economy – Sofia, Bulgaria; Faculty of Commercial and Business Studies – Celje, Slovenia; Faculty of Applied Management, Economics and Finance – Belgrade, Serbia, ISBN 978-86-80194-12-7

Abstract

The most recent global crisis of 2007 to 2009 exposed considerable vulnerability and numerous weaknesses of the financial system worldwide. More specifically the crisis highlighted the costs incurring because of delays in recognition of credit losses on loans and receivables not only on the part of banks, but also on the part of other financial institutions and lenders. All this proved out to be inconsistent with the philosophy of prudence, for long considered an overriding accounting principal especially in Continental Europe and an essential theoretical concept in the Anglo-Saxon world. Subsequently the debates on the matter have extremely intensified, and it has become more than obvious that the strategic far-reaching goal of making efforts to globally improve not only the resilience of the financial system, but the lending practices as a whole should be regarded as being of highest priority.
Logically the considerable part of the discussions has focused extremely on the essence of various shortcomings in accounting standards that embody or are based on a prudential philosophy, the relevant requirements, and, on the everlasting societal and social necessity of neutral and well-balanced compliance with the guiding principles of prudential policy as well as on the key importance of regulatory oversight process as emphasized by the G20.
Consequently a major area of focus for a long time up to now has been the development of coherent approaches, and attempts have been globally made to search for and propose well-grounded models of accounting recognition of objects, whose valuation needs estimation, so as to resolve the most crucial problems as the issue of provisioning for loan losses. All this has not occurred unexpectedly. The recognition of loan losses and the provisioning for loan losses consistent with the previous International Accounting Standards approaches have also been criticized as not being designed on a prudential basis even to the point of being unsound. As a result the new IFRS 9 Financial Instruments was intended to respond to attacks on the part of large number of academicians, professionals and other stakeholders. The major motive was that IAS 39 Financial Instruments: Recognition and Measurement was perceived as too complex, inconsistent in the approaches to recognizing losses experiencing because of impairment of financial assets of various categories, and inconsistent with the manner entities manage their business activities and inherent risks. There was criticism and disapproval because some of the rules under IAS 39 give rise to significant delays in the recognition of credit losses on loans and loan receivables until it is too late in the credit cycle.
The key question of whether the International Accounting Standards Board’s decision to introduce the model of expected credit losses will contribute to achieve greater transparency of the information produced for and provided by financial statements, and whether it will improve its quality, still stands. It is too early probably to give an objective and unambiguous answer, and any attempt to generalize would most probably be not unmistakable. At present the most realistic answer perhaps is that this will largely depend on the specific circumstances, since too much subjective judgements regarding the possible impact of various external and internal factors and indicators, including ones related to the forward-looking macroeconomic conditions, will influence the reliability (consistency) of the estimates of the expected credit losses; the reliability of these judgments will depend first and foremost on the competencies, professionalism, expertise, integrity and the independence and professional responsibilities of people at the highest levels of corporate governance and management.
The underlying argument, central to the present article, supporting the author’s view, is that too much discretionary power in modelling expected credit losses is retained, that is, set aside for entities’ officials, executives, high-ranking managers and other superiors. The discussions on the possible implications of the expected credit loss model under IFRS 9 often emphasize that such circumstance may potentially inhibit the long-standing efforts targeted at achieving greater transparency of information, which is inherent in IFRS 9 main objectives.
Managerial shifts towards more prudential policies can be expected, and that in turn can possibly improve the transparency not only in theory. However, in practice that may not be the case at all times. The implementation of the new expected credit loss model poses challenges for many undertakings concerned. Actions are needed on the part of policy makers to ensure consistency in its development and implementation, in order to constrain the emergence of potential dissimilarities in respect of the reported results even if created under the burden of similar set of risky circumstances. As regards disclosure of information related to the inputs, assumptions and techniques used to duly identify significant increases in credit risk and to estimate expected credit losses (ECLs), they will continue to be crucial, and its quality not just quantity will be of great importance for improving transparency and taking advantage of the forecasted (predicted) reduced procyclicality.
A complete understanding of the importance of auditors’ key role would be also critical. This could be constructive in promoting an improvement of auditing practices worldwide, and, as a result of this, in achieving the long-desired higher degree of quality of financial statements information, and globally restoring trust in its credibility.

Key words

Prudence, incurred loss model, expected loss model, transparency, managerial discretion, financial accounting and financial reporting;

References

1. Alexander, D, Nobes, C. (2010). Financial accounting: An International Introduction, Prentice Hall.
2. Bank for International Settlements (2011) Basel Committee on Banking Supervision Consultative document: “The internal audit function in banks”, December, pp.1-27.
3. Bank for International Settlements (2015) Basel Committee on Banking Supervision Guidelines: “Corporate governance principles for banks”, July, pp. 1-43.
4. Bank for International Settlements (2017) FSI Insights on policy implementation No 5 Prudential policy considerations under expected loss provisioning: lessons from Asia, by F. Restoy and R. Zamil, October, pp.1-32.
5. Cohen, Benjamin H., Gerald A. Edwards Jr. (2017). The new era of expected credit loss provisioning, BIS Quarterly Review, March, pp.39-56.
6. Deloitte & Touche, IFRS 9: Financial Instruments – high level summary, April 2016.
7. Dugan, J. (2009). “Loan loss provisioning and pro-cyclicality”, remarks by John C. Dugan, Comptroller of the Currency, before the Institute of International Bankers, March, Washington DC.
8. E&Y (2017) “Financial Instruments: A summary of IFRS 9 and its effects”, March.
9. EFRAG (2013) Comment Letter – Financial Instruments: Expected Credit Losses, July, pp.1-25.
10. European Banking Authority (2016) “Report: On results from the EBA impact assessment of IFRS 9”, November, 2016.
11. European Banking Authority (2017) “EBA report on results from the second EBA impact assessment of IFRS 9”, July.
12. European Systemic Risk Board (2017) “Financial stability implications of IFRS 9”, July, 2017.
13. Financial Services Commission (FSC) Guidance Note (2013): Internal Audit Function in Banks, pp.1-20.
14. G20 2009 The Global Plan for Recovery and Reform and Declaration on Strengthening the Financial System, G20 London Summit, April, 2009.
15. G20, London Summit – Leader’s Statement, 2nd April, 2009; https://www.imf.org/external/np/sec/pr/2009/pdf/g20_040209.pdf
16. Gebhardt, G. & Z. Novoty-Farkas. (2011). Mandatory IFRS Adoption and Accounting Quality of European Banks, Journal of Business Finance & Accounting, 38, April, pp. 289-333.
17. Gorgan, C. (2013). Convergenta contabilă internaţională. Implica܊ii asupra raportării financiare, Editura ASE, Bucharest.
18. Horomnea, E. (2012). Dimensiunile științei, sociale și spirituale în contabilitate, Editura Tipo Moldova.
19. IFRS 9, Official Journal of the EU, Commission Regulation (EU) 2016/2067 of 22 November 2016, L323.
20. IFRS 9: Matters for Non-Financial Entities Extract, IFRS Discussion Group Report on the Meeting, May 30, 2017.
21. IFRS Foundation (2017) IFRS Standards and financial stability, pp.1-20.
22. Laeven, L. and G. Majnoni. (2003). Loan loss provisioning and economic slowdowns: too much, too late?, Journal of Financial Intermediation, 12 (2), April, pp. 178-197.
23. Măciucă, Geanina, Hlaciuc, Elena and Ursache, Antonela. (2015). The role of prudence in financial reporting: IFRS versus Directive 34, Procedia Economics and Finance 32 (2015), pp. 738 – 744.
24. Milanova, E. (2012). Accounting aspects of anti-cyclical policy of the banks in Bulgaria”, Jubilee International Scientific Conference: ‘Crisis and Economic Growth’, UNWE, Sofia, University Press, pp. 111-119.
25. Milanova, E. (2017). Compatibility between IFRS 9 Financial Instruments and the Basel framework for capital requirements, Yearbook 2016 IDES (ICPA) in Bulgaria, pp.31-78.
26. Niklas Frykström and Jieying Li, Financial Stability Department of the Riksbank (2018) IFRS 9 – the new accounting standard for credit loss recognition, No. 3, 2018.
27. Novotny-Farkas, Z. (2015) ‘The Significance of IFRS 9 for Financial Stability and Supervisory Rules’, European Parliament, Directorate General for Internal Policies Policy Department A: Economic and Scientific Policy, Brussels, European Union, 2015, Study for the ECON Committee.
28. Official Journal of the European Union, L 323, Commission Regulation (EU) 2016/2067 of 22 November 2016 amending Regulation (EC) No 1126/2008 adopting certain international accounting standards in accordance with Regulation (EC) No 1606/2002 of the European Parliament and of the Council as regards International Financial Reporting Standard 9.
29. Peek, J and E Rosengren (1995): “The capital crunch: neither a borrower nor a lender be”, Journal of Money, Credit and Banking, Vol. 27, pp 625 – 638.
30. Regulation (EU) 2017/2401 of the European Parliament and of the Council of 12 December 2017 amending Regulation (EU) No 575/2013 on prudential requirements for credit institutions and investment firms.
31. Restoy, F. & Zamil, R. (2017). Prudential policy considerations under expected loss provisioning: lessons from Asia, Financial Stability Institute (FSI) Insights on policy implementation No 5, Bank for International Settlements (BIS), October, pp.1-32.
32. Stefano, N., Norges Bank Economic Commentary, no. 8, 2017, IFRS 9, Implementation. N. Stefano thanks Henrik Andersen, Arild Lund, Kjell Bjørn Nordal, Elise Vik Sætre, Ylva Søvik and Sindre Weme for comments.
33. Sunder, S. (2016). Rethinking Financial Reporting: Standards, Norms and Institutions, Foundations and Trends in Accounting, Vol. 11, No. 1-2 (2016), 1-122.
34. Vítor Constâncio: Resolving Europe’s NPL burden – challenges and benefits: Keynote speech by Mr. Vítor Constâncio, Vice-President of the European Central Bank, at an event “Tackling Europe’s non-performing loans crisis: restructuring debt, reviving growth”, organised by Bruegel, Brussels, February 2017, pp.1-13, BIS central bankers’ speeches.
35. Walter, J. R., (1991): “Loan Loss Reserves, Economic Review”, July/August, pp.20-30.
36. ZAO Deloitte & Touche CIS (2016) “IFRS 9: Financial Instruments – high level summary”, April, pp.1-18.​
    
    
    ​