This article mainly covers business model for amortisation method and its accounting aspects under Ind AS 109. As notified by RBI, the entity may grant moratorium period as follows:
- The moratorium period will be granted for a period of three month for payment instalments due between March 1, 2020 and May 31, 2020. However, interest will be accrued on outstanding balance at contracted rate for granted period and such will be recovered as per policy drafted by entity.
- The moratorium period will be granted for all term loans including principal/ interest components, EMIs and credit card dues.
- The circular is applicable for all commercial banks (including regional rural banks, small finance banks and local area banks), co-operative banks, all-India Financial Institutions, and Non-Banking Financial Companies (including housing finance companies).
The major questions which may arise for accounting aspect under Ind AS 109 for financial asset are as follows:
- Will it lead to modification accounting on account of change in number of EMI and its amount as per policy of entity?
- Will it lead to increase in Expected Credit Risk (ECL) for impairment by considering the forward - looking information and economic impact of interruptions amid COVID 19?
Ind AS 109, Para 5.4.3 provides, 'When the contractual cash flows of a financial asset are renegotiated or otherwise modified and the renegotiation or modification does not result in the derecognition of that financial asset in accordance with this Standard, an entity shall recalculate the gross carrying amount of the financial asset and shall recognise a modification gain or loss in profit or loss. The gross carrying amount of the financial asset shall be recalculated as the present value of the renegotiated or modified contractual cash flows that are discounted at the financial asset’s original effective interest rate (EIR) or revised EIR, if applicable.’
As per the guidelines by RBI, interest will be accrued for moratorium period as well as per contracted rate. So irrespective of change in number of EMI or amount of EMI, IRR will remain intact at the end and also there will be no additional cost for providing moratorium period. By considering above two aspect Effective Rate of Interest (EIR) will also remain constant conceptually under amortisation method as per Ind AS 109, which results in same carrying amount as on date whether discount to present value or not. Thus, there will be no question for modification accounting as there is no difference in EIR as well as present value of carrying amount also. Thus, interest will be charged as per computed EIR and same will remain continue for moratorium period and at the end of the revised term it will be adjusted by all the receipts made from borrowers. Ultimately in this part there will be no major modification on account of interest as per EIR.
Expected Credit Loss (ECL)
Entity shall recognise loss allowance for Expected Credit Loss (ECL) by assessing the information available for past and present condition which obtained without undue cost or effort. As information available with entity is varies according to its portfolio and exposure at risk, assessment is not uniform for all entities.
However, para 5.5.11 of Ind AS 109 provides for using forward - looking information available without undue cost or effort.
Para 5.5.11 provides, 'If reasonable and supportable forward - looking information is available without undue cost or effort, an entity cannot rely solely on past due information when determining whether credit risk has increased significantly since initial recognition. However, when information that is more forward - looking than past due status (either on an individual or a collective basis) is not available without undue cost or effort, an entity may use past due information to determine whether there have been significant increases in credit risk since initial recognition.’
With reference to above, by considering the economic impact of interruptions made due to steps taken for COVID - 19 and i.e. impact on businesses of borrowers and degree of risk for repayment which might get increases on account of damaged net inflow of borrower. This indicates higher probability of default (PD) for repayment which ultimately leads to higher ECL. The major component in computing ECL is PD. For the purpose of PD, we use historical information by assessing the entities internal credit risk data as well as forward - looking economic impacts to arrive at PD.
Formulae for calculating ECL and its different stages to account for ECL are as follows:
- ECL = EAD * PD * LGD
- EAD = Exposure at default
- PD = Probability of default
- LGD = Loss given default
LGD is measured by percentage of loss incurred on exposure at default after considering value received on account of collateral. However, we should also consider forward - looking impact on impairment of value of collateral which leads to increase in loss i.e. % of LGD and ultimately increase in ECL.
EAD is also remain higher compared to what would have been if no moratorium period on account of interruptions made in repayment. By considering all above aspect, we can conclude that there will be increase in ECL due to considerable forward - looking impact. However, how to use the information available with entity and how to account for it will lies with management considerations which varies for each entity but economic impacts will affect all the entities and its borrowers in portfolio.
Ind AS 109 provides three stage model for classifying its asset for the purpose of computing ECL and summary form of 3 stages are as follows:
12-month ECL: Had no significant increase in credit risk since its initial recognition
Life time ECL: Significant increase in credit risk since its initial recognition but interest will be charged as per EIR as asset is not yet completely impaired.
Life time ECL: Significant increase in credit risk since its initial recognition and asset will be impaired i.e. 100% ECL.
There will be also chances for shifting of stages of financial assets as significance of increase in asset is increase from now. Major asset might be shifted from 12 Month ECL to Life time ECL and the assets which are likely to impair before, might get impaired due to this. So, shifting of asset from one stage to other is also impact on amount of Expected Credit Loss.
Considering the Ind AS-109 for ECL, every aspects, methods or stages is influenced by the interruptions made due to COVID 19. Hence, this forward - looking information is considerable for computing ECL and each component of formulae for ECL and each stage of ECL should be analysed minutely for providing loss allowance on financial asset. As, using past information only for computing ECL might not provide the true and fair position of entity and its portfolio. So, all above discussed aspect need to consider to provide best judgement for the purpose of providing loss allowance on exposure held by entity and its financial impact should also be disclosed. It will be a good approach to disclose the information available with the entity and make financial statement true and fair presented. We should also consider the impact on repayment towards the debt obtained by entity (generally higher in NBFCs) as its regular cycle and financial flow will get affected.
We should also consider the measures taken by regulatory authorities and government for this particular aspect and industry wide impact of such interruption as entities have different profiles in its portfolio and it should consider the portfolio by dividing in the groups or sub-groups which might be a flexible approach to analyse the each and every aspect of economic and industrial impact. This approach not only work for dividing industry in portfolio, but also for dividing portfolio in collateral asset wise, borrower’s income slab wise, ageing of all cases, area wise and end number of aspects available with the entity. It will be interesting to see the assumptions and treatment made by entities for computing ECL.
It is to be concluded that accounting for interest and loss allowance will become important for moratorium period by considering the all aspect discussed above i.e. guidelines by RBI for EIR, steps taken by government for economy, industrial impact, impact on borrower’s business, impact on value of collateral, significant impact on risk, impact on classification of stages for ECL and impact of all other affecting factors with reference to borrower i.e. area, ageing, business, regulatory environment etc. which all leads to computing ECL and may provide true and fair presentation of entity as on date and reflect true image of its portfolio. As major part for any financial entity is its financial assets and any adverse impact on such asset will affect the whole business entirely so, accounting and presentation of these assets is necessary to make appropriately and for this only, we will have to follow all the aspect covered under Ind AS 109.
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