Impairment for debt instruments classified as FVOCI
Is impairment testing necessary for debt instruments classified as fair value through other comprehensive income?
Debt instruments that are classified as fair value through other comprehensive income are also subjected to impairment test. This is because while the financial asset classified as FVOCI is shown in the balance sheet at fair value, the changes in the fair value of such instruments are taken to the other comprehensive income. Fair valuing a debt instrument does not consider the impairment of the instrument. Fair value of a debt instrument is arrived at by discounting of the contractual cash flows at the current interest rate and recognising the differences in fair value in other comprehensive income. However, impairment loss allowance is required to be calculated based on the present value of the cash short falls expected to occur over the entire life of the instrument based on the profitability of default occurring over the next 12 months which essentially is a forward looking model. The loss allowance is taken to the profit and loss account and may even be a write back of the loss allowance depending upon the changes in the expected cash short falls. It should be noted that the impairment loss allowance is not considered while computing fair value of the instrument and hence debt instruments that are classified and measured at fair value through other comprehensive income are subjected to impairment testing.