Financial Guarantee Valuation

Financial Guarantee Valuation Software

Financial guarantee liability 

Financial guarantees should be shown in the balance sheet as a liability at fair value. No longer can this be shown as a contingent liability. Also if no commission is involved, the entity should provide imputed commission.

Key highlights:

  • Computation of Fair Value of Financial Guarantees as per the requirements of the Accounting Standard
  • Determine impact on profit and loss account  
  • Compute the imputed guarantee commission and recognise income 
  • Account for the guarantees and commission income depending upon the relationship with the entity for which guarantee is provided

Data upload

  • Upload the guarantee details
  • Input the loan repayment schedule for which guarantee is provided
  • All transition matrix published by top credit rating agencies available in the system for easy computation

System highlights:

  • Cloud-based application with full security
  • Three User Profiles provided in the Customer Portal:
  1. Accountant role – Multiple accountants can enter the data. Each accountant can view or edit the data uploaded by him/her
  2. Manager role – One person responsible for the processed output, who can view and edit all data entered by any accountant. He/she can process the data and generate all reports
  3. Auditor role – One auditor login to view all the input data and reports available in the system. Can view the entire audit trail for all transactions and processes
  • Dashboard providing details of guarantee liability to be provided and the imputed commission income

What is a financial guarantee contract?

A financial guarantee contract is a contract that requires the issuer to make specified payments to reimburse the holder for loss it incurs because a specified debtor fails to make payment that is due in accordance with the original or modified terms of a debt instrument.

Accounting for financial guarantee contracts

If an issuer of financial guarantee contracts has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting that is applicable to insurance contracts, the issuer may elect to apply either Ind AS 109 or Ind AS 104 to such financial guarantee contracts. The entity may make that election on a contract by contract basis. How-ever, the election for each contract is not revocable.

Financial guarantee contracts after initial recognition is measured at the higher of:

  1. Impairment loss allowance determined as per requirements of Ind AS 109 and
  2. The amount initially recognised less cumulative amount of income recognised as per Ind AS 18.

Date of initial recognition

For financial guarantee contracts, the date the entity becomes a party to the irrevocable com-mitment is considered to be the date of initial recognition for the purpose of applying the im-pairment requirements.

Legal form

A financial guarantee contract may have different legal forms viz., guarantee, letter of credit, a credit default contract or an insurance contract. The accounting treatment for such financial guarantee contract is not dependent on its legal form.
Contracts that are not financial guarantee contracts

Some credit-related guarantees do not, as a precondition for payment, require that the holder is exposed to, and has incurred a loss on, the failure of the debtor to make payments on the guaranteed asset when due. An example of such a guarantee is one that requires payments in response to changes in a specified credit rating or credit index. Such guarantees are not financial guarantee contracts as defined in this Standard, and are not insurance contracts as defined in Ind AS 104. Such guarantees are derivatives and the issuer should apply Ind AS 109 for such contracts.

If a financial guarantee contract was issued in connection with the sale of goods, the issuer should apply Ind AS 18 in determining when it recognises the revenue from the guarantee and from the sale of goods.
If a financial guarantee contract was issued to an unrelated party in a standalone arm’s length transaction, its fair value at the inception is likely to be equal to the premium received.

Timing of recognising life time expected credit losses

For financial guarantee contracts, an entity should consider the changes in the risk that the specified debtor will default on the contract. The significance of a change in the credit risk since initial recognition depends on the risk of a default occurring as at initial recognition. Thus, a given change, in absolute terms, in the risk of a default occurring will be more significant for a financial instrument with a lower initial risk of a default occurring compared to a financial instrument with a higher initial risk of a default occurring.

The risk of a default occurring on financial instruments that have comparable credit risk is higher the longer the expected life of the instrument; for example, the risk of a default occurring on an AAA-rated bond with an expected life of 10 years is higher than that on an AAA-rated bond with an expected life of five years.

For a financial guarantee contract, the entity is required to make payments only in the event of a default by the debtor in accordance with the terms of the instrument that is guaranteed. Accordingly, cash shortfalls are the expected payments to reimburse the holder for a credit loss that it incurs less any amounts that the entity expects to receive from the holder, the debtor or any other party. If the asset is fully guaranteed, the estimation of cash shortfalls for a financial guarantee contract would be consistent with the estimations of cash shortfalls for the asset subject to the guarantee.

Period over which to estimate expected credit losses

For financial guarantee contracts, this is the maximum contractual period over which an entity has a present contractual obligation to extend credit.

Time value of money

Expected credit losses on financial guarantee contracts for which the effective interest rate cannot be determined shall be discounted by applying a discount rate that reflects the current market assessment of the time value of money and the risks that are specific to the cash flows but only if, and to the extent that, the risks are taken into account by adjusting the discount rate instead of adjusting the cash shortfalls being discounted.

Impairment on transition to Ind AS

On transition, an entity should seek to approximate the credit risk on initial recognition by considering all reasonable and supportable information that is available without undue cost or effort. An entity is not required to undertake an exhaustive search for information when determining, at the date of transition, whether there have been significant increases in credit risk since initial recognition. If an entity is unable to make this determination without undue cost or effort an entity shall recognise a loss allowance at an amount equal to lifetime expected credit losses at each reporting date until that financial instrument is derecognised.

In order to determine the loss allowance on financial guarantee contracts to which the entity became a party to the contract prior to the date of initial application, both on transition and until the derecognition of those items an entity shall consider information that is relevant in determining or approximating the credit risk at initial recognition. In order to determine or approximate the initial credit risk, an entity may consider internal and external information, including portfolio information.

Your subscription could not be saved. Please try again.
Your subscription has been successful.

Book a preliminary Consultation