New impairment methodology
What is the new impairment methodology? Is this concept entirely new?
Yes. The new impairment methodology is completely new and this is the one instance where the accounting bodies on both sides of the Atlantic agreed to disagree. The bone of contention as far as the US GAAP is concerned, is relating to the reversal of impairment loss. The new impairment methodology is expected to act more like a whistle blower so as to caution the entity of the impending loss that could arise on account of a financial asset over the life of such asset. The earlier model used to be ‘incurred credit loss model’ which is criticised on the grounds that it is ‘too little and too late’.
As per the new requirement, it is no longer necessary for a credit event to have occurred before credit losses are recognised. As per the revised requirements, an entity should always account for the expected credit losses and changes in those expected credit losses. The amount of expected credit losses is computed at each reporting period to reflect changes in the credit risk since initial recognition. This is expected to provide more timely information about the expected credit losses. This estimation about the expected credit losses happens when the financial asset is first originated. For the purpose of measuring the expected credit losses, the entity should use all relevant information available, of course, without undue cost or effort. The effect of this requirement is that for the purpose of considering the expected credit losses the entity should use not only the historical losses and other relevant current information, but should also apply judgments in using reasonable and supportable forward looking information. This is a marked change from the previous requirements where the impairment losses were considered based on the incurred credit losses without considering any forward-looking information available with the entity.