New expected credit loss model applies to intercompany loans
Most preparers of financial statements for 30 June 2019 are aware of the change in the way provisioning (impairment allowances) are calculated for financial assets such as loans receivable, trade debtors and contract assets under IFRS 15 Revenue from Contracts with Customers.
IFRS 9 Financial Instruments, effective for periods beginning on or after 1 January 2018 (30 June 2019 year-ends), requires impairment allowances to be recognised on the basis of expected, rather than incurred credit losses.
However, many are not aware that this new ‘expected credit loss model’ (ECL) also applies to intercompany loans and loans to key management personnel.
What types of intercompany loans are impacted?
Intercompany loans impacted by the new ECL model include those made to:
- Joint ventures and associates
- Other related parties, and
- Key management personnel.
Applying IFRS 9 to related company loans can present a number of application challenges as they are often advanced on terms that are not arms-length or sometimes advanced on an informal basis without any terms at all. In addition, they can contain features that expose the lender to risks that are not consistent with a basic lending arrangement. Preparers need to be aware of these issues when applying IFRS 9.
Why loans to subsidiaries if these eliminate on consolidation?
While loans to subsidiaries eliminate on consolidation, and are therefore excluded from consolidated financial statements, preparers need to remember that financial statements prepared under Part 2M.3 of the Corporations Act 2001 must disclose additional parent summarised balance sheet information as required by Regulation 2M.3.01 Disclosures required by notes to consolidated financial statements-annual financial reports.
In making these additional parent entity disclosures, the ECL model must be applied when determining appropriate amounts of total current assets, and total assets, of the parent entity.
Loans to joint ventures and associates
Many groups fund the operations of associates and joint ventures using long-term loan funding rather than injecting equity, particularly in the exploration industry. Such loans do not eliminate on consolidation and must be tested for impairment using the ECL model in the group financial statements.
Amendments to IAS 28 Investments in Associates and Joint Ventures (AASB 2017-7 Amendments to Australian Accounting Standards – Long-term interests in Associates and Joint Ventures, which have not yet been fully compiled into the latest version of AASB 128 on www.aasb.gov.au), also need to be noted. The process for determining impairment on long-term interests that in substance form part of the entity’s net investment in an associate or joint venture (and the equity method is not applied) is as follows:
|Step 1: Determine if the interest is in the scope of IAS 28 or IFRS 9
|Step 2: Apply IFRS 9 ECL model to the long-term interest
|Step 3: Apply the equity method to equity interests
|Step 4: Allocate any remaining losses to the long-term interest
|Step 5: Apply IAS 28 impairment indicators to the net investment and, if there is objective evidence of impairment, apply IAS 36
The amendments clarify that the ECL is applied to long-term interests before allocating any remaining equity accounted losses, and the final IAS 28 impairment test (based on the incurred loss model) is a ‘catch all’ test which is conducted last.
These changes could have a significant impact on the carrying amount of long-term loans to associates and joint ventures because currently impairment testing is typically ‘left until last’ and determined using the incurred loss rather than the ECL model.
While the AASB 2017-7 amendments only apply for periods beginning on or after 1 January 2019 (and therefore do not technically apply to 30 June 2019 year-ends), we recommend that these are considered because they serve to clarify the process, rather than being a new requirement. Financial statements for the half-year ending 30 June 2019 must apply these amendments.
Other related parties
Loans to other related parties also do not eliminate on consolidation and the ECL model must be applied to such balances in the consolidated financial statements.
Key management personnel – don’t forget disclosures
It is important to remember that the ECL model also applies to loans granted to key management personnel (KMPs).
While expected credit losses on these loans may not be material in quantitative terms, they are likely to be considered qualitatively material. Additional disclosures are therefore required by IAS 24 Related Party Disclosures and in remuneration reports for listed entities.
For each type of related party loan receivable, including loans to KMPs, IAS 24, paragraph 18 requires entities to disclose information such as:
- The amount of outstanding balances, and
- Provisions for doubtful debts related to the amount of outstanding balances.
Listed entities will additionally be required to disclose information about the amount of impairment allowances for loans to KMPs:
- In aggregate for all loans to KMPs – refer Corporations Regulation 2M.3.03(1) item 20(d)
- For each KMP - where the loan is greater than $100,000 during the reporting period - refer Corporations Regulation 2M.3.03(1) item 21(d).
BDO’s IFRS in Practice - Applying IFRS 9 to Related Company Loans sets out a summary of the key requirements of IFRS 9 (focusing on those that are likely to be most relevant to related company loans) and uses examples to illustrate how these requirements could be applied in practice.