‘Expected credit loss’ model under IFRS 9 to be applied to loans advanced to associates and joint ventures
As part of its annual improvements programme (2015-2017 cycle), the International Accounting Standards Board (IASB) last month approved changes to IAS 28 Investments in Associates and Joint Ventures. These changes have not yet been approved by the Australian Accounting Standards Board.
The changes are likely to have a major impact on entities with investments in overseas exploration projects that are funded primarily through loans advanced to associates and joint ventures, rather than via equity funding.
Currently, many such entities may be relying on projects not yet being at a stage to be tested for impairment under AASB 6 Exploration for and Evaluation of Mineral Resources to conclude that there is no objective evidence of impairment under IAS 28.
The changes clarify that loans are first tested for impairment under IFRS 9, and then under IAS 28.
These changes clarify that:
- Loans advanced to an associate or joint venture, which in substance form part of the net investment but to which the equity method is not applied, must be tested for impairment by applying the ‘expected credit loss’ model in IFRS 9 Financial Instruments, and
- IAS 28, paragraph 38 is applied to discontinue recognising equity accounted losses where these exceed the ‘interest in associate or joint venture’
- IAS 28, paragraphs 40-43 are applied to determine whether there is any further impairment loss on the net investment using the ‘incurred loss model’, i.e. there must be objective evidence of impairment.
The ‘interest in the associate or joint venture’ comprises:
- Carrying amount of the investment in associate or joint venture using the equity method, plus
- Any long-term interests that in substance form part of the entity’s net investment in the associate or joint venture, such as long-term loans where settlement is neither planned nor likely to occur in the foreseeable future.
If an entity’s share of losses of an associate or a joint venture equals or exceeds its interest in the associate or joint venture, the entity discontinues recognising its share of further losses. The interest in an associate or a joint venture is the carrying amount of the investment in the associate or joint venture determined using the equity method together with any long-term interests that, in substance, form part of the entity’s net investment in the associate or joint venture. For example, an item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, an extension of the entity’s investment in that associate or joint venture. Such items may include preference shares and long-term receivables or loans, but do not include trade receivables, trade payables or any long-term receivables for which adequate collateral exists, such as secured loans. Losses recognised using the equity method in excess of the entity’s investment in ordinary shares are applied to the other components of the entity’s interest in an associate or a joint venture in the reverse order of their seniority (i.e. priority in liquidation).
IAS 28, paragraph 38
After application of the equity method, including recognising the associate’s or joint venture’s losses in accordance with paragraph 38, the entity applies paragraphs 41A–41C to determine whether there is any objective evidence that its net investment in the associate or joint venture is impaired.
IAS 28, paragraph 40
To further clarify how these amendments work, the IASB has released an ‘Illustrative Example – Long-term Interests in Associates and Joint Ventures’ which demonstrates that long-term loans are first considered for impairment under IFRS 9 using the expected loss model, and equity accounted losses are then deducted off these investment loans.