 Hello, and welcome to the session. This is Professor Farhad. In this session, we would look at IFRS 9 specifically impairment. This topic is covered in international accounting, the CPA exam, the ACCA exam as well. As always, I would like to remind you to connect with me on LinkedIn. YouTube is where you would need to subscribe. I have over 1500 plus accounting, auditing and tax lectures. Please like my lectures. Click on the like button. It helps me tremendously. Share them, put them in the playlist that the world know about them. If you're benefiting from my YouTube, it means other people might benefit. So please share the wealth. This is my Instagram account. Please follow me on Instagram. I'm trying to grow my Instagram. This is my Facebook. And this is my website. On my website, you always have the option to donate, support the channel if you chose to. Also on my website, I do have limited offer. For example, right now, Becker CPA is offering $1000 discount under Bucker Bundle. Becker is the best CPA prep course out there. It's the gold standard in CPA preparation. Although you may be an accounting student, you can use the material to supplement your college education. The whole package will offer you 10,000 plus multiple choice exercises and over hundreds of hours of lectures by CPA qualified. Instructors. Today, we're going to talk about IFRS 9 specifically impairment. Now it's very, very helpful to learn a little bit more about the background. When did that IFRS 9 impairment rule came about and what's the reason for it? The reason for it is basically the financial crisis. And if you don't know anything about the financial crisis, it's specifically the financial crisis of 07 and 08, I suggest you watch The Big Short or read the book. I read the book. I watched the movie. It's one of my favorite topics to discuss. So because I lived through the crisis and I really love it. So it came about after the financial crisis and specifically, you know, this is the book that you want to read. It's called The Big Short. What happened is this? During the financial crisis, banks incurred large losses suddenly. So what happened is this? Banks lend money. That's the banks are in the business of lending money and they lend money to people who are buying homes. I'm just trying to simplify this process here. Lend people who are who are buying homes and you're supposed to make payments on their home. Well, you'll pay the bank interest and principal. Well, guess what? If you cannot pay your interest and principal, the bank will incur a loss. Basically, in a sense, I'm sure you are familiar with that expense. Basically, the bank will have to incur losses. And what happened in 2007, 2008, suddenly, all the people or the majority of the people who took loans in 2005, starting in 2004, 2004, 2005, 2006 and 2007, a large portion of these people started to default, started not to be able to pay their loans. Now, the reason why that's a different story, I can't get into it here, but the point is banks were experiencing experience suddenly large losses. So the previous rules for such losses for the impairment is the rules were reactive. The rules were reactive. What does reactive mean? It means we book the losses as they occur. So wait for the losses. And if they happen, guess what? We have losses. What we have now is expected credit loss model. Notice the word expected. Expected means future. Now we have to look into the future and try to guess, try to anticipate, try to anticipate what our losses are going to be. Why are we trying to do so? So we don't get caught again with large losses suddenly. That's the purpose of the expected credit loss model, which is basically part of the IFRS 9 impairment. So the new rules are more proactive. They're they're anticipatory. They're expected. You have to guess. You have to estimate and also to a great degree, they are simplified. The rules might be simplified, but applying them is a little bit more challenging. We'll see why shortly. And we want to avoid large losses. We don't want no surprises. So that's the basically the purpose of IFRS 9. To simplify the process, make sure losses are not, they don't hit us in the face all at once. And we have some system that's anticipate those losses. And those rules technically applies to security is classified at amortized cost. Why is that? And what's classified at amortized cost? Basically, as we talked about in the prior session is bonds or debt investments. When you lend money out or when you buy investments. Why? Because usually equity investment, the changes goes into the income statement. So there's no need to to worry about this. And debt securities help for a fair value OCI. That's also the impairment would apply to those. Again, why not securities? Equity securities. We go through the we got we take the losses and the gains through the income statement, generally speaking. So we don't have to worry about this. So let's talk about the model, the IFRS model. There are two models. There is the general model and the simplified model. I'm going to cover the general model. The general model has three stages. Basically, the simplified model is once one stage, and there are rules when you would use one or the other. We don't get into this. It gets very specific. But the point is to kind of understand the big idea. Okay. The three stages is we have three stages. The stage one is insignificant deterioration. What does that mean? It means when the company and specifically here, these rules apply to banks, companies that lend out money, okay. Financial institution, or it doesn't have to be a bank companies that invest in debt securities like insurance company, okay. Insurance company, they buy a lot of bonds. They take their money and they invest them in bonds. So when they make that investment, when they when the bank makes that loan, when they when the bank make that investment, they have to upfront upfront guess what's their losses in the next 12 months. So they have to estimate the probability of the fault for the first 12 months. And basically, they have to look into the future. Now there's this small binocular here. They have to look into the future. And they don't have to look that much, at least the next 12 months that's upfront. So interest revenue is based on the gross amount. So they would recognize interest revenue. So when they take when they make a loan or when you buy a bond, let's assume it's for a million dollar, you're earning 5%, your interest revenue is 50,000. Then you have to make a guess. And let's assume the change the chance, not the change, the chance of the folding is 2%. So the chance of the folding on this loan is 2%. What does that mean? It means there's a good chance you may not collect $20,000 from the million dollar that you that you invested or that you lent out. Well, what does that mean? It means you have to write down your loan. You have to take a loss of 20,000. Not a big deal. 20,000 for a million dollar. Then we have to go into stage two, stage two when you have significant deterioration. Now, when do you when do you go into stage two? Generally speaking, at the end of the accounting period, at the end of the quarter, okay, depending on the situation, sometime, maybe a month later, what you do here is you would review, you have a bigger. Now, you are you, you already, you already, you already lend the money. And now you are in the industry, you're monitoring what's going on. Now you're reviewing macroeconomic factors, industry information, geographical risk, and reassessing risk in general. Here you are having a bigger vernacular. Now you have a telescope, but that's not a big telescope, a small telescope. And now you have more information or you're looking at a little bit into the future. Okay. What's happening to them is the economic situation deteriorating overall. Did we lend money to the real estate industry? Did we lend money to the, to the retail industry? Is the retail industry experiencing difficulties? So we want to know what's going on. Did we lend our money in a particular geographical area where this geographical area is experiencing expansion or deterioration? Now, we have more information. So you would reassess. Now you have to estimate the probability once you are in of default for the remaining life of the loan. Now that remaining life of the loan could be three years, could be five years, could be 10 years, could be 20, 30 years. For example, a mortgage could be 30 years. And this is the most challenging for the bank. Why? Because think about you want to estimate your losses in the next 20, 30 years. This is where it's significant deterioration. Once again, it doesn't have to be significant deterioration stage two. If the situation is good, well, we don't have to do anything. But the question is you have to assess that situation. Well, well, for example, after the financial crisis for the past 10 years, post the financial crisis, we had, we had, I would say the great expansion. Okay. So it doesn't have to be deterioration. But the point is you have to go into stage two and determine your situation. Interest revenue in this stage would still be based on the gross amount. Let's assume, again, let's not assume anything, a million dollar, 5% is $50,000. Then let's assume you assess the chance, not the change, the chance, the chance of defaulting. And now the situation did deteriorate. We're going to work an example where it did deteriorate. If it doesn't deteriorate, you might have to reverse your losses or you might not have to do anything. But here we're going to assume it did deteriorate. And now the change of defaulting over the life of the loan is 20%. Now, how do we come up with that 20%? It could be a weighted average. Okay, they'll take many factors into account and they determine on average there's a chance of 20% default rate of defaulting. It means we're not going to get 200,000 of the loan. At this stage, we would still record interest revenue of 50,000. Then we have to go into stage three. And what is stage three? Stage three is called credit impaired. Here, you have a large telescope and you're looking into the future based on current information, based on past information. And now you're monitoring the data and you have actual data. You know what's going on. Now you have to, again, estimate the probability of defaulting over the remaining life and record the loss if the situation is deteriorating. What does change in stage three once you reach what's called credit impaired? Your interest revenue now is based on the net value of the loan. So remember, you wrote your loan down. Now your interest revenue will have to be lower. So if there's a 50% chance of defaulting, that's a huge chance. It means you're not going to receive half of your loan. If your loan is a million dollar, now your loan, you're going to not receive half a million. Okay, so you have to book half a million of losses. And your interest revenue will be based on the half a million remaining because the loan is a million, half a million you will not collect. That's the change of the fault, the chance of defaulting. What's left is the half a million that you will collect. And based on that half a million, you would compute your interest revenue, which is based on 5%, which your interest revenue will be 25,000. Now, this is a simplified example in the real world. This is more challenging, much, much more challenging in application, but this is for educational purposes. If you have any questions about this topic, please email me. If you happen to visit my website, please consider supporting the channel. And I strongly suggest you watch The Big Four or read the book. I would say read the book then watch the movie. It's a great movie. Good luck and study hard for your exam, whether it's the CPA or the ACCA.