Question

My Co purchased interest-bearing bonds in Your Co on December 1, 2019 for $10m and classified these assets to be measured at amortized cost. The CFO of My Co had read the interim financial statements of Your Co, which were released just before this purchase; these statements had indicated a strong financial position and yearly growth prospects. External credit rating agencies had also graded the bonds as having a low credit risk.

In May 2020, Your Co released its annual financial statements that showed that the company had suffered weak trading performance in the final six months of the reporting period. In addition, its cash generating ability from operations showed a large decline compared to the previous year, and the company was in danger of breaking its loan contracts. The share price of Your Co has fallen by 20% since December 2019 despite the fact that bonds issued by other listed companies in the same sector show increase in prices. It has been rumored that the credit rating agencies are revising the credit rating of Your Co. Till now, despite being in financial trouble, Your Co. had been able to meet its obligations to its lenders and bondholders.

The directors of My Co need advice on how the above information will impact the carrying amount of its financial assets.

You are required to advise My Co on how the above transaction should be correctly dealt with in its financial statements with reference to relevant international financial reporting standards (IFRSs).

Answer 1

IFRS 9 says that loss allowances must be recognised for financial assets that are debt instruments and which are measured at amortised cost.

To assess whether there has been a significant increase in credit risk, IFRS 9 requires entities to compare the asset's risk of default at the reporting date with its risk of default at the date of initial recognition. Entities should not rely solely on past information when determining if credit risk has increased significantly. An entity can assume that credit risk has not increased significantly if the instrument has a low credit risk at the reporting date. Credit risk can be assumed to have increased significantly if contractual payments are more than 30 days overdue at the reporting date.

If the credit risk on the financial asset has not increased significantly since initial recognition, the loss allowance should be equal to 12 month expected credit losses.

IFRS has provided guidelines to measure expected credit losses.

An entity’s estimate of expected credit losses should be unbiased and probability-weighted, reflective of the time value of money and based on information about past events, current conditions and forecasts of future economic conditions.

From the scenario above, we can find that Your Co has been able to meet its obligations to its lenders and bondholders. From this it can be assumed that the credit risk has not increased significantly since its initial measurement. But the remaining indications do suggest otherwise.