IFRS 9 Bridges the Gap Between Accounting and Risk Management
By Eva De Leon, CPA, Product Manager, Bloomberg L.P.
For years, accounting and risk management have not always been fully in sync. Limitations in the prevailing accounting standard meant that firms were not always able to accurately reflect their risk management activities in financial statements. While the emphasis of accounting was on the forensics of company finances, risk management was traditionally focused on the prospective future. IFRS 9 will help to clarify the role and outcome of risk management in the accounting output.
IFRS 9’s impact - and opportunity - will be in encouraging clarity among stakeholders and providing a common language and framework that finance, treasury, risk functions and the CFO can use. Closer collaboration across multiple functions should improve the information flowing to the treasurer and CFO, and enable them to better communicate financial performance to investors in a way that helps them understand the risks a company faces.
Key changes introduced to achieve closer alignment
The global financial crisis exposed many problems with IFRS 9’s predecessor, IAS 39. It was viewed as complex, challenging to implement, inflexible and confusing to investors in its treatment and reporting of risk management. The crisis highlighted the deficiencies of the incurred loss impairment model, whereby a provision is booked after a loss event has happened, resulting in delayed credit-loss recognition. This was commonly referred to as ‘too little, too late’. A further criticism of IAS 39 was the complicated and restrictive nature of the hedge accounting requirements. Companies often found themselves unable to achieve hedge accounting for common hedging strategies. The inability to achieve hedge accounting and postponement of credit losses resulted in financial statements not necessarily reflecting the true status of risk management application.
Key changes under IFRS 9 aim to address the weaknesses found in IAS 39. IFRS 9 sees a general shift from a prescriptive to a principle-based approach, changes to the way financial assets are classified and measured based on their nature and how they are managed, changes to the impairment model based on expected rather than incurred credit losses, and a move to hedge accounting guidelines that are less rigid and more aligned to the underlying transactions.
Adopting the new expected credit loss (ECL) model will require companies to consider multiple, probability weighted scenarios and macroeconomic factors in order to apply a forward-looking approach. Credit losses will be recognised earlier, from the point a loan is issued, and will be based on the expectation of losses over the life of the instrument. Credit risk modelling is likely to be a key feature in the assessment of credit risk and the subsequent tracking of credit risk. However, equally as important, ECL calculations will require significant management judgement. Both must be accompanied by enhanced disclosure, covering amongst other things provisioning policies, definitions of key concepts impacting ECL estimation and performance ratios.
The need for increased judgement and disclosure is an opportunity for CFOs to explain their reasoning and strategy because it creates a need for more discernment and explanation of assumptions. Under an ECL approach, financial statements will reflect the credit risk management process more closely; therefore they must be prepared with evidence and justification for decisions such as the threshold to indicate a ‘significant increase’ in credit risk. These changes create an opportunity for treasurers and CFOs to open the dialogue with investors about how risk is managed in a company.
Fig 1 - Sample airline key performance indicators and impact of IFRS 9