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THE RISKS AND OPPORTUNITIES
What is IFRS 9?
“IFRS” is an acronym for “International Financial Reporting Standards”. IRFS 9 is an international accounting standard established by the IASB (International Accounting Standards Board). It requires assets to be valued prospectively, or looking forward, rather than retrospectively, or based on historical performance. It applies to all assets, but has an outsized-impact on accounts receivable, particularly high-risk, high-return products such as credit card portfolios that have no set term.
When does it come into effect?
IFRS 9 comes into effect for all businesses in Canada for fiscal years beginning on or after January 1, 2018. OSFI (Office of the Superintendent of Financial Institutions) decided that it must be implemented by “Domestic Systemically Important Banks” (D-SIBs, Canada’s six largest banks) for their accounting year beginning on November 1, 2017 (see http://www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/adv-prv/Pages/freifrs9.aspx).
Who does it impact?
IFRS 9 applies to all businesses but has the greatest impact on lenders, particularly those who issue credit cards and other loans that have no set term. Because of the increased risks and financial rewards for better risk management IFRS 9 will generate, service providers may be impacted to a greater extent than in the past for how they help or hinder creditors in their receivables management processes.
How does it work?
Rather than creating an allowance for bad debt that is based on historical default rates, IFRS 9 sets rules that require lenders to project the performance of each loan or account for the life of the product. Lenders must “impair” the value of each product based on expectations for each individual account. Financial institutions have extensively prepared for IFRS 9 by building accounting systems and models to revalue or “impair” their accounts receivable using data on current account statuses, revaluing them as frequently as daily.
What is the expected impact?
With the implementation of IFRS 9, financial institutions have already or will be increasing their allowances for bad debt, a liability on their balance sheets, by up to ten times. Under IFRS 9 rules, an allowance for bad debt of $100 million could jump to as high as $1 billion. In the transition to IFRS 9, businesses get a one-time free pass to increase that allowance without incurring a corresponding expense to fund it.
The risks and opportunities come with adjusting that allowance after it is established. Under IFRS 9 you do not only expense bad debts as you incur them as in the past. You must also expense future expected losses in the current period by increasing the allowance immediately.
What are the risks?
Under IFRS 9 if there is an unaccounted-for high-impact event like the crash in oil prices that greatly increased expected default rates in Alberta, those increased expected losses would impact the income statement and balance sheet now, not in future financial reporting periods when the expected losses are actually incurred. Any event, business performance degradation, or economic downturn that is expected to impair the value of accounts receivable must be reflected by adjusting the bad debt allowance.
What are the opportunities?
The flip side to this risk is the opportunity that comes by having greatly increased the allowance for bad debt to accord with IFRS 9’s future-looking rules. That allowance was established based on historical performance. The value of any sustained improvement in collection and recovery processes that reduces the expectation of future losses may result in a reduction in the bad debt allowance. The future benefit of these expected improvements over many accounting periods may thus be realized in the current accounting period, amplifying the current financial impact of the improvements.
This amplified financial impact creates an environment ripe for creditors and service providers to collaborate in implementing process improvements. Because of IFRS 9, opportunities for improvement that may have stayed on the back burner for lack of a strong-enough business case compared to other priorities might now become high-impact attention-grabbers.
Want to learn more?
The Credit Association of Greater Toronto is hosting a dinner meeting on Tuesday March 6, 2018 with a panel of experts on IFRS 9:
Daniel Longridge, Credit Risk Manager at Canadian Tire Bank
Mahdi Amri, Partner, CFA Deloitte
Pedro Maya, Vice President, Canada Collections and Global Operations at Scotiabank.
Come out to learn from the best and spend an evening building relationships with other lenders and service providers. See https://www.cagt.ca/dinner-meetings/.
Have a question you’d like the panel to address?
If you have any questions about IFRS 9 that you would like the panel to address, please send them to me at ifrs9@christensenlawfirm.com. I will be the moderator for the panel.
Todd R. Christensen, LL.B., MBA, Barrister & Solicitor
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