1.1 Investments in Loans and Receivables

Classification and measurement categories

Financial assets (except those for which the fair value option (FVO) has been elected; see Section 5.5) are classified on the basis of both (1) the entity’s business model for managing them and (2) their contractual cash flow characteristics. Three classification categories are used:

• Amortized cost — The assets are held within a business model with the objective to collect contractual cash flows that are solely payments of principal and interest (SPPI).
• Fair value, with changes in fair value through other comprehensive income (FVTOCI) — The assets have contractual cash flows that are SPPI and are held within a business model with the objective of both collecting contractual cash flows and selling financial assets.
• Fair value through profit or loss (FVTPL) — The assets have contractual cash flows that are not SPPI or are not held within a business model with the objective to (1) collect contractual cash flows or (2) both collect contractual cash flows and sell financial assets.

Generally, loan receivables are classified on the basis of management’s intent as either held for sale (HFS) or held for investment (HFI). Unless the FVO is elected (see Section 5.5), loan receivables are measured at either (1) the lower of cost or fair value (for HFS loans) or (2) amortized cost (for HFI loans).

Recognition and measurement of impairment losses

Expected-loss approach — An impairment loss on a financial asset accounted for at amortized cost or at FVTOCI is recognized immediately on the basis of expected credit losses.

Depending on the financial asset’s credit risk at inception and changes in credit risk from inception, as well as the applicability of certain practical expedients, the measurement of the impairment loss will differ. The impairment loss would be measured on a discounted cash flow basis as either (1) the 12-month credit loss or (2) the lifetime expected credit loss.

Further, for financial assets that are credit impaired at the time of recognition, the impairment loss will be based on the cumulative changes in the lifetime expected credit losses since initial recognition.

Current expected credit loss approach — An impairment loss on a loan or receivable accounted for at amortized cost is recognized immediately on the basis of expected credit losses.

Entities have flexibility in measuring expected credit losses as long as the measurement results in an allowance that:

• Reflects a risk of loss, even if remote.
• Reflects losses that are expected over the contractual life of the asset.
• Takes into account historical loss experience, current conditions, and reasonable and supportable forecasts.

Use of the discounted cash flow model is not required.

Effective interest method

The effective interest rate is computed on the basis of the estimated cash flows that are expected to be received over the expected life of a loan by considering all of the loan’s contractual terms (e.g., prepayment, call, and similar options) but not expected credit losses.

Interest revenue is calculated on the basis of the gross carrying amount (i.e., the amortized cost before adjusting for any loss allowance) unless the loan (1) is purchased or originated credit impaired or (2) subsequently became credit impaired. In those cases, interest revenue is calculated on the basis of amortized cost (i.e., net of the loss allowance). If estimated receipts are revised, the carrying amount is adjusted to the present value of the future estimated cash flows, discounted at the financial asset’s original effective interest rate (cumulative catch-up approach). The resulting adjustment is recognized within profit or loss.

The effective interest rate is computed on the basis of the contractual cash flows over the contractual term of the loan, except for (1) certain loans that are part of a group of prepayable loans and (2) purchased loans for which there is evidence of credit deterioration. For purchased credit-deteriorated assets, interest income is recognized on the basis of the purchase price plus the initial allowance accreting to the contractual cash flows.

If estimated payments for certain groups of prepayable loans are revised, an entity may adjust the net investment in the group of loans, on the basis of a recalculation of the effective yield to reflect actual payments to date and anticipated future payments, to the amount that would have existed had the new effective yield been applied since the loans’ origination/acquisition (retrospective approach), with a corresponding charge or credit to interest income.

Interest recognition on impaired loans

IFRS Accounting Standards do not permit nonaccrual of interest. However, for assets that have become credit-impaired, interest income is based on the net carrying amount of the credit-impaired financial asset.

There is no explicit requirement in U.S. GAAP for when an entity should cease the recognition of interest income on a receivable measured at amortized cost. However, the practice of placing financial assets on nonaccrual status is acknowledged by U.S. GAAP.

Loan modifications

A modification of the contractual cash flows of a financial asset is accounted for by derecognizing the original asset and recognizing a new asset if the modified terms are substantially different from the original terms.

If the modified financial asset is accounted for as a new asset, a gain or loss is recognized on the basis of the difference between (1) the net carrying amount of the original asset and (2) the fair value of the consideration received (including the fair value of the modified asset).

A loan modification is accounted for as a new loan if both (1) the terms are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks (i.e., effective yield is at least equal to the effective yield for comparable loans) and (2) the present value of the cash flows under the modified terms is at least 10 percent different from the present value of the remaining cash flows under the original terms (i.e., the modification is “more than minor”).

If the loan is accounted for as a new loan, any unamortized net fees or costs and any prepayment penalties associated with the original loan are recognized in interest income.