Comparison of “Incurred Loss Approach” and

“Expected Credit Loss Impairment Approach”

◤
Impairment of
Loans
◤
Incurred Loss Approach

▪ PFRS 9- recognize Loss Allowance for Expected Credit Losses

on Financial Assets at Amortized Cost

▪ Loss Allowance= amount equal to Lifetime Expected Credit

Losses where credit risk has increased significantly since initial
recognition

▪ Credit Risk= Risk that one party to a financial instrument will

cause a financial loss for the other party by failing to discharge
an obligation
◤

Carrying amount of Loan (includes principal and accrued interest)

LESS: Present Value of estimated future cash flows (using original

effective rate)

= Amount of Impairment Loss

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Sample Problem

▪ International Bank loaned P5,000,000 to BankCard Company on January 1,

2018. The terms of the loan require payments of P1,000,000 each year for
5 years plus 10% interest.

▪ The first principal and interest payment was due December 31, 2018.
BankCard made the required payments on December 31, 2018 and
December 31, 2019

▪ However during 2020, BankCard began to experience financial difficulties

and failed to make the required principal and interest payment on
December 31,2020

▪ On December 31,2020 International Bank assessed the collectibility of the

loan and has determined that the remaining PRINCIPAL PAYMENTS WILL
BE COLLECTED but the COLLECTION OF INTEREST IS UNLIKELY
◤
▪ The loan receivable has a carrying amount of P3,300,000,
including the accrued interest of P300,000 on December 31,
2020

▪ International Bank projected the cash flows from the loan

Date of Cash Flow Amount Projected

December 31, 2021 P500,000
December 31,2022 P1,000,000
December 31, 2023 P1,500,000
 Incurred Loss Approach Steps:
◤
1. Determine the type of loan: In this case, the loan is paid in Installments

2. Determine when default occurred or when there was an assessment for credit risk and
the projected collection: In this case, it was at the end of Year 3 (December 31,2020)
principal collection will be made will interest payments are unlikely, meaning default will
occur for the next 3yrs. Or the remaining term of the loan

3. Determine the Carrying Amount of the Loan = Principal + Accrued Interest if any:
Original loan amount was P5,000,000 less 2 principal payments of P1,000,000 the
balance is P3,000,000 and accrued interest for year 3 amounted to P300,000
( P3,000,00 x 10%)

4. Determine the PV of FCF (PV OF 1 IS USED USUALLY 4 DECIMAL PLACES)

Projected Amount PV of 1 Factor Present Value
P500,000 0.9091 P454,550
P1,000,000 0.8264 P826,400
P1,500,000 0.7513 P1,126,950
TOTAL PV OF EXPECTED CF: P2,407,900
 1. 5. Determine
◤ Impairment Loss
Carrying Amount: P3,300,000

Less: PV of CF: P2,407,900

Impairment Loss= P892,100

2. 6. Construct a table if necessary (for chain questions)

Date Payments Made: Interest Income Deductible from CV

CV
2,407,900
December 31,2021 500,000 240,790 259,210 2,148,690
December 31, 2022 1,000,000 214,869 785,131 1,363,559
December 31,2023 1,500,000 *136,441 -
 Journalizing
◤

▪ December 31,2020: Year when credit risk increased and defaul occurred, record
Impairment Loss (if there is AIR, it should be credited first since collection is unlikely)
Loan Impairment Loss 892,100

Accrued interest Receivable 300,000

Allowance for Loan Impairment 592,100

▪ FS presentation at December 31,2020

Loans Receivable: P3,000,000
Allowance for Impairment: (592,100)
Carrying Amount- December 31,2020: P2,407,900
 ◤
▪ December 31, 2021 Collection of principal and recognition of interest income
charged against Allowance for Impairment:
Cash P500,000

Loans Receivable P500,000

Allowance for Impairment P240,790

Interest Income P240,790

▪ FS presentation at December 31,2021

Loans Receivable: P2,500,000

Allowance for Impairment (592,100- 240,790): (351,310)
Carrying Amount- December 31,2021: P2,148,690
 ◤

▪ December 31, 2022 Collection of principal and recognition of interest income

charged against Allowance for Impairment:
Cash P1,000,000

Loans Receivable P1,000,000

Allowance for Impairment P214,869

Interest Income P214,869

FS presentation at December 31,2022

Loans Receivable: P1,500,000

Allowance for Impairment (351,310- 214,869): (136,441)
Carrying Amount- December 31,2022: P1,363,559
 ◤

▪ December 31, 2023 Collection of principal and recognition of interest

income(balancing figure) charged against Allowance for Impairment:
Cash P1,500,000

Loans Receivable P1,500,000

Allowance for Impairment P136,441

Interest Income P136,441

◤
1. Determine the type of loan: In this case, the loan is paid in Lumpsum
◤
2. Determine when default occurred or when there was an assessment for credit risk and
the projected collection: In this case, the credit risk was assessed at the end of year
one citing default in Years 2 and 3 (2021 and 2022) so the default is for 2 years only.
Remember that the first payment was made thus when finding the PV factor start at
period 3.

3. Determine the Carrying Amount of the Loan = Principal + Accrued Interest if any:
Original loan amount was P3,000,000 without any accrued interest since

4. Determine the PV of FCF (PV OF 1 IS USED USUALLY 4 DECIMAL PLACES)

Year Projected PV of 1 Factor Present Value
Amount
2023 P240,000 0.794 P190,560
2024 P240,000 0.735 P176,400
2025 P240,000 0.681 P163,440
2026 P3,240,000 0.630 P2,041,200
TOTAL PV OF EXPECTED CF: P2,571,600
 ◤
1. 5. Determine Impairment Loss
Carrying Amount: P3,000,000

Less: PV of CF: P2,571,600

Impairment Loss= P428,400

6. No need to construct a table since it will only be amortized for two years (2021
and 2022 which was the years where payment of interest was defaulted)
 IFRS 9
◤
Three Stage Impairment Approach
 Interest Income= Gross/Face
Interest Income= Net Carrying
amount x Effective Rate
◤ Amount x Effective Rate

Stage 1: Stage 2: Stage 3:

12-Month Expected Credit Lifetime Expected Credit Lifetime Expected Credit
Loss Loss Loss

PERFORMING UNDERPERFORMING NON-PERFORMING

Debt instrument not Debt Instrument has Debt Instrument has

declined significantly in declined significantly in declined significantly in
quality credit quality BUT DO NOT credit quality WITH
HAVE OBJECTIVE OBJECTIVE EVIDENCE
LOW CREDIT RISK EVIDENCE
Expected Credit Loss
Portion of lifetime Expected Expected Credit Loss that that results from all
Credit Loss from default results from all default default events over the
events that are possible events over the expected life expected life of the
within 12 months after end of the instrument instrument
of reporting period.
◤
◤
◤
Comparison
Estimated Credit Loss
Approach (Three Stage
Incurred Loss Approach Impairment)
recognizes credit losses only a more forward looking
when evidence of loss is approach
apparent continuous or staggered
approach

Stage Three of ECL Approach is the same as

Incurred Loss Approach since there is objective
or apparent evidence ALMOST same approach.
Interest Income is charged against Allowance for
Impairment
 General Format for Computing Impairment Loss
◤ in the Three Stage Approach
STAGE 1:
▪ *Carrying Amount x Probability of Collection = Expected Cash Flows
x PV Factor
= PV OF CASH FLOWS

▪ Carrying Amount - PV of Cash Flows =TOTAL ECL

X Prob. of default within 12
months
= 12-MONTH ECL

★ RECORD INTEREST INCOME AS % OF GROSS OR FACE AMOUNT

 ◤

STAGE 2: NOTE: Check REMAINING PERIODS FOR DISCOUNTING

▪ *Carrying Amount x Probability of Collection = Expected Cash Flows
x PV Factor
= PV OF CASH FLOWS

▪ Carrying Amount - PV of Cash Flows =TOTAL ECL

X Prob. of default within remaining periods
= REQUIRED ALLOWANCE FOR IMPAIRMENT LOSS
LESS: Unadjusted Allowance(Prev.Year)
=IMPAIRMENT LOSS FOR THE CURRENT YEAR

★ RECORD INTEREST INCOME AS % OF GROSS OR FACE AMOUNT

 ◤
STAGE 3: NOTE: Check REMAINING PERIODS FOR DISCOUNTING
▪ *Carrying Amount x Probability of Collection = Expected Cash Flows
x PV Factor
= PV OF CASH FLOWS

▪ Carrying Amount - PV of Cash Flows =TOTAL ECL

= ALLOWANCE FOR IMPAIRMENT LOSS (before writeoffs)
LESS: Unadjusted Allowance(Prev.Years)
=IMPAIRMENT LOSS FOR THE CURRENT YEAR

★ RECORD INTEREST INCOME AS % OF NET CA OR PV OF CF

★ MAJOR DIFFERENCE BETWEEN LAST 2 STAGES, WITH OBJECTIVE
EVIDENCE SO % UNCOLLECTIBLE IS WRITTEN OFF. Interest Income is
charged against Allowance for Impairment
 Sample Problem
◤

On January 1, a bank loaned P2,000,000 to a borrower. The contract specified an

effective interest pf 10%, a term of 8 years and interest is payable annually every
December 31.
On December 31, 2020, based on the most relevant information available, the
bank determined that the loan had a 12-month probability of default of 5% and
expected to collect only 80% of the principal.
STAGE 1:
◤
▪ Carrying Amount x Probability of Collection = Expected Cash Flows
x PV Factor
= PV OF CASH FLOWS
▪ P2,000,000 x80% = P1,600,000 x 0.51= P816,000

▪ Carrying Amount - PV of Cash Flows =TOTAL ECL

X Prob. of default within 12 months
= 12-MONTH ECL
▪ P816,000 x 5%= P59,200

★ RECORD INTEREST INCOME AS % OF GROSS OR FACE AMOUNT

Impairment Loss P59,200
Allowance for Impairment Loss P59,200
Cash P200,000
Interest Income (P2,000,00 x10%) P200,000
 ◤

On December 31, 2021, the bank determined that there was a significant
increase in the credit risk of the loan receivable but no objective evidence of
impairment.
The Bank concluded that there is a 40% probability of default over the remaining
life of the loan and the bank expected to collect only 70% of the principal
balance
STAGE 2: NOTE: Check REMAINING PERIODS FOR DISCOUNTING (8yrs-2yrs=6yrs.)
▪ *Carrying Amount x Probability of Collection = Expected Cash Flows
◤ x PV Factor
= PV OF CASH FLOWS
▪ P2,000,000 x 70%= P1,400,000 x 0.56= P784,000

▪ Carrying Amount - PV of Cash Flows =TOTAL ECL

X Prob. of default within remaining periods
= ALLOWANCE FOR IMPAIRMENT LOSS(before
writeoffs)
LESS: Unadjusted Allowance(Prev.Year)
=IMPAIRMENT LOSS FOR THE CURRENT YEAR
▪ P2,000,000- P784,000= P1,216,000 x 40%= P486,400- P59,200= P427,200

★ RECORD INTEREST INCOME AS % OF GROSS OR FACE AMOUNT

Impairment Loss P427,200
Allowance for Impairment Loss P427,200
Cash P200,000
Interest Income (P2,000,00 x10%) P200,000
 ◤

On December 31, 2022, the borrower was in financial difficulty and the loan was
considered impaired.
The bank concluded that 50% of the principal balance will be collected on
December 31, 2027. Interest for 2022 was collected.
 ◤
STAGE 3: NOTE: Check REMAINING PERIODS FOR DISCOUNTING (6yrs.-1yr= 5yrs.)
▪ *Carrying Amount x Probability of Collection = Expected Cash Flows
x PV Factor
= PV OF CASH FLOWS
▪ P2,000,000 x 50%= P1,000,000 x 0.62= P620,000

▪ Carrying Amount - PV of Cash Flows =TOTAL ECL

= REQUIRED ALLOWANCE FOR IMPAIRMENT LOSS
LESS: Unadjusted Allowance(Prev.Years)
=IMPAIRMENT LOSS FOR THE CURRENT YEAR
▪ P2,000,000- P620,000= 1,380,000 - P486,400= P893,600
 ◤

★ RECORD INTEREST INCOME AS % OF NET CA OR PV OF CF

★ MAJOR DIFFERENCE BETWEEN LAST 2 STAGES, WITH OBJECTIVE
EVIDENCE SO % UNCOLLECTIBLE IS WRITTEN OFF. Interest Income
is charged against Allowance for Impairment

Impairment Loss P893,600

Allowance for Impairment Loss P893,600
Cash P200,000
Interest Income (P2,000,00 x10%) P200,000
Allowance for loan impairment P1,000,000
Loan Receivable P1,000,000
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