IMPAIRMENT OF A LOAN

PFRS 9, paragraph 5.5.1, provides that an entity shall recognize a loss allowance for expected credit losses
on financial asset measured at amortized cost.

PFRS 9 Paragraph 5.5.3 provides that an entity shall measure the loss allowance for a financial instrument
at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument
has increased significantly since initial recognition.

Credit losses are the present value of all cash shortfalls.

Expected credit losses are an estimate of credit losses over the life of the financial instrument.

Measurement of impairment
When measuring expected credit losses, an entity should consider
a. The probability-weighted outcome
The estimate should reflect the that possibility that a credit loss occurs and the possibility that no
credit loss occurs

b. The time value of money

The expected credit losses should be discounted

c. Reasonable and supportable information that is available without undue cost or effort.

PFRS 9 does not prescribe particular method of measuring.

An entity may use various sources of data both internal or entity-specific and external in measuring
expected credit
The amount of impairment loss can be measured as the difference between the carrying amount and the
present value of estimated future cash flows discounted at the original effective rate.

The carrying amount of the loan receivable shall be reduced either directly or through the use of an
allowance account.

Meaning of credit risk

Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party
by failing to discharge an obligation.

The risk contemplated is the risk that the issuer will fail to / perform a particular obligation.

The risk does not necessarily relate to the credit worthiness of the issuer.

For example, if an entity issued a collateralized liability and noncollateralized liability that are otherwise
identical, the credit risk of the two liabilities will be different.

The credit risk of the collateralized liability is surely less than the credit risk of the noncollateralized
liability.
The credit risk for a collateralized liability may be zero.

ILLUSTRATION 1
I-Bank loaned P5,000,000 to Bankard Company on January 1, 2017 payable at P1,000,000 every Dec. 31
for 5 years plus 10% interest. Bankard experienced financial difficulties in 2019 and was unable to pay on
December 31, 2019.

I-Bank assessed the collectibility the loan and showed the following projections:
Date of Cash Flow Amount Projected PV of Cash Flows
Dec. 31, 2020 500,000 454,550
Dec. 31, 2021 1,000,000 826,400
Dec. 31, 2022 1,500,000 1,126,950
2,407,900

As of Dec. 31, 21019, loan receivable has a carrying amount of P3,300,000 inclusive of accrued interest
receivable. Present value of 1 is .9091 (x 500,000) for one period, .8264 (x 1,000,00) for two periods and
.7513 (x 1,500,000) for three periods.

IMPAIRMENT LOSS: 3,300,000 – 2,407,900 = 892,100

Amortization
Interest Income Carrying Amount
(Collected –
DATE Amount Received (Carrying (Previous balance
interest
Amount x 10% – Amortization)
income)
Dec. 31, 2019 2,407,900
Dec. 31, 2020 500,000 240,790 259,210 2,148,690
Dec. 31, 2021 1,000,000 214,869 785,131 1,363,559
Dec. 31, 2022 1,500,000 136,441 1,363,559 -

JOURNAL ENTRIES
December 31, 2019
Loan impairment loss 892,100
Accrued interest receivable 300,000
Allowance for loan impairment 592,100

December 31 2020 2021 2022

Cash 500,000 1,000,000 1,500,000
Loan Receivable 500,000 1,000,000 1,500,000
Allowance for loan impairment 240,790 214,869 136,441
Interest income 240,790 214,869 136,441
ILLUSTRATION 2
Urban Bank granted a loan of P3,000,000 to a borrower on January l, 2019. The terms of the loan were
payment in full on December 31, 2024 plus annual interest payment at 8% every December 31. The first
interest payment was made on Dec. 31, 2019

On December 31, 2019 due to financial difficulties, borrower informed Urban Bank that it probably would
miss the interest payments for the next two years.

After that, the borrower expects to resume the annual interest payment but the principal would be paid
on December 31, 2025 or one year late with interest paid for that additional year

Schedule of payments from the borrower

December 31, 2020 No interest payment 0
December 31, 2021 No interest payment 0
December 31, 2022 Interest payment (8% x P 3,000,000) 240,000
December 31, 2023 Interest payment 240,000
December 31, 2024 Interest payment 240,000
December 31, 2025 Interest payment 240,000
Principal payment 3,000,000

Using the original effective interest rate of 8%, the present value of 1 is .794 for three periods, .735 for
four periods, .681 for five periods, and .630 for six periods.

COMPUTATION
December 31, 2022 (240,000 x .794) 190,560
December 31, 2023 (240,000 x .735) 176,400
December 31, 2024 (240,000 x .681) 163,440
December 31, 2025 (3,240,000 x .630) 2,041,200
Total Present Value of Loan 2,571,600

Carrying amount of loan equal to principal

only because there is no accrued interest on
December 31, 2019 3,000,000
Present value of loan 2,571,600
Impairment loss 428,400

Interest Income Carrying Amount

DATE
(Carrying Amount x 8%) (Previous balance + Interest Income)
Dec. 31, 2019 2,571,600
Dec. 31, 2020 205,728 2,777,328
Dec. 31, 2021 222,672 3,000,000
*Adjusted due to rounding off difference
 2019
Jan. 1 Loan Receivable 3,000,000
Cash 3,000,000
Dec. 31 Cash 240,000
Interest income 240,000
Loan impairment loss 428,400
Allowance for loan impairment 428,400

December 31 2020 2021

Allowance for impairment loss 205,728 222,672
Interest income 205,728 222,672
*Amortization of allowance for period of default

December 31 2022 2023 2024 2025

Cash 240,000 240,000 240,000 3,240,000
Interest income 240,000 240,000 240,000 240,000
Loan Receivable 3,000,000
 Three-stage impairment approach
Stage 1 - This stage covers debt instruments that have not declined significantly in credit quality since
initial recognition or that have low credit risk. Under this scenario, a 12-month expected credit

Stage 2 — This stage covers debt instruments that have declined significantly in credit quality since initial
recognition but do not have objective evidence of
Under this scenario, a lifetime expected credit loss.
There is rebuttable presumption that there is a significant increase in credit risk if the contractual
payments are more than 30 days past due

Stage 3 — This stage covers debt instruments that have objective evidence of impairment at the reporting
Under this scenario, a lifetime expected credit loss is recognized.

12-month expected credit loss

A 12-month expected credit loss is defined as the portion of the lifetime expected credit loss from default
events that are possible within 12 months after the reporting period.

Lifetime expected credit loss

Lifetime expected credit loss is defined as the expected credit loss that results from all default events over
the expected life of the instrument.
Lifetime expected credit loss shall always be recognized for trade receivables through aging, percentage
of accounts receivable and percentage of sales.

Interest income
a. Under stages 1 and 2, interest income is computed based on the gross carrying amount or face
amount.
b. Under stage 3, interest income is computed based on the net carrying amount which is equal to
the gross carrying amount or face amount minus allowance for credit loss.

Stage 1 — Low credit risk

on January 1, 2019, a bank loaned to a borrower. The contract specified an effective Interest of 10%, a
term of 8 years and interest is payable annually every December 31

On December 31, 2019, 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.
The present value of 1 at 10% for 7 periods is 0.51.

Journal entries for 2019

Jan. 1 Loan Receivable 2,000,000

Cash 2,000,000
Dec. 31 Cash (2M x 10%) 200,000
Interest income 200,000
Impairment loss 59,200
Allowance for loan impairment 59,200
 Carrying amount, Dec. 31, 2019 2,000,000
Probability of collection 80%
Expected cash flow 1,600,000
Multiply by PV Factor 0.51
PV of cash flows, Dec. 31, 2019 816,000

Carrying amount, Dec. 31, 2019 2,000,000

PV of Expected Cash flows 816,000
EXPECTED CREDIT LOSS 1,184,000
Probability of default 5%
12-month Expected Credit Loss 59,200

Loan Receivable 2,000,000

Allowance for loan impairment 59,200
Carrying amount, Dec. 31, 2019 1,940,800

Stage 2 - Significant increase in credit risk but no objective evidence of impairment

On December 31, 2020, 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.

The present value of 1 at 10% for 6 periods is 0.56.

Journal entries for 2020

Dec. 31 Cash 200,000
Interest income 200,000
Impairment loss 427,200
Allowance for loan impairment 427,200

Carrying amount, Dec. 31, 2020 2,000,000

Probability of collection 70%
Expected cash flow 1,400,000
Multiply by PV Factor 0.56
PV of Expected Cash Flows 784,000

Carrying amount, Dec. 31, 2020 2,000,000

PV of Expected Cash flows - Dec. 31, 2020 -784,000
EXPECTED CREDIT LOSS 1,216,000
Probability of default 40%
Lifetime Expected Credit Loss Allowance 486,400
Unadjusted allowance, Dec. 31, 2019 -59,200
 Impairment loss 427,200

Loan Receivable 2,000,000

Allowance for loan impairment -486,400
EXPECTED CREDIT LOSS 1,513,600

Stage 3 - Objective evidence of impairment

On December 31, 2021, the borrower was in difficulty and the loan was considered impaired. The bank
concluded that only 50% of the principal balance will be collected on December 31, 2026. Interest for
2021 collected. The present value of 1 at 10% for 5 periods is 0.62

Journal Entries for 2021

Dec. 31 Cash 200,000

Interest income 200,000
Impairment loss 893,600
Allowance for loan impairment 893,600
Allowance for loan impairment 1,000,000
Loan Receivable 1,000,000

Carrying amount, Dec. 31, 2021 2,000,000

Probability of collection 50%
Expected cash flow 1,000,000
Multiply by PV Factor 0.62
PV of Expected Cash Flows 620,000

Carrying amount, Dec. 31, 2021 2,000,000

PV of Expected Cash flows - Dec. 31, 2020 -620,000
EXPECTED CREDIT LOSS 1,380,000
Unadjusted allowance, -486,400
Impairment loss 893,600
 Loan Receivable, Dec. 31, 2021 1,000,000
Allowance for loan impairment 380,000
Carrying Amount, Dec. 31, 2021 1,380,000

Allowance for loan impairment, Jan. 1, 2021 486,400

Increase in allowance - 2021 893,600
Allowance before writeoff 1,380,000
Writeoff of uncollectible loan -1,000,000
Allowance for loan impairment, Dec. 31, 2021 380,000

Interest income Carrying Amount

Jan. 1, 2022 620,000
Dec. 31, 2022 62,000 682,000
Dec. 31, 2023 68,200 750,200
Dec. 31, 2024 75,020 825,220
Dec. 31, 2025 82,522 907,742
Dec. 31, 2026 92,258 1,000,000

Journal Entries on Dec. 31

2022 2023 2024

Cash 62,000 68,200 75,020
Interest income 62,000 68,200 75,020

2025 2026
Cash 82,522 92,258
Interest income 82,522 92,258
Cash 1,000,000
Loan Receivable 1,000,000