A bank originates a portfolio of loans that show no signs of credit deterioration at origination, no missed payments, no downgrade in borrower creditworthiness, nothing beyond the ordinary credit risk already priced into the loan at inception. Under ASC 326, the current expected credit loss standard, and separately under IFRS 9, how much of an allowance for expected credit losses must the bank recognize on these loans immediately at origination?
- Under ASC 326, no allowance is recognized until the loans show a significant increase in credit risk, the same trigger IFRS 9 uses for its Stage 2
- Under ASC 326, the entity recognizes an allowance for lifetime expected credit losses at initial recognition, with no 12-month-loss stage; under IFRS 9, the loan begins in Stage 1 with only a 12-month expected credit loss allowance, moving to a lifetime expected credit loss allowance only if credit risk increases significantly
- Both frameworks require an allowance for the full lifetime expected credit losses to be recognized immediately at origination, with no staged approach under either standard
- Under IFRS 9, no credit loss allowance is recognized until a loan actually defaults; under ASC 326, an allowance is recognized only once a loan is classified as non-performing
Why B? And why not the others?
Correct answer: B. Under ASC 326, the entity recognizes an allowance for lifetime expected credit losses at initial recognition, with no 12-month-loss stage; under IFRS 9, the loan begins in Stage 1 with only a 12-month expected credit loss allowance, moving to a lifetime expected credit loss allowance only if credit risk increases significantly
ASC 326's current expected credit loss model requires an entity to recognize an allowance for the full lifetime expected credit losses on a financial asset like this loan at the moment of initial recognition, regardless of whether any deterioration has occurred, because the standard has no separate lower-loss stage for assets that have not yet shown increased risk. IFRS 9 instead places a newly originated loan with no credit deterioration into Stage 1 of its three-stage general approach, where the entity recognizes only a 12-month expected credit loss allowance, reflecting losses expected from default events possible within the next twelve months; the loan moves to Stage 2, and a lifetime expected credit loss allowance, only if its credit risk has increased significantly since origination, and to Stage 3 if it becomes credit-impaired. The option describing ASC 326 as waiting for a significant increase in credit risk is wrong because that staged trigger belongs to IFRS 9, not to the day-one lifetime model of ASC 326. The option requiring lifetime losses under both frameworks immediately is wrong because IFRS 9's Stage 1 allowance is deliberately limited to a 12-month horizon. The option requiring actual default or non-performing status under either framework is wrong because both standards require a forward-looking allowance well before any actual default occurs, based on expected, not incurred, losses.
Source: FASB Accounting Standards Codification ASC 326-20 (current expected credit losses, lifetime allowance recognized at initial recognition); IFRS Foundation, IFRS 9 Financial Instruments, paragraphs 5.5.1-5.5.5 (three-stage general approach to impairment: 12-month versus lifetime expected credit losses)