What is the purpose of the expected credit loss model?

What is the purpose of the expected credit loss model?

• A. To guarantee loan repayments
• B. To recognize impairment on financial assets
• C. To assess risk of loan defaults
• D. To inflate asset values

Answer: (B)

The expected credit loss (ECL) model is an essential framework for recognizing impairment on financial assets, particularly under the International Financial Reporting Standards (IFRS 9). This model shifts the focus from incurred losses to expected losses, meaning that entities must estimate and recognize credit losses on financial assets at the time of their initial recognition and regularly thereafter. This proactive approach to impairment ensures that potential losses are accounted for before they actually occur, reflecting a more accurate picture of the financial position of the entity. By evaluating the risk of default and the expected loss over the life of the financial asset, entities can provide users of the financial statements with better information regarding credit risk and asset quality. The option focusing on guaranteeing loan repayments is misaligned with the ECL model's purpose, as it does not seek to guarantee repayments but rather to highlight potential impairments. Similarly, assessing the risk of loan defaults is a function of analyzing credit risk but does not directly reflect the recognition of impairment that the ECL model mandates. Lastly, inflating asset values contradicts the fundamental principles of accounting and reporting faithfully, which the ECL model supports by encouraging accurate and conservative valuation of financial assets.

The expected credit loss (ECL) model is an essential framework for recognizing impairment on financial assets, particularly under the International Financial Reporting Standards (IFRS 9). This model shifts the focus from incurred losses to expected losses, meaning that entities must estimate and recognize credit losses on financial assets at the time of their initial recognition and regularly thereafter.

This proactive approach to impairment ensures that potential losses are accounted for before they actually occur, reflecting a more accurate picture of the financial position of the entity. By evaluating the risk of default and the expected loss over the life of the financial asset, entities can provide users of the financial statements with better information regarding credit risk and asset quality.

The option focusing on guaranteeing loan repayments is misaligned with the ECL model's purpose, as it does not seek to guarantee repayments but rather to highlight potential impairments. Similarly, assessing the risk of loan defaults is a function of analyzing credit risk but does not directly reflect the recognition of impairment that the ECL model mandates. Lastly, inflating asset values contradicts the fundamental principles of accounting and reporting faithfully, which the ECL model supports by encouraging accurate and conservative valuation of financial assets.