POCI Financial Assets IFRS 9: Key Insights

With International Financial Reporting Standards (IFRS) already imposing numerous requirements in relation to financial instruments, and a significant focus on expected credit loss provisioning by management teams and auditors alike, it is perhaps unsurprising that the requirements relating to purchased or originated credit-impaired (‘POCI’) financial assets are often overlooked.

In this article, we recap the definition of POCI financial assets, how they can be identified, when they are likely to arise, and the relevant IFRS requirements which may impact the financial statements.

What is a POCI financial asset?

Appendix A of IFRS 9 Financial Instruments defines a POCI financial asset as a purchased or originated financial asset which is credit-impaired on initial recognition.

The standard states that a financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred.

How to identify a POCI financial asset

There are no strict criteria within the standard which will determine categorically whether a financial asset is POCI or not. An entity is ultimately required to apply judgement in determining whether a new asset is credit-impaired, though the definition in Appendix A of IFRS 9 provides a helpful basis to apply such judgement. Whilst not an exhaustive list, the following examples given by the standard cover many of the situations that lenders will encounter as part of their day-to-day business:

Significant financial difficulty of the borrower.
A breach of contract, such as a default or past due event.
The lender having granted concessions to the borrower for economic or contractual reasons relating to the borrower’s financial difficulty, that the lender would not otherwise have considered.
An increased probability of the borrower entering bankruptcy or other financial reorganisation.
The disappearance of an active market for that financial asset because of financial difficulties.
The purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.

Most of these considerations are qualitative in nature. However, factors such as past due and default events may be quantitative, depending on the definitions applied by management (eg defining default in line with the IFRS 9 backstop of 90 days past due).

In practice, it may not be possible to identify a single discrete event as having occurred. Instead, the combined effect of several events may have caused financial assets to become credit impaired.

It is important to note that the definition of credit-impaired financial assets is the same whether an entity is considering financial assets at the point of purchase or origination, or existing assets at the financial reporting date. Crucially, however, for an asset to be classified as POCI, one or more events must have occurred prior to or at the point of purchase or origination.

It is important to document and substantiate any significant judgements made by management in this area, especially where the magnitude of potential POCI financial assets would be material to the financial statements. Such judgements may warrant disclosure in the financial statements and will almost certainly be an area of interest to statutory auditors.

When might a POCI financial asset arise?

There are many situations when a POCI financial asset may arise. Below we have set out the three commonly encountered scenarios:

1. Acquisitions

Starting with the ‘P’ in POCI, the acquisition of a book of assets, or a business carrying such assets, would likely give rise to POCI assets being recognised in most instances. It is expected that any assets considered to be credit impaired by the original lender at the point of acquisition would meet the POCI definition, since there must have been events in the past that led to this determination. For example, if the seller applies the requirements of IFRS 9 in accounting for their financial assets, any assets in stage 3 at the point of sale would typically be recognised as POCI financial assets by the buyer.

The acquiring entity should, however, consider the differences between their credit risk management practices and accounting policies and those of the seller, since there may be differences in opinion over whether the ‘credit impaired’ definition was met in the first place.

There may also be instances where such acquisitions occur at a deep discount, for instance the sale of an aged debtor book by an entity in wind-up, which could indicate credit impairment even where the seller does not account for the assets in this way.

2. Refinancing and repeat borrowers

Originated credit-impaired financial assets may arise when an existing borrower seeks to either refinance or borrow again. At the point of the new financial asset being originated, consideration must be given to the customer’s current and expected future financial situation, their adherence to the original contractual terms, and their reason for seeking additional or new financing. Much of this should already be factored into an entity’s decision to lend again, but where that decision is a ‘Yes’, entities should still have regard to the POCI definition as there could be a material impact on the financial statements.

Example
A long-standing customer approaches a business to request a second personal loan. The customer’s existing loan is now out of contractual term, due to a 6-month period where the customer was unemployed and unable to make any repayments. However, they have now returned to making monthly repayments in full.

Where the business has approved a second loan, management must consider (amongst other things) whether the customer is in, or is expected to be in, significant financial difficulty, the historic period of missed repayments, and the fact that the customer has now continued to repay on time. In this case, management must assess whether the borrower’s temporary financial difficulty constitutes credit impairment at the point of origination of the new loan.

3. Substantial modifications

There are a multitude of reasons why the contractual terms of a financial asset may be amended. Where these amendments result in a substantial modification and the derecognition of the original financial asset followed by the recognition of a new financial asset, the accounting standard deems this to be an origination and therefore the POCI criteria may apply. This might occur, for example, where a borrower is in financial difficulty and is offered forbearance measures (eg interest rate cuts, payment holidays), resulting in a substantial change of contractual terms by the lender. In such a case, it is possible that the modification results in a new financial asset which is credit-impaired at initial recognition, particularly if the terms offered by the lender would not have been considered had the customer not been in financial difficulty.

How are POCI financial assets accounted for?

Although many of the requirements of the applicable IFRSs continue to apply, there are some distinct differences:

	Non-POCI financial assets	POCI financial assets
Loss allowance	Except for trade receivables, financial assets are initially measured at fair value plus transaction costs that are directly attributable to the acquisition or issue. At each reporting date, an entity must recognise the cumulative changes in either a) 12-month expected credit losses (‘ECLs’), if the credit risk has not increased significantly since initial recognition, or b) lifetime ECLs, if the credit risk has increased significantly since initial recognition.	Except for trade receivables, financial assets are initially measured at fair value plus transaction costs that are directly attributable to the acquisition or issue. Neither a loss allowance nor credit losses are recognised on initial recognition. At each reporting date, an entity must recognise only the cumulative changes in lifetime expected credit losses (‘ECLs’) since initial recognition as a loss allowance. Favourable changes in lifetime ECLs should be recognised as an impairment gain, even if the resulting expected cash flows of the financial asset exceed the estimated cash flows on initial recognition.
Effective interest rate (‘EIR’)	Expected losses on financial assets measured at amortised cost are discounted to the reporting date using the EIR. The EIR is the rate which discounts the expected cash flows at initial recognition (including all contractual terms but explicitly excluding ECLs) back to the amortised cost at initial recognition. The EIR is determined at the point of purchase / origination and does not change, even if there are changes in the expected future cash flows.	Expected losses on financial assets measured at amortised cost are discounted to the reporting date using a ‘credit-adjusted EIR’. The credit-adjusted EIR is the rate which discounts the expected cash flows at initial recognition (including all contractual terms but explicitly including ECLs) back to the amortised cost at initial recognition. The credit-adjusted EIR is determined at the point of purchase / origination and does not change, even if there are changes in the expected future cash flows.
Interest revenue	Interest revenue is recognised by applying the EIR to the gross carrying amount of the financial asset, except for assets which have subsequently become credit impaired. For those financial assets, the EIR is applied to the amortised cost carrying amount.	Interest revenue is always recognised by applying the credit-adjusted EIR to the amortised cost carrying amount, regardless of subsequent improvements in or deterioration of credit quality.
Disclosures	IFRS 7 Financial Instruments: Disclosures contains a significant number of disclosure requirements which have not been replicated here. The requirements relating specifically to POCI financial assets are covered in the right-hand column.	IFRS 7 explicitly requires the following disclosures to be made separately for POCI financial assets: A reconciliation from the opening balance to the closing balance of the loss allowance [para 35H]. The total amount of undiscounted ECLs at initial recognition on financial assets initially recognised during the reporting period [para 35H]. The gross carrying amount of financial assets, by credit risk rating grades [para 35M]. An entity must also consider whether any additional disclosures are required to provide the users of the financial statements with sufficient understanding. For instance, this could include disclosure of the volume of financial instruments purchased or originated.

Summary

POCI financial assets represent a nuanced area of IFRS 9 that requires careful judgement and documentation by management. These assets arise when credit impairment is evident at the point of acquisition or origination, often in scenarios such as asset acquisitions, refinancing or substantial loan modifications.

Key considerations include:

Identification: Entities must assess both qualitative and quantitative indicators of credit impairment at inception.
Accounting treatment: POCI financial assets differ from other financial assets in their treatment of expected credit losses, effective interest rate calculations, and interest revenue recognition.
Disclosure requirements: IFRS 7 mandates specific disclosures for POCI financial assets, emphasising that transparency and understandability for users of the financial statements must be at the forefront of preparers’ minds.

Given the potential material impact, it is essential for entities to apply consistent judgement, maintain robust documentation, and ensure compliance with both recognition and disclosure requirements.