Under IAS 39, the IASB financial instrument standard in effect at the time, loans receivable were valued at amortized cost. That is, valuation was based on expected future receipts from the loan discounted at the effective rate of interest established at loan acquisition. If the loan became impaired (i. e., expected future receipts fell), the loan would be written down to its new expected value, discounted at the original effective rate.During the 2007– 2008 market meltdowns, loan impairment writedowns were criticized for waiting “too long.” That is, writedowns were delayed until the financial institution holding the loan decided that impairment had occurred. This often generated huge sudden writedowns, particularly if the impairment had been building up over some considerable period of time prior to the impairment recognition.Subsequently, in 2009, the IASB proposed to record writedowns sooner. Specifically, a loan loss allowance at the end of each period would be accumulated even if the loan was not impaired, based on expected future credit losses (see Section 7.5.4 for the current state of this proposal). This proposal did not satisfy the Basel Committee on Banking Supervision, a group of central bankers and financial supervisors from major world economies. The Committee proposed that the IASB should consider providing for credit losses through the business cycle (dynamic provisioning). That is, in periods of high economic activity, loan lenders should provide greater- than- expected credit losses when calculating the loan loss allowance. This would create an excess allowance that could be used to absorb greater- than-expected credit losses in periods of low economic activity. The result would be to bolster banks’ loan loss protection and smooth reported earnings over the business cycle. Required a. Evaluate the relevance of each of the three loan loss policies outlined above. b. Evaluate the reliability of each policy. c. Why not require fair value accounting for loans, rather than amortized cost accounting? Consider Levels 1, 2, and 3 of the fair value hierarchy in your answer, and note that most loans are not traded on a market.View Solution:
Under IAS 39 the IASB financial instrument standard in effect

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