Expected credit losses on lease receivables

Lease receivables are inside the IFRS 9 impairment scope, but leasing companies have a choice that banks lending on loans do not: they may elect, as an accounting policy, to measure the allowance on lease receivables at lifetime ECL at all times (the simplified approach), separately for finance and operating lease receivables. The choice changes day-one losses on new business, removes the need to track significant increases in credit risk, and changes how the provision moves with portfolio growth. Separately, the lessor's main protection is the leased asset itself, which it already owns: expected repossession and sale proceeds reduce loss given default, and overstating them is one of the most common reasons lease ECL is too low.

Has the company made and documented an accounting policy choice, separately for finance lease receivables and for operating lease receivables, between the general three-stage approach and the simplified lifetime approach, and is it applied consistently? If the general approach is used, how is a significant increase in credit risk identified, and is the 30-days-past-due presumption rebutted anywhere? Are cash shortfalls measured using the cash flows used to measure the lease receivable under IFRS 16, discounted at the same rate? How are expected recoveries from repossessing and selling the leased asset estimated (time to repossess, legal costs, haircuts by asset type, historical recovery rates), and are they updated for current used-asset prices? Are operating lease receivables (rents already due) included in the ECL assessment?

1. Choose and document the impairment policy for lease receivables: the general approach (12-month ECL unless credit risk has increased significantly, then lifetime) or the simplified approach (lifetime ECL from initial recognition); the choice is made separately for finance lease receivables and for operating lease receivables.
2. Recognise a loss allowance from commencement of each finance lease, including on new business.
3. Measure cash shortfalls using the cash flows used in measuring the lease receivable under IFRS 16 (lease payments, including guaranteed residuals) and discount them at the rate used for the lease receivable (the implicit rate).
4. Include in expected cash flows the recoveries from repossessing and selling or re-leasing the leased asset, net of costs to repossess, store, repair and sell, and reflecting the expected timing.
5. Keep unguaranteed residual value risk out of ECL (see BANK-083).
6. For operating leases, assess ECL on rents due, not on the underlying asset, which is tested under IAS 36; whether straight-line accrued rent (not yet due) falls within the IFRS 9 impairment scope or is assessed with the underlying asset varies in practice, but its credit risk must be considered either way.
7. Write off amounts when there is no reasonable expectation of recovery, and move to the repossessed or returned asset accounting when the lease is terminated (see BANK-088).

ECL is an unbiased, probability-weighted estimate of the present value of cash shortfalls, using reasonable and supportable information about past events, current conditions and forecasts. For a lease portfolio this is usually modelled as probability of default x loss given default x exposure at default, with loss given default driven by asset recovery: expected sale price of the repossessed asset (by asset type and age), recovery rate after legal and remarketing costs, and the time to realise. Under the simplified approach the horizon is always lifetime; under the general approach it is 12 months for Stage 1. Forward-looking scenarios should affect both default rates and used-asset prices, because the two often move together in a downturn.

Disclose: (1) the policy choice made for finance and operating lease receivables (general or simplified approach); (2) the loss allowance reconciliation, showing lease receivables under the simplified approach separately where applicable; (3) inputs, assumptions and estimation techniques, including how recoveries from leased assets are estimated; (4) for credit-impaired lease receivables, quantitative information about the leased assets held that mitigate credit risk; (5) the gross carrying amount by credit risk grade; (6) the write-off policy and amounts written off still subject to enforcement.

• Applying the simplified approach without documenting it as an election, or applying it to finance leases but switching to the general approach for some sub-portfolios
• assuming the leased asset fully covers the exposure because the lessor holds title, ignoring repossession time, legal costs and used-asset price falls
• using book value or original cost of the asset as the recovery amount
• discounting shortfalls at a rate other than the implicit rate
• recognising no allowance on new leases until they fall past due
• ignoring operating lease receivables and the credit risk on straight-line accruals
• double counting residual value risk in both the residual review and ECL