IFRS quantitative finance series
Amortised Cost and the Effective Interest Method Under IFRS 9
Amortised cost is a dynamic measurement produced by contractual cash flows, effective interest, repayments and impairment. It is not simply principal outstanding. The effective interest method spreads economics over time in a way that reconciles origination value to expected contractual receipts.
Construct the effective yield
The effective interest rate discounts estimated contractual cash flows through expected life to the gross carrying amount at initial recognition. Integral fees, points, transaction costs and premiums or discounts affect the yield rather than being recognised arbitrarily at inception.
Run the roll-forward
Interest revenue, cash receipts, modifications, write-offs and ECL interact with gross and net carrying amounts. Credit-impaired assets require particular attention to the basis on which interest is calculated.
Modifications and derecognition
When contractual terms change, the bank assesses whether the old asset is derecognised. If not, the gross carrying amount may be recalculated using modified cash flows discounted at the original effective interest rate, with a modification gain or loss.
Quantitative expression
Implementation controls
- Validate fee classification at origination.
- Reperform cash-flow yields independently.
- Separate gross carrying amount from loss allowance.
- Control derecognition and modification decisions.