Page 440 - SBR Integrated Workbook STUDENT S18-J19

Chapter 25

Example 8

Loss allowances

The loss allowance is based on whether credit risk has increased significantly.
Thwaite’s bonds appeared to have a high credit risk at inception. However, it
would seem that credit risk has not increased significantly since inception.
This is because of the following:

 The decrease in initial sales volumes was in line with expectations and
so would have been factored into the initial assessment of credit risk.

 Thwaite’s forecasts suggest that its cash flow, and thus its ability to
service debt, will improve.

 Thwaite’s restructuring will improve its ability to service its finance and so
is likely to have led to an improvement in the credit risk of its bonds.

 The increased bond price is likely to signal an improvement in investor
confidence about Thwaite’s credit risk, particularly in light of the more
general decline in bond prices.

Credit risk has not increased significantly so the loss allowance should be
calculated at an amount equal to 12-month expected credit losses.
Increases/decreases in the allowance will be charged to profit or loss.

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