INCURRED LOSSES vs. EXPECTED LOSSES: A CRITICAL COMPARISON

Our paper discusses critically two models which can be used to measure credit losses: ILM and ELM. So far, International Accounting (IAS 39) was oriented towards the ILM. This method is based on the assumption that loans will be repaid, unless there is evidence which strongly suggest the opposite. Only in case there is clear indication that a loan will not be repaid, the reporter has to write down the asset to a lower value. This method leaves a certain margin of optimism, as diminution of value does not have to be recognized even when a loss is reasonably probable. However, there is another method, called ELM, which has been endorsed by IFRS 9. The International Accounting Standard Board (IASB) and the US Financial Accounting Standard Board (FASB) are cooperating in order to refine the prescriptions associated with IFRS 9. According to this seemingly innovative model, the value of a financial asset can be written down when a loss is expected, without the need to wait until the loss itself materializes. Background is to foster the idea of early recognition and to provide a more realistic presentation of those financial assets which should be measured according to the ELM. Our paper discusses critically advantages and disadvantages of both models and formulates recommendations.