The Emergence of the ‘Incurred-Loss’ Model for Credit Losses in IAS 39

Following the financial crisis, the view became widespread that International Financial Reporting Standards (IFRS), because it is based on a so-called incurred-loss approach, led to significant overstatements of financial assets by placing tight restrictions on the recognition of loan losses. As a result, the International Accounting Standards Board (IASB) undertook a project to introduce an alternative expected-loss model in its standards, which would allow earlier recognition of loan losses. This paper is a historical study of the introduction of the incurred-loss model in International Accounting Standard (IAS) 39 between 1998 and 2003. With respect to the topic of loan losses, it argues that, especially at the beginning of that period, it was not yet common to view the issue in terms of a clear-cut dichotomy of incurred-loss versus expected-loss models, and that this had a significant complicating influence on the course of the debate. More generally, the paper illustrates some of the pressures on the quality of the Board's due process during its early years, when it attempted to complete an ambitious agenda in time for the first mass adoption of IFRS in 2005. While this paper takes no position on the correctness of the IASB's decisions as embodied in IAS 39 (2003), it does suggest that the episode covered provides justification for the considerable enhancements of its due process effected by the IASB over recent years.