The implementation of IFRS 9, Financial Instruments, has brought significant changes to how financial assets and liabilities are accounted for, particularly in the areas of classification and measurement, impairment, and hedge accounting. For Kenyan entities, navigating these new standards has presented a steep learning curve, and auditors are meticulously examining compliance. Here, we delve into some of the common findings observed during IFRS 9 audits in Kenya.
1. Impairment Provisions (Expected Credit Loss – ECL) Calculations:
This is arguably the most complex and frequently scrutinized area of IFRS 9. Auditors are looking for robust methodologies and sufficient documentation to support the ECL calculations. Common findings include:
- Lack of Granularity: Many entities struggle with segmenting their financial instruments into appropriate categories (e.g., by customer type, industry, risk rating) to apply specific ECL models. A “one-size-fits-all” approach is rarely acceptable.
- Insufficient Historical Data and Forward-Looking Information: IFRS 9 requires the use of reasonable and supportable forward-looking information to estimate ECLs. Auditors often find that entities rely too heavily on historical data without adequately incorporating macroeconomic forecasts, industry-specific outlooks, or changes in internal credit policies.
- Inadequate Staging Criteria: The three-stage impairment model (Stage 1: Performing, Stage 2: Underperforming, Stage 3: Default) requires clear and consistently applied criteria for moving instruments between stages. Auditors frequently identify inconsistencies or a lack of clear triggers for transitions.
- Documentation Deficiencies: Even if the ECL calculations are conceptually sound, a lack of clear documentation explaining the methodologies, assumptions, data sources, and judgments made is a common audit finding.
- Absence of Multiple Scenarios: IFRS 9 mandates considering multiple future economic scenarios (e.g., optimistic, pessimistic, base case) and weighting them appropriately. Some entities may only present a single scenario, which is a key area of auditor focus.
- Model Validation Issues: Auditors expect to see evidence that the ECL models used have been independently validated and reviewed for their effectiveness and accuracy.
2. Classification and Measurement of Financial Instruments:
IFRS 9 introduces a principles-based approach to classifying financial instruments based on their contractual cash flow characteristics (SPPI test – Solely Payments of Principal and Interest) and the entity’s business model for managing them. Common findings in this area include:
- Incorrect Application of the SPPI Test: Some financial instruments, particularly those with embedded derivatives or complex features, are incorrectly assessed against the SPPI criterion, leading to misclassification.
- Ambiguous Business Models: Entities may not have clearly defined or documented business models for managing their financial assets, which is crucial for determining the appropriate classification (e.g., amortised cost, fair value through OCI, fair value through P&L).
- Reclassification Errors: While reclassification is rare under IFRS 9, instances of incorrect reclassification or a lack of proper accounting for such changes can be identified.
3. Disclosure Requirements:
IFRS 9 significantly expands the disclosure requirements, demanding more transparency about an entity’s exposure to credit risk, how it manages that risk, and the impact of IFRS 9 on its financial statements. Common findings include:
- Incomplete or Generic Disclosures: Auditors often find that disclosures are boilerplate or lack specific information relevant to the entity’s unique circumstances. For example, general statements about risk management policies without specific quantitative details.
- Lack of Reconciliation: Disclosures relating to changes in ECL allowances and the movement of financial instruments between stages require clear reconciliations, which are sometimes missing or poorly presented.
- Insufficient Explanation of Significant Judgments and Assumptions: Entities are required to disclose significant judgments and assumptions made in applying IFRS 9, particularly concerning ECL calculations and the SPPI test. These explanations are frequently found to be inadequate.
4. Transition Adjustments:
For entities transitioning to IFRS 9, ensuring the correct application of transition provisions is critical. Auditors will scrutinize:
- Proper Recognition of Opening Balances: The accurate calculation and recognition of the cumulative effect of applying IFRS 9 as an adjustment to the opening retained earnings or other components of equity.
- Comparability Issues: Ensuring that comparative information is either restated or clear explanations are provided for non-comparability, depending on the chosen transition approach.
5. Internal Controls and Data Management:
The complexity of IFRS 9, especially the ECL calculations, necessitates robust internal controls and reliable data. Auditors will assess:
- Data Integrity and Availability: The quality and completeness of data used for ECL modeling (e.g., historical default rates, recovery rates, credit ratings, macroeconomic variables).
- System Capabilities: Whether existing IT systems are capable of handling the data requirements and complex calculations mandated by IFRS 9.
- Review and Approval Processes: The adequacy of internal review and approval processes for IFRS 9 judgments, models, and disclosures.
Conclusion:
The move to IFRS 9 represents a paradigm shift in financial reporting, particularly in how entities account for credit risk. Kenyan auditors are keenly focused on ensuring that entities not only comply with the technical aspects of the standard but also demonstrate a deep understanding of its implications. To avoid common findings, entities should prioritize developing robust methodologies, investing in appropriate systems, maintaining comprehensive documentation, and ensuring that their finance teams possess the necessary expertise to navigate the intricacies of IFRS 9. Proactive engagement with auditors and a commitment to continuous improvement in IFRS 9 application will be key to successful audits.
Navigating IFRS 9 audit expectations in Kenya requires more than technical compliance—it demands defensible models, strong governance, and audit-ready documentation. FineIT partners with Kenyan banks, microfinance institutions, SACCOs, and insurers to strengthen IFRS 9 implementation and withstand regulatory and external audit scrutiny.
Our IFRS 9 services in Kenya include:
- ECL model development, review, and independent validation
- Stage allocation and SICR framework design aligned with CBK expectations
- Macroeconomic scenario design and probability weighting
- Audit-ready IFRS 9 documentation and disclosures
- System implementation and data remediation support
- Pre-audit and post-audit IFRS 9 gap assessments
Whether you are preparing for your next external audit, responding to audit findings, or enhancing your IFRS 9 framework, FineIT helps you move from compliance risk to audit confidence.
Talk to a FineIT IFRS 9 expert today and ensure your IFRS 9 models, controls, and disclosures meet Kenyan audit and regulatory expectations.