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- at which the financial asset or financial liability is measured at initial recognition
- minus principal repayments,
- plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and
- minus any reduction (directly or through the use of an allowance account) for impairment or un-collectability.
Amortisation based on estimated cash flows helps to smoothen the financial statement by incorporating the prepayment estimation into EIR calculation. With a proper prepayment model:
- At portfolio level, estimated cash flows follow patterns similar to actual prepayments.
- Amortisation already considers prepayment behaviour since prepayment is considered in EIR calculation
Hence, P&L volatility will be much smoother.
Amortised cost is derived using the EIR which is calculated by means of the cash flow plan:
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In view of the definition of the amortised cost, the following formula is used for its calculation:
The cumulative total amortisation TA(tn) of payment date tn is defined by
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