Introduction
In the first of this three-part series of blog entries on impairment and the new IFRS 9 we laid the groundwork and introduced the reader to the intricacies of the new standard. In the second, we looked in detail at a worked example of the three-stage approach demanded by the new standard. In this final blog entry, we consider some of the ancillary issues.
The Measurement of Credit Losses
IFRS 9 defines expected credit losses as the “weighted average of credit losses with the respective risks of default occurring as the weights.” This means that expected credit losses are a probability weighted estimate of credit losses over the expected life of a financial instrument.
Building a Measurement of Credit Losses
IFRS 9 does not prescribe a method for measuring expected credit losses. However, it does require that a business uses a method that considers three elements. Those three elements are:
- The time value of money.
- An unbiased probability weighted amount that is determined by evaluating a range of possible outcomes.
- Reasonable and supportable information about past events, current conditions, and future forecasts.
The Time Value of Money
IFRS 9 requires expected credit losses to be discounted to the reporting date using the effective interest rate determined at initial recognition or an approximation to it. For fixed rate assets, this is the effective interest rate determined at initial recognition. For variable rate assets, it is the current effective interest rate.
What is reasonable and supportable information?
Reasonable and supportable information is information that is reasonably available at the reporting date without undue expense or cost to obtain it. This includes information about past events, current conditions and forecasts of future economic conditions. Possible data sources for this information include:
- Internal credit ratings.
- Credit loss experience of other businesses.
- External ratings, reports, statistics.
- Data from the CSO.
- Internal historic credit loss experience.
What is a Credit Loss under IFRS 9?
IFRS 9 defines that a credit loss arises even if the business expects to be paid in full but later than when full repayment is contractually due. Under IFRS 9 expected credit losses consider the timing of payments as well as the possibility that those payments could result in a cash shortfall (the total payments received are less than the amount contractually due).
The Measurement of Credit Losses under IFRS 9
Under IFRS 9 the measurement of credit losses can be defined as:
IFRS 9 also applies to Trade Receivables
The three-stage approach that we have outlined in this and the previous two blog entries in this series, was considered by the International Accounting Standards Board to be too complicated for some assets. Two assets that are specifically included under this heading are trade receivables and lease receivables.
For these two types of assets the following is applicable:
The key advantage of this simplified approach is that businesses are not required to determine whether credit risk has increased significantly since the asset was initially recognised.
How to Determine if there is a Significant Financing Component under IFRS 15
IFRS 9 interacts with IFRS 15 – Revenue from Contracts with Customers – under this heading. Businesses would have to consider:
- The difference between the promised consideration and the cash price.
- The combined effect of (a) the expected length of time between delivery of the goods or services and receipt of payment (b) the prevailing interest rates in the relevant market.
Example of IFRS 9 and Trade Receivables
Harrier Limited is a manufacturer and has trade receivables that total TT$100,000,000. These receivables represent balances from many small clients. None of the trade receivables have any financing element. Because the trade receivables have no financing element they are measured for impairment purposes at an amount that is equal to the lifetime expected credit losses.
Harrier Limited uses a provision matrix to determine expected credit losses on its receivables. The provision matrix is based upon historically observed default rates, and is adjusted for forward looking estimates of economic conditions.
The provision matrix for Harrier Limited is as follows:
Assuming trade receivables along the following lines then the following credit loss provision would arise:
While IFRS 9 provides little practical help in producing a provision matrix, the above is likely to be an example of the way most businesses will go.
Readers of this blog – consider the following:
The 1st January 2018 is getting closer every day. Many businesses will be impacted by the new IFRS 9. If your accountants have not already advised you off the implications of this new standard consider contacting them for further guidance as to what steps you should be taking now in preparation for implementation at the start of next year.
Closing thoughts – a time to chill and a time to invest?
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