In July 2014, the standard IFRS 9 was finally completed and the latest amendments brought us new impairment rules (besides the other things).

In my humble opinion, new impairment rules will cause a lot of headaches for mainly financial institutions.


Well, they will have a hard time to adjust or upgrade their own information systems in order to provide just the right information and calculate loss provision in line with the new requirements.

But – even if you’re not working in a financial institution, don’t celebrate that much.

Do you have some trade receivables?

In such a case, you ARE affected as well.


You need to change the way of calculating “bad debt” provision related to your receivables. Let me show you how.

Expected Credit Loss Model – the basics

IFRS 9 introduces so-called “general model” of recognizing impairment loss. This model requires recognizing impairment losses in line with the stage in which the financial asset currently is. There are 3 stages:


ECL model


Stage 1: Performing financial assets

Here, we have financially healthy financial assets that are expected to perform normally in line with their contractual terms and there are no signs of increased credit risk.

IFRS 9 requires recognizing impairment loss amounting to 12-month expected credit losses.

What is 12-month expected credit loss?

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It is the expected credit loss resulting from default events on a financial instrument that are possible within 12 months after the reporting date.

In this case, the interest revenue is recognized based on effective interest rate method on gross carrying amount, so no loss allowance is taken into account.

Stage 2: Financial assets with significantly increased credit risk

When the credit risk of certain financial asset significantly increased and the resulting credit quality is NOT low risk, then an entity needs to recognize full lifetime expected credit losses.

What are they?

They are present value of losses that arise if a borrower defaults on their obligations throughout the life of the financial instrument.

In fact, 12-month expected credit losses are just the portion of the life time expected credit losses.

Now, please be careful, because expected credit losses are in fact a difference between:

  • The present value of cash flows based on the contract of a financial instrument; and
  • The present value of cash flows that an entity really expects to obtain from the financial instrument.

As a result, the timing of payments from the financial instrument directly affects their present value and thus the amount of an impairment loss.

In practice, if you expect that debtor will pay you in full, but later than in line with the contract, there IS an impairment loss!

Interest revenue for stage 2 assets is calculated exactly in the same way as in stage 1 (on gross carrying amount).

Stage 3: Credit-impaired financial assets

When your financial asset has already become credit impaired (meaning that certain default events have occurred), then an entity still recognizes lifetime expected credit losses.

However, this time, interest revenue is calculated and recognized based on the amortized cost (that is gross carrying amount less loss allowance).

In this stage, financial assets might need to be individually assessed.

Why is this model so demanding?

Maybe it’s not apparent immediately, but the correct application of this model requires lots of reliable information, for example:

  • Information for estimating debtor’s credit risk and identifying its significant increase;
  • Information for estimating occurrence of default events within 12 months from the reporting date;
  • Information for estimating occurrence of default events within the life of the instrument, their probable outcomes and weights;

and many more.

Even slight change in 1 parameter can affect the resulting amount of recognized impairment loss and thus financial results of an entity. Therefore, it’s everything else but NOT easy to adopt these newest requirements.

However, the good news is that unless you work for a financial institution like bank, you don’t have to follow the above general model.


Great exception for non-financial companies: trade receivables

There are many entities whose primary business is simply NOT providing loans or finances, but for example selling goods or services. These companies might have huge portfolios of trade receivables in their accounts.

Of course, trade receivables do meet the definition of a financial instrument and as a result, they are subject to IFRS 9 as well.

And exactly as I wrote above – if you expect your customer will pay you a bit later than agreed, you have an impairment loss on your trade receivable that you need to recognize!

But don’t worry, you don’t need to go from stage 1 to stage 3, calculate probabilities of default events and recognize 12-month expected credit losses first, followed by life time expected credit losses.

That would be enormous burden for the companies whose focus is something very different.

Instead, standard IFRS 9 permits the use of simplification.

If your trade receivables do not contain significant financing component, you can recognize lifetime expected credit losses right on initial recognition.

Moreover, as a simplification, you can use so-called provision matrix.

Let’s take a look at our example to clarify that.


Example: bad debt provision

ABC, a trading company, has trade receivables with gross carrying amount of CU 500 000 at the end of 20X4. Careful analysis of the trade receivables showed the following:

  • One of ABC’s customers, debtor A, filed for bankruptcy proceedings during 20X4. ABC’s receivable to debtor A amounts to CU 2 200 and ABC expects to recover close to nil.
  • Aging structure of remaining trade receivables is as follows:
Past due days Amount in CU % of expected credit loss
Within maturity 392 200 0.50
1-30 days 52 300 0.80
31-90 days 27 600 5.60
91-180 days 13 200 8.90
181-365 days 7 500 20.30
365+ days 5 000 70.00
Debtor A 2 200 100.00
Total 500 000 n/a

The last column of the table contains percentages of expected credit loss in the individual aging groups. ABC estimated these percentages based on the historical experience and adjusted it, where necessary, for forward-looking estimates.

How should ABC calculate bad debt provision in line with IAS 39 and IFRS 9?

Bad debt provision in line with IAS 39

Firstly, let’s try to calculate bad debt provision in the old way, in line with IAS 39.

IAS 39 requires recognizing the impairment loss to the extent it has already been incurred. So you are not looking to future expectations or anything like that. Instead, you need to examine just the events leading to impairment loss already incurred.

In the ABC company’s trade receivables portfolio, there’s only one such a receivable with incurred impairment loss. Here, bankruptcy proceedings against debtor A would probably represent the default event causing that ABC will not recover its trade receivable.

As ABC assumes the recovery close to nil, it can recognize bad debt provision amounting to 100% of the receivable’s gross carrying amount of CU 2 200.

Although past experience shows that some percentage of other receivables might not be recovered (look to the 3rd column of the table), ABC can’t recognize any bad debt provision to remaining receivables, as there’s no evidence of impairment loss really incurred.

Thus the statistics in the 3rd column is irrelevant for IAS 39 and total bad debt provision in line with IAS 39 is CU 2 200.


Bad debt provision in line with IFRS 9

Here, the things totally change.

Of course, bad debt provision to debtor A’s receivable of CU 2 200 will not be any different. This receivable has already been credit impaired and full lifetime expected credit loss is simply 100% of this receivable – CU 2 200.

However, what about remaining receivables?

Well, based on the statistics in the 3rd column it seems that ABC can reasonably expect some credit loss in the future, although no loss events have happened yet.

However, ABC’s past experience shows that ABC can expect 0.5% credit loss on the trade receivables that are totally healthy and performing normally in line with the contractual terms. The percentages increase with increasing days that the receivables are overdue.

As a result, ABC needs to recognize bad debt provision based on provision matrix, as this simplification is permitted by IFRS 9.

Bad debt allowance is then calculated as:

(392 200 x 0.5%) + (52 300 x 0.8%) + (27 600 x 5.6%) + (13 200 x 8.9%) + (7 500 x 20.3%) + (5 000 x 70%) =

1 961 + 418.4 + 1 545.6 + 1 174.8 + 1 522.5 + 3 500 = CU 10 122.30.

Add provision to debtor A of CU 2 200 and the total bad debt provision in line with IFRS 9 is CU 12 322.30.

Hmhm. That’s quite different from IAS 39 provision, isn’t it?


ECL model


When to apply new IFRS 9 impairment model

OK, so maybe you have just found out that IFRS 9 can hurt you pretty much. What to do? Is there some time to get ready?

IFRS 9 will be mandatorily applicable for periods starting 1 January 2018 or later, so you still have some time.

However, you can adopt IFRS 9 earlier, if you want.

In this case, if you adopt IFRS 9 before 1 February 2015, you can adopt previous versions of IFRS 9, meaning that you can continue with impairment rules under older IAS 39.

But not after 1 February 2015 – after that date, your only option is to apply new IFRS 9 in its entirety, if you opt to apply it early.

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