Simplified approach Lifetime expected credit losses

Next to recording loss allowances based on expected credit losses under the ‘general approach’  IFRS 9 has also made it possible to use a Simplified approach Lifetime expected credit losses for trade receivables, contract assets and lease receivables.

Under the “expected credit loss” model, an entity calculates the allowance for credit losses by considering on a discounted basis the cash shortfalls it would incur in various default scenarios for prescribed future periods and multiplying the shortfalls by the probability of each scenario occurring. The allowance is the sum of these probability weighted outcomes. Because every loan and receivable carries with it some risk of default, every such asset has an expected loss attached to it—from the moment of its origination or acquisition.

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IFRS 13 establishes that management should measure expected credit losses over the remaining life of a financial instrument in a way that reflects: Simplified approach Lifetime expected credit losses

  • an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes;
  • the time value of money; and
  • reasonable and supportable information about past events, current conditions and reasonable and supportable forecasts of future events and economic conditions at the reporting date.

Probability of Default (PD)

Focussing on PD, in the context of trade receivables the requirement to track a significant increase in credit risk for the purposes of distinguishing between a 12-month expected credit loss and a lifetime expected credit loss seems overly complex. This is because trade receivables are typically outstanding for a relatively short period of time and it is impractical to attempt identifying significant increases in credit risk. For example, typical credit terms for trade receivables might be 30 days. Simplified approach Lifetime expected credit losses

General approach

Applying the ‘general approach’ would require an entity to identify trade receivables for which there has been a significant increase in credit risk since initial recognition. On that basis it would separate the measurement between 12-month expected credit losses and lifetime expected credit losses as explained under the ‘general approach’ above. However, from a pure measurement basis the ‘general approach’ would not yield a different answer for a 12-month or lifetime expected credit loss. This is because the credit terms are only 30 days.

Need for simplification

Herein lies the need for a simplification. It is not practical or of any benefit to require entities to apply the general approach for short-term receivables. Consequently, IFRS 9 allows entities to apply a ‘simplified approach’ for trade receivables, contract assets and lease receivables. The simplified approach allows entities to recognise lifetime expected losses on all these assets without the need to identify significant increases in credit risk. Simplified approach Lifetime expected credit losses

Trade receivables contract assets no significant financing components

Non-current (trade) receivables

However, not all trade receivables, contract assets or lease receivables are short term (i.e. of a short enough term for the distinction between 12-month and lifetime expected credit losses not to matter). For example, the trade receivables of an entity that provides customers with extended credit terms like a furniture retailer that allows its customers to pay for their purchases over three years. In such situations, recognising a lifetime expected credit loss can give rise to a larger loss allowance and larger impairment losses compared to a 12-month expected credit loss. Simplified approach Lifetime expected credit losses

Financing components

While IFRS 9 does not want to overburden entities, it allows entities accounting policy choices in situations where significant financing components are present. This is to address situations where the use of a lifetime expected credit loss on an asset which has not experienced an increase in credit risk would result in an excessive loss allowance compared to when a 12-month expected credit loss is applied.

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Simplified approach Lifetime expected credit losses

See also: Provision matrix in the simplified approach

Simplified approach Lifetime expected credit losses Simplified approach Lifetime expected credit losses


Simplified approach Lifetime expected credit losses

Simplified approach Lifetime expected credit losses

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