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With increasing uncertainity in macroscopic scnearios the standards have also evolved to incorporate the impact of economic variables in the Expected Credit Loss ('ECL') valuations. As per IFRS 9 and Ind AS 109, Financial Instruments, the companies have to account for the expected loss on the day of raising invoice considerinh the historical as well as macroeconomic factors.
With increasing uncertainity in macroscopic scnearios the standards have also evolved to incorporate the impact of economic variables in the Expected Credit Loss ('ECL') valuations. As per IFRS 9 and Ind AS 109, Financial Instruments, the companies have to account for the expected loss on the day of raising invoice considerinh the historical as well as macroeconomic factors.
What is Credit Loss?
What is Credit Loss?
As per IFRS 9 (Appendix A), credit loss is defined as:
As per IFRS 9 (Appendix A), credit loss is defined as:
"Credit loss is the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive, discounted at the original effective interest rate (EIR) or credit-adjusted EIR"
"Credit loss is the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive, discounted at the original effective interest rate (EIR) or credit-adjusted EIR"
How is ECL Estimated?
How is ECL Estimated?
The simplified approach is mandatory for trade receivables without a significant financing component and optional for lease and trade receivables with a significant financing component. Under the simplified approach as well, there is no distinction between stage 1 (Initial recognition) and stage 2 (Significant increase in credit risk) and requires calculation of lifetime expected loss for each asset. There is no mandated way to estimate the ECL, we have shared some suggested steps for the analysis:
The simplified approach is mandatory for trade receivables without a significant financing component and optional for lease and trade receivables with a significant financing component. Under the simplified approach as well, there is no distinction between stage 1 (Initial recognition) and stage 2 (Significant increase in credit risk) and requires calculation of lifetime expected loss for each asset. There is no mandated way to estimate the ECL, we have shared some suggested steps for the analysis:
Step 1: Grouping of Trade Receivables (Ageing Table)
Step 1: Grouping of Trade Receivables (Ageing Table)
Grouping is required as all the trade receivables do not necessarily share the same characteristics, and therefore, it would not be reasonable to put them into the same bucket. Grouping purely depends on the factors that effects the repayment of receivables.
Grouping is required as all the trade receivables do not necessarily share the same characteristics, and therefore, it would not be reasonable to put them into the same bucket. Grouping purely depends on the factors that effects the repayment of receivables.
Step 2: Estimation of Flow Rates
Step 2: Estimation of Flow Rates
Historical Flow rate of default need to be estimated for each group of financial assets or trade receivables. The period selected for this analysis can neither be too short so as to make no sense nor too long because market changes are frequent and longer period may result in considering market assumptions that may no longer be valid.
Historical Flow rate of default need to be estimated for each group of financial assets or trade receivables. The period selected for this analysis can neither be too short so as to make no sense nor too long because market changes are frequent and longer period may result in considering market assumptions that may no longer be valid.
Step 3: Estimation of Credit Loss Rate
Step 3: Estimation of Credit Loss Rate
Credit Loss Rate or Default rate is the loss of an account receivable of a time period based on empirical data.
Credit Loss Rate or Default rate is the loss of an account receivable of a time period based on empirical data.
Step 4: Incorporate forward looking information
Step 4: Incorporate forward looking information
Once the Default Rate is computed, the next step is to adjust them with the forward-looking information. These are all the information that could affect the credit losses in future, for example, macroeconomic forecasts of GDP, interest rate, lending rate, unemployment, sectoral inflation, etc.
Once the Default Rate is computed, the next step is to adjust them with the forward-looking information. These are all the information that could affect the credit losses in future, for example, macroeconomic forecasts of GDP, interest rate, lending rate, unemployment, sectoral inflation, etc.
Step 5: Expected Credit Loss Calculations
Step 5: Expected Credit Loss Calculations
The concluded ECL is estimated based on weighted average of scenarios considered.
The concluded ECL is estimated based on weighted average of scenarios considered.
Alps Venture Partners' valuation services help companies to comply with IFRS 9 standard’s complex provisions and avoid any audit issues in their quarterly and annual reporting. Our experts at Alps Venture Partners have experience in both valuation appraisal and audit services, and provide unique and robust valuation products that ensure that the valuation will withstand audit scrutiny of the highest standard.
Alps Venture Partners' valuation services help companies to comply with IFRS 9 standard’s complex provisions and avoid any audit issues in their quarterly and annual reporting. Our experts at Alps Venture Partners have experience in both valuation appraisal and audit services, and provide unique and robust valuation products that ensure that the valuation will withstand audit scrutiny of the highest standard.
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