Demystifying Expected Credit Losses: A Guide to Recognition and Measurement under IND AS 109

Case Name:

“KGF Limited: Applying Practical Approaches for Expected Credit Losses on Trade Receivables”

Key Takeaways:

• Recognition and measurement of expected credit losses (ECL) are essential under IND AS 109 for financial assets such as trade receivables, lease receivables, contract assets, and financial guarantee contracts.
• The general approach for ECL recognition involves applying impairment requirements for financial assets measured at fair value through other comprehensive income, with the loss allowance recognized in other comprehensive income.
• ECL measurement at each reporting date depends on whether the credit risk has increased significantly since initial recognition, with lifetime expected credit losses or 12-month expected credit losses being applied accordingly.
• Practical approaches for ECL measurement include the Bad Debts % Approach and the Sales Return Approach, offering entities flexibility in determining ECL for trade receivables.
• Entities are encouraged to select accounting policies for trade receivables, lease receivables, and contract assets independently of each other, aligning with the specific requirements of IND AS 109.

Synopsis:

The International Financial Reporting Standards (IFRS) 9, specifically the Indian Accounting Standards (IND AS) 109, provides guidance on the recognition and measurement of expected credit losses (ECL) for financial assets. The standard requires entities to recognize a loss allowance for expected credit losses on financial assets measured at amortized cost or fair value through other comprehensive income. This includes financial assets such as lease receivables, contract assets, loan commitments, and financial guarantee contracts to which impairment requirements apply.

The key points mentioned in the document:

Recognition of Expected Credit Losses

1. General Approach: The entity shall apply the impairment requirements for the measurement of a loss allowance for financial assets that are measured at fair value through other comprehensive income. However, the loss allowance shall be recognized in other comprehensive income and shall not reduce the carrying amount of the financial asset in the balance sheet.

2. Measurement at Reporting Date: At each reporting date, the entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition. If the credit risk has not increased significantly, the entity shall measure the loss allowance at an amount equal to 12-month expected credit losses.

3. Specific Assets: For trade receivables/contract assets and lease receivables, the entity shall always measure ECL at an amount equal to lifetime expected credit losses. An entity may select its accounting policy for these assets independently of each other.

4. Recognition in Financial Statements: For financial assets measured at amortized cost, the ECL shall be recognized in the profit & loss account.

Measurement of Expected Credit Losses

1. Principles for Measurement: An entity shall measure ECL of a financial asset in a way that reflects an unbiased and probability-weighted amount determined by evaluating a range of possible outcomes, the time value of money, and reasonable & supportable information available at the reporting date about past events, current conditions, and forecasts of future economic conditions.

2. No Specific Methods: The standard does not mention any specific methods for measuring ECL, leaving room for practical approaches.

Practical Approaches for Measurement of ECL

1. Bad Debts % Approach: This approach involves calculating the average rate of bad debts on sales for previous years and applying that rate to the sales of the current year. The document provides an example of how this approach is applied using the turnover and bad debts of a listed company.

2. Sales Return Approach/Percentage of Return Approach: This method calculates the average sales return percentage with respect to each customer for the relevant previous years and applies that percentage to the closing balance of trade receivables of the respective customer to arrive at the ECL figure. An example is provided to illustrate this approach.

Conclusion

The document concludes by emphasizing the prominence of computing ECL for financial assets under IND AS reporting, particularly for trade receivables. It highlights the two common methods discussed and invites readers to share any other methods for deriving the ECL amount.

In summary, the document provides a comprehensive overview of the recognition and measurement of expected credit losses for financial assets under IND AS 109, including the general approach, specific measurement requirements, and practical approaches for ECL measurement.

FAQ:

Q1: What are the key financial assets for which expected credit losses (ECL) recognition and measurement are essential under IND AS 109?

A1: Financial assets such as trade receivables, lease receivables, contract assets, and financial guarantee contracts are subject to ECL recognition and measurement under IND AS 109.

Q2: What are the practical approaches available for measuring expected credit losses (ECL) for trade receivables?

A2: The document outlines the Bad Debts % Approach and the Sales Return Approach as practical methods for measuring ECL for trade receivables, providing examples to illustrate their application.

Q3: How does IND AS 109 address the recognition and measurement of expected credit losses (ECL) for financial assets measured at fair value through other comprehensive income?

A3: IND AS 109 requires entities to apply impairment requirements for the measurement of a loss allowance for financial assets measured at fair value through other comprehensive income, with the loss allowance recognized in other comprehensive income without reducing the carrying amount of the financial asset in the balance sheet.