Simplified Approach for ECL for trade receivables
Trade receivables, contract assets & lease receivables
An entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for:
(a) trade receivables or contract assets that result from transactions that are within the scope of Ind AS 115, and that:
(i) do not contain a significant financing component (or when the entity applies the practical expedient for contracts that are one year or less) in accordance with Ind AS 115; or
(ii) contain a significant financing component in accordance with Ind AS 115, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all such trade receivables or contract assets but may be applied separately to trade receivables and contract assets.
(b) lease receivables that result from transactions that are within the scope of Ind AS 116, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all lease receivables but may be applied separately to finance and operating lease receivables.
An entity may select its accounting policy for trade receivables, lease receivables and contract assets independently of each other.
Provision Matrix method
An entity may use practical expedients when measuring expected credit losses if they are consistent with the principles given below:
An entity shall measure expected credit losses of a financial instrument in a way that reflects:
(a) an unbiased and probability‑weighted amount that is determined by evaluating a range of possible outcomes;
(b) the time value of money; and
(c) reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions.
An example of a practical expedient is the calculation of the expected credit losses on trade receivables using a provision matrix. The entity would use its historical credit loss experience for trade receivables to estimate the 12‑month expected credit losses or the lifetime expected credit losses on the financial assets as relevant.
A provision matrix might, for example, specify fixed provision rates depending on the number of days that a trade receivable is past due (for example, 1 per cent if not past due, 2 per cent if less than 30 days past due, 3 per cent if more than 30 days but less than 90 days past due, 20 per cent if 90–180 days past due etc).
Depending on the diversity of its customer base, the entity would use appropriate groupings if its historical credit loss experience shows significantly different loss patterns for different customer segments. Examples of criteria that might be used to group assets include geographical region, product type, customer rating, collateral or trade credit insurance and type of customer (such as wholesale or retail).
6 Steps to compute the ECL
Step 1 – Segmentation
- Determine the appropriate groupings of receivables based on
- geographical region
- product type
- customer rating
- trade credit insurance
- type of customer say wholesale /retail
- Aggregate receivables into groups that share similar credit risk characteristics
Step 2 – Determine the sample period (analysis period)
- Determine the period over which historical loss rates are appropriate
- Historical loss data should be collected for each sub-group
- Judgment is needed to determine the period over which reliable historical data can be obtained that is relevant to the future period over which the trade receivables will be collected
- The period should be reasonable – not an unrealistically short or long period of time
- In practice, the period could span two to five years
Step 3 – Determine the historical loss during the analysis period
- Determine the historical loss rates
- Determine the loss rates for each sub-group sub-divided into past-due categories
- Example, loss rate for balances that are 0 days past due, a loss rate for 1-30 days past due, a loss rate for 31-60 days past due and so on
Step 4 – Build scenarios using macro-economic factors
- Consider forward looking macro-economic factors to arrive at the appropriate loss rates
- The historical loss rates are a starting point for identifying expected losses
- They are not necessarily the final loss rates that should be applied to the carrying amount
- Determine the adjusted loss rates under economic conditions that are representative of those expected to exist during the exposure period for the portfolio at the balance sheet date
Step 5 – Apply the historical loss percentage on receivable balance
- Calculate the expected credit losses
- The expected credit loss of each sub-group is calculated by multiplying the current gross receivable balance by the adjusted loss rate as per Step 4
- The specific adjusted loss rate should be applied to the balance of each age-band for the receivables in each group
- Add all the expected credit losses of each age-band for the total expected credit loss of the portfolio
Step 6 – Probability weighted expected credit loss
- Use appropriate weights for each of the three scenarios to arrive at the probability weighted expected credit loss.