IFRS 9 Financial Instruments

February 1, 2021

Impairment of accounts receivable

To whom it applies

All entities that grant a credit term for their commercial invoices, under the International Financial Reporting Standard (IFRS No. 9 – Financial Instruments), should have a credit risk management process in place to identify losses in a timely manner.

Requirements of the Standard

The main paragraphs that mention it are as follows:

5.5.1 An entity shall recognize an allowance for expected credit losses on a financial asset that is measured at amortized cost or fair value.

5.5.3 Subject to paragraphs 5.5.13 to 5.5.16, at each reporting date, an entity shall measure the allowance for losses on a financial instrument at an amount equal to the expected credit losses over the life of the asset if the credit risk on that financial instrument has increased significantly since initial recognition.

In making the estimate, the entity must assess whether the financial instrument has increased its risk since initial recognition and, additionally, it must assess what will happen to that risk within 12 months from the time of assessment, i.e., at the date of the financial statements.

Recognition phases

The basic outline of the phases of impairment recognition is as follows, from lesser to greater deterioration in credit quality:

Phase 1

Phase 2 Phase 3
Instruments whose credit risk has not increased significantly since initial recognition are required to provide for credit losses over the next 12 months. Instruments whose credit risk has increased significantly since initial recognition are required to provide for credit losses over the life of the instrument.

Assets with evidence of impairment, expected credit losses are required to be recognized.

Evidence of impairment

Some of the following evidence of impairment may be present and therefore an entity should recognize an impairment loss:

  1. Delinquency, that is, the receivable is past due for payment of principal and interest.
  2. Financial difficulties of the debtor.
  3. Bankruptcy of the debtor.
  4. Restructuring or refinancing, the customer is granted more time to pay its obligation as a result of financial difficulties and lack of liquidity.
  5. Any observable issues that may lead to the conclusion of a loss of cash flow on the receivable, such as market behavior, technology, legal and economic issues.

Determining an estimation method

In essence, the company should have an impairment study for its financial assets for each fiscal year.

Expected credit losses will be estimated based on future uncollectibility considering the following:

  • historical experience of uncollectibility;
  • current macroeconomic conditions; and
  • macroeconomic conditions for the foreseeable future.

The practical expedient permitted by IFRS 9 for the determination of expected losses requires that an estimated probability of uncollectibility be assigned, based on the Company’s historical uncollectibility applied to the totality of its accounts receivable, taking into account the grouping of the portfolio according to risk.