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How Dubai Chartered Accountants Calculate Bad Debt Provision Based on IFRS 9

If you have a massive portfolio of trade receivables, you are more likely to experience the same set of problems every now and then.

What Does IFRS 9 Require of Accounting Services?

Accounting and financial services must recognize the impairment of financial assets in the figures of expected credit loss.  There are two formulas of doing this:

‘General Approach’ To Impairment

According to general approach, chartered accountants in Dubai recognize a loss allowance for lifetime expected credit losses for a financial instrument is there is a considerable influx in credit risk. This is usually calculate through the lifetime probability of default, from the first recognition of financial asset.

If the credit risk does not increase massively since initial recognition on a financial instruments, as at the reporting date, then the accounting services will recognize a loss allowance for a 12 month duration expected credit losses.

What we mean is, the general approach includes two bases on which Dubai chartered accountants can measure expected credit losses – lifetime expected credit losses and expected credit losses.

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Lifetime Expected Credit Loss

This is the expected credit losses arising from various default events throughout the expected life of a financial instrument. The lifetime expected credit losses duration is usually 12-month expected credit loss, representing credit losses that accrue from default events that occur within 12 months after the reporting date.

IFRS 9 does not define the term “default”. A Dubai company would have to create its own definition of default, and implement this definition in accordance with internal credit risk management  for the appropriate financial instrument.

According to IFRS 9, a default does not take place late than 90 days past due unless a chartered accountant has beyond reasonable doubt, data that shows a more lagging default model is ideal. As for actual measurement in general approach, accounting services must measure expected credit losses of a financial instrument in a manner the represents the guidelines stipulated in IFRS 9.

Simplified Approach

In simplified approach, accounting and financial services in Dubai do not need to find measure the stage of a financial asset since the impairment loss is calculate at lifetime ECL for the assets. This is incredible news for Dubai accounting services because troubles simply vanish. Note however, not every accounting expert in Dubai can handle simplified approach, as it requires some heavy calculations and effort.

Implementing The 'Simplified Approach' With A Provision Matrix

In the simplified approach, provision matrices can be applied to trade receivables that do not have a significant financing component. An aged analysis of trade receivables is simply applying the relevant loss rates to the outstanding balances of trade receivables. To illustrate how to use a provision matrix under IFRS 9 in a stepped manner, we provide a step-by-step explanation below.

1.Organize Receivables into Appropriate Groups

A grouping of trade receivables in accordance with IFRS 9 is not explicitly prescribed, but could be based on geographic area, product type, customer rating, collateral or trade credit insurance, or type of customer (such as a wholesale or retail business).

It is necessary to group trade receivables based on similar credit risk characteristics before applying a provision matrix. Identifying and understanding the factors that drive each group's credit risk is critical when grouping items for the purpose of defining shared credit characteristics.

2. Determine The Appropriate Period for Applying Historical Loss Rates

In order to determine historical losses for each sub-group, it is necessary to identify the sub-groups. IFRS 9 does not specify how far back historical information should be collected. Depending on the future period over which the trade receivables will be collected, judgment is required as to the period for which reliable historical data can be obtained. A reasonable time frame should be adopted - not one that is unrealistically short or long. Typically, the time period would be between two and five years.

3. Calculate The Historical Loss Percentages

The entity determines past-due categories for each subgroup after recognizing sub-groups and selecting the time period over which loss data will be captured. After establishing sub-groups and selecting the data collection period, the entity determines expected loss rates in each subgroup.

In other words, the loss rate for balances that are 0 days past due, 1-30 days past due, 31-60 days past due, etc. By obtaining observable data from the previous period, entities can determine the historical loss rate of each group or sub-group. Loss rates are not specifically addressed by IFRS 9 and judgment is needed.

4.Take Into Accounting Macro-economic Factors and Determine The Right Loss Rates

The historical loss rates determined in the earlier step represent the economic situation in place in the period the historical data associates with. Even though they are a starting point for determining expected losses they are not the ultimate loss rates that must be applied to the carrying figures.

5.Determine the Expected Credit Losses

Accountants should calculate the expected credit loss of all the sub-groups mentioned in the first step by multiplying the loss rate by the current gross receivable balance. After this, all the expected credit losses for the receivables should be summed up. To calculate total expected credit loss of the portfolio, add all the expected credit losses for age-bands.

For more information about IFRs Credit Losses, visit Farahat & Co website. You can also contact us if you are looking for auditing services in Dubai.

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Ervee is a CPA with international experience in Tax and Accounting. He has over 12 years of experience in accounting and bookkeeping and over a year in VAT implementation, registration, and accounting in UAE. He regularly drives out inefficiencies in company operations and loves the challenge of helping clients find additional ways for an easier and improved compliance and verification of transactions.