The IFRS 9 standard was completed in July 2014, and recent changes brought audit firms in Dubai & UAE new impairment rules. These new rules will not affect only financial institutions but any entity with some trade receivables. Companies will need to adjust how they calculate “bad debt” provisions associated with receivables. In this article, we will explain in-depth.
Basics of Expected Credit Loss Model
A new concept in IFRS 9 called the “general model” is designed to recognize an impairment loss. Chartered accountants are supposed to recognize impairment losses based on the state of the financial asset.
There are three primary phases:
Phase 1: Conducting Financial Assets
Here, the financial assets are healthy and perform well according to their contractual terms, and there are little to no signs of credit risk. Auditors must recognize impairment loss summing up to 12-month expected credit losses.
Phase 2: Defining 12-month Expected Credit Loss
This is the expected credit loss arising from default events on financial instruments in the last 12 months following the reporting date. As such, auditors recognize interest revenue based on a practical interest rate approach on grossing carrying amount. Therefore, the accountants do not consider loss allowance.
Phase 3: Financial Assets With Considerably Increased Credit Risk
If some financial asset credit risk considerably increases and the subsequent credit quality is not low risk, then a Dubai chartered accountant must recognize entire lifetime expected credit losses.
Read also: Auditing Firms In Dubai Overview Of IFRS 9
But what are these components?
These are the present value of losses resulting from borrower defaults on their responsibilities throughout the Lifecycle of the financial instrument. As a matter of fact, 12-month expected credit losses are elements of the lifetime expected credit losses. There is a significant difference, however, between credit losses:
An estimate of cash flows from a financial instrument based on its contract; and
The present value of cash flows generated by the financial instrument that an entity is expecting to receive.
Due to this, the time payments are made from the financial instrument directly affects their present value and impairment losses.
A claim of impairment does exist if, in practice, you expect your debtor to pay in full but later than anticipated by the contract.
Credit-impaired financial assets
When a financial asset becomes credit impaired, an entity recognizes lifetime expected credit losses (even if certain default events have already occurred). Unlike in the past, interest revenue is computed based on amortized costs (gross carrying amounts less loss allowance). This stage might require an individual assessment of financial assets.
The model is very demanding, so why?
You might not see it at first, but for this model to be used correctly, you need a lot of reliable information, for instance:
Identifying and estimating the credit risk of a debtor
A report that estimates the likelihood that defaults will occur within 12 months.
Estimating the likelihood of default events occurring during the life of an instrument, their probable outcomes, and their weights.
An entity’s results may be affected by a slight change in just one parameter. Therefore, it’s easy to adopt everything else except these newest requirements.
If you don’t work for a financial institution like a bank, the general model applies to you.
Exception For Non-Financial Entities in Dubai & UAE: Trade Receivable
There are numerous companies in Dubai & UAE whose primary focus is not to issue finances or loans, for instance, selling goods or services. These firms may boast a massive portfolio of trade receivables in their accounts. Remember that trade receivables meet the financial instrument requirements and are subject to IFRS 9.
So, suppose companies expect that customers will pay them at a later date. In that case, there is an impairment loss on trade receivables that must be recognized. Audit services can recognize lifetime expected credit losses right on initial recognition if trade receivables don’t have sufficient financing. To make things simple, accountants can use a provision matrix.
Bad Debt Provision According to IAS 39
According to IAS 39, audit services must recognize the impairment loss to its extent accrued. Therefore, you are not concerned about future expectations. Rather, auditors need to examine the events leading to impairment loss already been incurred.
When Auditors Can Implement the New IFRS 9 Impairment Model
IFRS 9 became mandatory for application from 1st January 2018. So, what do you do if you are a Dubai & UAE company and have not adopted IFRS 9 yet? You can implement the older versions. This means you can continue with impairment rules under IAS 39.
Alternatively, it would be wise to hire a professional audit firm in Dubai to help you adapt to IFRS 9. We Audit Firms in Dubai can help you with IFRS 9. Contact us for consultation or visit our website for more information.
Theshani is a Senior auditor and has experience of 4+ years in providing audit assurance and advisory services to a wide range of industry clients. She continues to stay on top of ever-changing industry dynamics by continuously learning and developing expertise.