On 24 July 2014, the International Accounting Standards Board (IASB) published the complete version of IFRS 9 which becomes mandatorily effective for periods commencing on or after 1 January 2018.
IFRS 9 replaces IAS 39 which is notorious for its complex financial reporting requirements. As well as being complex, changes in the way that modern businesses are operated and managed have rendered IAS 39 out of date. In addition, weaknesses in the standard’s impairment model were identified during the financial crisis.
The most significant changes to the accounting for financial instruments and how these changes are likely to affect the financial statements include:
- The new criteria used to determine how financial assets should be classified and measured
- How to apply the new impairment loss model
- How the changes introduced by IFRS 9 provide entities with an opportunity to reconsider the application of hedge accounting
Even companies without complex financial instruments will be affected by these changes. For example, the change that would significantly affect all companies that have debtors (receivables) is the second point above; and how the so called allowance for credit loss (commonly referred to as provision for bad debts) is calculated.
IFRS 9 mentions three methods in calculating credit loss and the credit loss relating to trade receivables is calculated under the simplified method.
Under the simplified approach, a loss allowance is recognised for the total expected loss from possible default events that may arise over the expected life of the financial asset. This means that a loss allowance might be recognised for amounts that are not overdue at the reporting date.
However, the benefit of this approach is that the loss allowance is measured in this way right from initial recognition and there is therefore no need to keep track of the credit risk associated with the financial asset on an annual basis.
From the above, the way in which the previous “provision for bad debts” was calculated will change. No longer is it based on the past and what receivable have become past due but rather what the entity expects the credit loss to be in the future.
This will affect all companies and if you are uncertain as to what the impact of IFRS 9 will be on your business, please contact us to discuss this further.