To analyze the impairment of accounts receivable, it’s necessary to keep in mind a concept known as expected credit losses; this concept incorporated in the IFRS 9 refers to the losses that come from events previous to default in payment on a financial instrument.
The accounts receivable impairment results from the loss of value of the amounts an entity has pending claim from its customers for the delivered goods or services.
An entity should assess and estimate the amounts that are unlikely to be paid to the company and recognize an impairment loss on these financial instruments.
IFRS 9 sets out the accounts receivable impairment must be recognized in advance.
This means that under this new approach, it is assumed all accounts receivable implicitly have a probability of an expected loss.
This standard presents a series of parameters to calculate this impairment.
In this way, under IFRS 9, a company must take into account parameters such as the geographic location of the client, its credit rating, the risk associated with its economic activity, the historical default rates with third parties present similar characteristics, and other parameters to obtain the best estimate of impairment of these financial instruments.
Before the entry into force of IFRS 9, the accounts receivable impairment was recognized based on events and circumstances presented after the initial recognition of these financial instruments.
This means with the previous approach, an entity could recognize an accounts receivable loss only to the extent that any impairment indicator would show a specific amount would not be recoverable.
In this way, under paragraph B5.5.35 of IFRS 9, a company, as a practical solution, can use a provision matrix that shows the parameters that we named above for impairment recognition.
That is, geographical location, historical default rates, and customer credit rating, among other factors.
And according to these elements, establish the credit loss of a customer, and proceed to recognize an impairment of receivable accounts, as we will see in the example shown below.
Impairment of receivables Example
An entity enters a series of agreements with several clients to sell medical equipment for 60,000; these clients are located in two different geographical areas.
That is, 70% in Europe and 30% in the United States.
For the expected impairment or credit losses to calculate, the entity uses a provision matrix.
In this matrix, the entity evaluates each client with the aim it makes a risk profile of each user and being able to make an estimate as close as possible to the amounts owed that the entity will surely not recover.
Therefore, the entity classifies customers based on the following parameters.
This analysis is carried out taking into account the following table:
Historical Observed Default Rates
Default rates by geographic area, credit level, are shown below:
Client’s geographical area Europe
Client’s geographical area USA
The provisions’ matrix is shown below
For the impairment of accounts receivable to calculate, the historical rate must be multiplied by the age range of accounts receivable.
Current = (1.900.000×0.10%) = 1.900
1 to 30 days = (1.900.000×0.10%) = 3.200
31 to 60 days = (1.900.000×0.10%) = 9.100
61 to 90 days = (1.900.000×0.10%) = 9.900
More than 90 days = (1.900.000×0.10%) = 6.000
We perform the same procedure for the other default rates.
Thus, the total impairment of these instruments amounts to: 30,100 + 6,000,000 + 835,500 + 8,965,000 = 15,830,600.
Non-current assets held for sale accounting recognition are regulated in IFRS 5. This standard determines that the assets can be