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Impacts of IFRS 9
FRS 9 is an extensive review of the current accounting standards which became mandatory from 1 January 2018. Currently in Australia, all listed companies,
financial institutions and foreign companies are required to follow these standards.
The new requirements have changed how credit losses must be accounted for. Companies are not allowed to consider a credit loss when the event is identified.
This means that some businesses will have to record a higher bad debt provision than under the old regime, which ultimately hurts the bottom line.
Trade Credit insurance can mitigate against this issue because it allows businesses to minimise the amount of bad debt provision it has to record in its financial statements.
Please refer below for an example:
Company ABC has $1,000 in trade receivables of which $200 is owed from Company XYZ. Company XYZ goes into administration.
Under the old reporting standard:
- Company ABC will need to recognize the $200 owed from Company XYZ as a bad debt provision given that XYZ is unlikely to repay the debt.
- There has been no evidence of an incurred credit loss for the remaining $800 in trade receivables therefore no further provision is required.
- Total Bad Debt Provision is $200.
Under IFRS 9:
- Company ABC will need to recognize the $200 owed from Company XYZ as bad debt provision given that XYZ is unlikely to repay the debt.
- Under IFRS 9, Company ABC is now required to also consider the credit risk of the remaining $800 of its trade receivable balance and estimate an expected credit loss even if the loss expectations are very low.
- For example, if ABC estimates a 20% expected credit loss on the remaining $800, under the new requirement ABC will need to provide an additional $160 (20% x $800) in bad debt provision.
- Total Bad Debt Provision under IFRS 9 is $360.
- If the client has taken out Trade Credit insurance, the expected credit loss percentage can be minimised as it is covered by Trade Credit insurance and therefore the total amount of Bad Debt Provision can be reduced.
Here are some examples (provided by leading Trade Credit Insurer Euler Hermes) on the cost of a Trade Credit policy versus the cost of provisioning for
the expected credit losses:
Written by Euler Hermes and GSA.