ECL Calculation Under IFRS 9 Guide for Companies

What Is ECL Calculation and Why Does It Matter?

Companies use ECL, which means Expected Credit Loss, to estimate possible losses from loans or receivables. The IFRS 9 standard says that every company must record these expected losses in their financial statements. IFRS 9 replaced the old backward-looking rules with a forward-looking model. It means firms must think ahead and record losses they expect, not just those that already happened.

Earlier, IAS 39 told firms to record losses only when they saw real evidence. Now, with IFRS 9, firms must make a provision for credit loss as soon as they recognize an asset, even if the loss hasn’t occurred yet.

Main Factors in ECL Calculation

Companies look at three main factors for ECL:

Exposure at Default (EAD): The total amount at risk if the borrower defaults at any time. For example, for bonds, it’s the book value at the report date.
Probability of Default (PD): The chance that a borrower will default on a payment.
Loss Given Default (LGD): The amount of money a company could lose if a default happens, after considering any collateral value.

The formula for ECL is:
ECL = EAD × PD × LGD

Companies refine this formula by including other factors like the expected life of the asset and using discount rates as required by their business.

What Approaches Can Companies Use for ECL Calculation?

IFRS 9 gives companies two ways to calculate ECL:

General Approach: This method uses a three-stage process. Companies must check if credit risk has gone up and decide if they should use 12-month ECL or lifetime ECL for the asset.
Simplified Approach: Companies use this for short-term receivables. Here, firms record a lifetime ECL from the start and skip some complex steps.

How to Spot a Significant Increase in Credit Risk?

To know if credit risk has gone up for an asset, companies check:

External market signals, like changes in cost of debt or equity
Negative shifts in economic or business situations
Lower credit ratings or internal risk signals
Big changes in collateral value or repayment patterns
Large drops in operating results or missed payments

These signs help firms decide how much ECL to recognize.

Challenges in ECL Calculation Models

Many companies struggle when updating their ECL models. Some challenges are:

It’s tough to get reliable outside data, like company ratings or market trends.
Firms often lack detailed internal data needed for calculations.
Each company and sector has special factors that must be added.
Companies need to document all model steps and assumptions.
When big changes happen in business or the economy, firms must update their models quickly.

How COVID-19 Changed ECL Calculations

COVID-19 caused big swings in economies everywhere. Most companies saw negative GDP growth, which made forecasting harder. This hurt the accuracy of ECL models.

When economies decline, it’s also hard to value collateral. If assets drop in value, the LGD (Loss Given Default) gets bigger. Many firms found it hard to update their ECL models as market conditions changed so fast.

How Mubarak Al Ketbi (MAK) Auditing Helps With ECL and IFRS 9

Mubarak Al Ketbi (MAK) Auditing has a skilled team for IFRS accounting. The experts guide companies through ECL and IFRS 9.

Here’s how the team helps:

Answers questions about ECL and IFRS 9
Builds ECL models for your assets
Helps document all assumptions and decisions
Reviews existing ECL models for compliance
Assists with automating ECL in ERP systems

Mubarak Al Ketbi (MAK) Auditing supports businesses so they meet every requirement.

How Mubarak Al Ketbi (MAK) Auditing Can Help You

If you want to solve your ECL problems, you shouldn’t put all your eggs in one basket! Mubarak Al Ketbi (MAK) Auditing gives clear guidance and strong support for IFRS 9 and ECL models.