IFRS 9 has profoundly transformed the way companies account for credit risk.
Where the former IAS 39 waited for a loss to be incurred before recognising it, IFRS 9 requires anticipation: as soon as a financial asset enters the balance sheet, the company must estimate the losses it expects to suffer and recognise a corresponding allowance.
This shift from an incurred-loss to an expected-loss approach directly concerns banks, but also any Luxembourg company publishing IFRS accounts:
- financing companies;
- holding companies;
- consolidated groups;
- businesses holding a significant portfolio of trade receivables.
Understanding the IFRS 9 impairment test is therefore essential, both to produce reliable financial statements and to avoid late corrections when the financial statements are reviewed. This article sets out its rationale, its scope and its practical implementation, supported by worked examples.
I. From an incurred loss to an expected loss
Under IAS 39, an impairment could only be recorded once an objective trigger had occurred: a confirmed missed payment, evident financial difficulty, or a counterparty default. This approach, considered too slow in the aftermath of the 2008 financial crisis, delayed the recognition of losses until they were almost certain.
IFRS 9 reverses this reasoning. The company no longer asks “has a loss occurred?” but “what loss can I reasonably anticipate?”.
The allowance is recognised from inception, then adjusted at each closing according to how the risk develops. The objective is twofold:
- to reflect credit risk more prudently;
- to give the reader of the accounts a truer and more forward-looking picture of the portfolio’s solvency.
II. Which assets are concerned
The expected credit loss model does not apply to the entire balance sheet. It mainly targets:
- financial assets measured at amortised cost (loans, bonds held, deposits);
- financial assets measured at fair value through other comprehensive income (FVOCI);
- trade receivables, contract assets and lease receivables;
- loan commitments given and financial guarantee contracts.
By contrast, instruments measured at fair value through profit or loss (FVTPL) are excluded: their change in value, which already incorporates credit risk, flows directly through profit or loss. Equity instruments are likewise outside the scope of the impairment test.
III. The general three-stage model
For instruments falling under the general model, IFRS 9 scales the provision according to how credit risk has evolved since initial recognition. Three stages follow one another, each entailing a different measurement of the expected loss and a different basis for recognising interest.
| Stage | Risk situation | Provision recognised | Basis for interest |
|---|---|---|---|
| 1 | Risk unchanged or low since origination | 12-month expected losses | Gross carrying amount |
| 2 | Significant increase in credit risk | Lifetime expected losses | Gross carrying amount |
| 3 | Credit-impaired asset (default confirmed) | Lifetime expected losses | Net amount (after the provision) |
Moving from stage 1 to stage 2 is the most delicate point of the standard. It does not depend on a missed payment, but on a significant increase in credit risk assessed against the risk estimated at inception.
In practice, a payment delay of more than thirty days gives rise to a presumption of such deterioration, but other signals also trigger it:
- a downgrade of the counterparty’s rating;
- a deterioration in its financial indicators;
- a worsening of the sector’s economic environment.
This assessment relies largely on judgement and must be carefully documented.
IV. How an expected loss is measured
An expected credit loss is not a single forecast, but a probability-weighted average of several scenarios, discounted to the reporting date. Three parameters structure the calculation:
- the probability of default (PD), i.e. the risk that the counterparty fails to repay;
- the loss given default (LGD), i.e. the portion of the receivable that would not be recovered;
- the exposure at default (EAD), i.e. the amount actually at risk.
The product of these three parameters gives the expected loss before discounting.
A distinctive feature of IFRS 9 is that the estimate must incorporate reasonable and supportable forward-looking information: growth prospects, interest rates, unemployment, sector conditions.
The allowance therefore does not look only at the past, but takes account of the future conditions anticipated at the reporting date.
V. The simplified approach for trade receivables
Requiring three-stage monitoring for every customer invoice would be disproportionate. IFRS 9 therefore provides a simplified approach:
- mandatory for trade receivables and contract assets without a significant financing component;
- optional for lease receivables.
It consists in recognising, from the outset, the losses expected over the whole life of the receivable, without having to track movement from one stage to another.
In practice, the company builds a provision matrix: it classifies its receivables by ageing and applies to each band a historical loss rate, adjusted for economic prospects. Consider a company with a trade-receivable balance of EUR 1,000,000 broken down as follows.
| Ageing | Balance | Loss rate | Provision |
|---|---|---|---|
| Not yet due | EUR 600,000 | 0.5% | EUR 3,000 |
| 1 to 30 days | EUR 250,000 | 2% | EUR 5,000 |
| 31 to 60 days | EUR 100,000 | 8% | EUR 8,000 |
| 61 to 90 days | EUR 30,000 | 20% | EUR 6,000 |
| More than 90 days | EUR 20,000 | 50% | EUR 10,000 |
| Total | 1 000 000 € | 32 000 € |
In this example, the company recognises an impairment of EUR 32,000, i.e. 3.2% of its balance. The rate applied increases with ageing, reflecting the decreasing likelihood of recovery, and the rates used must be reviewed at each reporting date to incorporate recent collection experience and economic prospects.
VI. The special case of guarantees and commitments
Financial guarantees and loan commitments given do not appear as assets: they represent a future risk, not an existing receivable.
The expected losses attached to them are therefore recognised not as a reduction of an asset, but as a provision in liabilities.
This point is frequently overlooked by groups granting intra-group guarantees, even though it can weigh on consolidated equity.
VII. Practical challenges for Luxembourg companies
In Luxembourg, a financial centre where many structures report under IFRS, the impairment test raises three recurring difficulties:
- Data quality: reconstructing a reliable loss history requires rigorous monitoring of recoveries, often missing in smaller structures.
- Judgement: the boundary between stage 1 and stage 2, like the choice of forward-looking scenarios, must be capable of being justified to the statutory auditor.
- Documentation: an unsupported allowance is a fragile allowance, liable to be challenged during the review of the accounts.
Conclusion
The IFRS 9 impairment test is not just a calculation: it is a discipline combining risk modelling, economic anticipation and rigorous documentation.
Well mastered, it strengthens the credibility of the financial statements with banks, investors and auditors; poorly handled, it exposes the company to costly adjustments and qualifications.
At Ease Advisory, we support Luxembourg companies in keeping their accounts under IFRS, building their provisioning matrices and preparing robust financial statements ready for review. In doubt about the treatment of your receivables or commitments? Let’s talk.
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