Expected credit losses, from your own history

Elvira measures the allowance on the IFRS 9 simplified approach: lifetime expected losses on trade receivables, with no stages to track. The honest question is where the percentages come from, and for most businesses the answer is that somebody picked them.

Which approach, and why it matters

IFRS 9 has two routes. The general approach sorts every receivable into three stages, tracks whether credit risk has increased significantly since it was recognised, and switches between twelve-month and lifetime losses accordingly. It is built for banks and lenders, and it is a great deal of machinery for a shop that invoices on thirty days.

The simplified approach exists precisely so that ordinary businesses do not have to do that. For trade receivables you measure lifetime expected credit losses from the start: no stages, no assessment of whether risk has moved, no transfers between buckets. This is what Elvira implements, and it is what almost every business selling on credit should be using.

Two ways to the number, both simplified

The first is a provision matrix: your own percentage on each aging bucket. It is what most auditors expect to see and it is defensible when the percentages have a reason behind them.

The second is the one worth having. Elvira derives the rate for each bucket from this company’s own payment history, by flow-rate analysis: for every invoice that ever went bad, which buckets it actually aged through on the way. A loss written off at day 45 raises the rates for Current and 1–30, because that is where the money genuinely sat, not the bucket it happened to die in.

What you get

• Buckets identical to the A/R aging report, so the provision and the aging can never disagree.
• A forward-looking factor you set and record a reason for: the part of the standard most implementations skip.
• A run that adjusts the allowance to its target and books only the difference, never the whole figure again.
• Write-off straight from the invoice, and recoveries when somebody pays after all.
• An allowance balance that is explainable by construction: provisions less write-offs, checked like any other control account.

Why the derived rates matter

A percentage somebody picked is a number you have to defend. A percentage your own ledger produced is a number you can show the working for: and it moves when your customers’ behaviour moves, which is the point of the standard.