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Applied Valuations has expertise in performing Expected Credit Loss analysis as per latest standards
With increasing uncertainity in macroscopic scnearios the standards have also evolved to incorporate the impact of economic variables in the Expected Credit Loss ('ECL') valuations. As per IFRS 9 and Ind AS 109, Financial Instruments, the companies have to account for the expected loss on the day of raising invoice considerinh the historical as well as macroeconomic factors.
What is Credit Loss?
As per Ind AS 109, credit loss is defined as:
"The difference between all contractual cash flows that are due toan entity in accordance with the contract and all the cash flowsthat the entity expects to receive (ie all cash shortfalls),discounted at the original effective interest rate(orcredit-adjusted effective interest rate for purchased ororiginated credit-impaired financial assets)."
As per para B5.5.28 of Ind AS 109, Financial Instruments:
“Expected credit losses are a probability-weighted estimate of credit losses (i.e., the present value of all cash shortfalls) over the expected life of the financial instrument. A cash shortfall is the difference between the cash flows that are due to an entity in accordance with the contract and the cash flows that the entity expects to receive. Because expected credit losses consider the amount and timing of payments, a credit loss arises even if the entity expects to be paid in full but later than when contractually due.”
How is ECL estimated?
How is ECL estimated?
The simplified approach is mandatory for trade receivables without a significant financing component and optional for lease and trade receivables with a significant financing component. Under the simplified approach as well, there is no distinction between stage 1 (Initial recognition) and stage 2 (Significant increase in credit risk) and requires calculation of lifetime expected loss for each asset. There is no mandated way to estimate the ECL, we have shared some suggested steps for the analysis:
Step 1: Grouping of Trade Receivables (Ageing Table)
Grouping is required as all the trade receivables do not necessarily share the same characteristics, and therefore, it would not be reasonable to put them into the same bucket. Grouping purely depends on the factors that effects the repayment of receivables.
Step 2: Estimation of Flow Rates
Historical Flow rate of default need to be estimated for each group of financial assets or trade receivables. The period selected for this analysis can neither be too short so as to make no sense nor too long because market changes are frequent and longer period may result in considering market assumptions that may no longer be valid.
Step 3: Estimation of Credit Loss Rate
Credit Loss Rate or Default rate is the loss of an account receivable of a time period based on empirical data.
Step 4: Incorporate forward looking information
Once the Default Rate is computed, the next step is to adjust them with the forward-looking information. These are all the information that could affect the credit losses in future, for example, macroeconomic forecasts of GDP, interest rate, lending rate, unemployment, sectoral inflation, etc.
Step 5: Expected Credit Loss Calculations
The concluded ECL is estimated based on weighted average of scenarios considered.
How Applied can add value
How Applied can add value
We structure the engagement as per client’s specific needs and the purpose of the engagement. Our valuation report provides an overview of the company, industry, economy; discusses value drivers; outlines the analysis performed, along with the inputs and assumptions; and incorporates detailed appendices that support our valuation conclusion. The valuation analysis is detailed, technically sound, and if challenged, we provide our clients with additional support, including responses to audit queries.
Why Applied Valuations?
Why Applied Valuations?
Applied Valuations assists clients with the valuation of businesses/ business interests, as well as intangible assets and complex instruments such as options, warrants, convertible notes, etc. Applied Valuations is founded by Valuation experts from Big 4 firms with the experience of valuing more than 1000+ business during their carrier.
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