Credit losses and the allowance method

Some customers won't pay. Rather than wait for them to default, IFRS 9 requires an allowance for expected credit losses (ECL) — a contra-asset that reduces receivables to the amount the business actually expects to collect. The expense is recognised in the period the sales are made, matching the loss with the revenue that created the risk.

The simplified approach. For trade receivables without a significant financing component, IFRS 9.5.5.15 requires the allowance to equal lifetime expected credit losses from day one; there's no need to track whether credit risk has increased. A common practical tool is a provision matrix (IFRS 9.B5.5.35): group receivables by how far overdue they are and apply a loss rate to each band. Rates start from the business's own historical loss experience and are adjusted for current conditions and forward-looking information — if a recession is coming or a key industry is struggling, historical rates are too low. Older balances carry higher rates because the longer a debt is overdue, the less likely it is to be paid.

The adjustment. The provision matrix gives the required closing balance of the allowance. The expense is whatever moves the allowance from its current balance to that figure: - Expense = required balance − existing credit balance. - If write-offs during the year exceeded the allowance, it has a debit balance before adjustment, and the expense must cover that shortfall and the required balance. - If the allowance is already higher than required, the adjustment reduces it and is a credit to credit loss expense.

Write-offs. When there's no reasonable expectation of recovering a specific debt (IFRS 9.5.4.4) — the customer is in liquidation, say — it is written off: debit the allowance, credit receivables. Net receivables and profit don't change, because the loss was already expected and expensed.

Recoveries. If cash later arrives on a debt already written off, reverse the write-off or credit the allowance (or the credit loss line) as the business's policy states — never revenue.

Direct write-off method. Expensing debts only when they go bad is simple but ignores expected losses until they happen. It isn't acceptable under IFRS 9 — nor under US GAAP, whose CECL model (ASC 326) also measures expected lifetime losses.