The next step

a worked example of how to calculate a bad debt provision under IFRS 9

[Spreadsheet]

HMRC’s guidance on tax treatment of IFRS 9 bad debt provisions

[Weblink]

How to calculate a bad debt provision under IFRS 9

IFRS 9

If your company prepares accounts under International Financial Reporting Standards (IFRS) or FRS 101 , then IFRS 9 tells you how to create a bad debt provision (referred to as impairment losses or credit losses).

Tip. If your company prepares FRS 102 accounts, you can still use the IFRS 9 method to calculate your bad debt provision.

Tip. Provided you correctly apply the IFRS 9 rules to arrive at your bad debt provision, any debit to the P&L will be an allowable deduction for tax purposes (see The next step ). The only exception would be where the debt is between connected companies.

What do the rules say?

IFRS 9 requires you to account for bad debts on an “expected loss” basis using what is referred to as the simplified approach unless the trade receivables have a significant financing component (they shouldn’t have if the trade debtors are all due within one year).

Lifetime expected credit loss. Under the simplified approach, the impairment loss is measured as the lifetime “expected credit loss” (ECL).

Provision matrix. It would be incredibly time consuming to calculate the ECL for each trade debtor so IFRS 9 allows you to a use what it calls a “provision matrix”. Simply put, this is a calculation of the impairment loss based on the relevant bad debt percentage for a segment of trade debtors.

Tip. The customers within each segment should have the same or similar bad debt patterns. For example, perhaps you sell in a few geographical regions and you note that customers from one area pay more reliably than those from another so you could segment your customers between geographical area. Other suggestions for segmenting are by product type, sales channel or type of customer (individual or business).

Calculating the default rate

IFRS 9 says that you should: (1) derive the default rates from your own historical credit loss experience; and (2) adjust them for forward-looking information.

Historic default rates. Take the appropriate period and analyse what percentage of trade debtors went bad during that period.

Tip. An appropriate period is likely to be one or two years. Too long a period might incorporate market effects that are no longer valid.

Tip. You should calculate the default rate for each time period when the debts were paid, e.g. 0-30 days, 30-60 days, 61-90 days, over 90 days, etc. For an illustrative example, see The next step .

Forward looking information. This is all the information which could affect the credit losses in the future. A key one now would obviously be the coronavirus effect which is likely to increase the default rate.

For HMRC’s guidance on tax treatment of IFRS 9 bad debt provisions and a worked example of how to calculate a bad debt provision under IFRS 9 , visit http://tips-and-advice.co.uk/financialcontroller-dz (FC 12.11.03).