How expected credit loss has impacted NBFCs one-year into the pandemic

The computation of Expected Credit Loss (ECL) for trade receivables is a one of the complex aspects of Ind AS which involves use of management judgement and assumptions. The COVID-19 crisis has added additional challenges to the computation of Expected Credit Loss (ECL). Here are few insights on the practical application of the ‘Simplified approach’ in the current situation.

Ind AS 109 provides three approaches for computation of ECL. These include general approach, simplified approach, and the purchased or originated credit-impaired approach.

Simplified approach is applicable to trade receivables, contract assets and lease receivables. An entity is required to always apply the simplified approach for trade receivables or contract assets that result from transactions within the scope of Ind AS 115, Revenue from contracts with customers, and that do not contain a significant financing component. However, for those trade receivables that contain a significant financing component, the Company has a policy choice whether to apply general approach or simplified approach.

The simplified approach does not require an entity to track the changes in credit risk, but, instead, requires it to recognize a loss allowance based on lifetime ECL at each reporting date, since initial recognition. Ind AS 109 allows that an entity may use practical expedients when measuring ECL under simplified approach, as long as the methodology reflects a probability-weighted outcome, the time value of money and reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions.

Some of the key challenges that entities may face in applying the ‘Simplified Approach’ are as follows:

a)  Segmenting the portfolios

b)  Factoring the impact of Macro-economic conditions

c)  Additional disclosures in the financial statements.

While developing the ECL methodology under the COVID-19 scenario, some key points which the entities may consider are as follows:

a)  Segmentation basis the stress inherent in the customers after evaluating the stress inherent post COVID-19 outbreak.

b)  Build specific macroeconomic scenarios or post-model overlays and adjustments if the potential impact of COVID-19 cannot be ascertained in the model.