COVID19 – IFRS 9: Challenges and solutions in the new collections environment

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The Coronavirus pandemic is bound to leave deep marks on everyday social and economic interactions. It is difficult to distinguish those fields and activities that have remain untouched by this unprecedented crisis.

Clearly, new developments concerning the vaccine mean that the return to “normality” is more clearly on the horizon than ever. Having said that, the changes the pandemic has wrought in terms of communication, working conditions and habits as well as personal and business relations will continue to be felt for some time. In this new context, businesses –the driving force of the economy– have to adapt to and operate in an environment of intense competition and intense uncertainty. 

In particular, listed companies and those preparing their financial statements in line with the International Financial Reporting Standards (IFRS) now face a new challenge, a “new virus” which directly affects their profitability.  I’m referring to the challenges arising from implementing the IFRS 9 standard; in fact it’s not something new, a “new virus”, at all, but given its sweeping impact on company results due to the COVID-19 pandemic, it will be treated by businesses as something “new”.

The “new IFRS 9”, refers to a specific standard, the ninth in the series of International Financial Reporting Standards. These standards are internationally accepted and are essential when recording the financials of companies round the globe listed on stock exchanges. Consequently, the IFRS have been adopted by almost all multinational groups and companies with major importance for the economy such as insurance and financial companies and businesses.   IFRS 9 sets out how businesses manage their collections from any third-party counterparty, whether a natural or legal person. In other words, IFRS 9 obliges companies to form provisions (an estimated of how much money they will lose if their client delays paying them or does not pay them at all). Under IFRS 9 that provision (the potential loss of money) relates to all customers of a business and must be calculated at the time the commercial relationship is entered into, not when some event (like delay in payment) occurs. 

The provision made by a company under IFRS 9 is in effect the product of the value of the balance to be paid by its customer times the likelihood that payment will not be made on time. 

It should be clear that, as per IFRS 9, the size of the provision formed reduces the company’s final profits. In other words, even if there is no delay or no actual bad debt, profits will be down by the size of the provisions formed. Whether large or small, profits are the lifeblood that allows companies to take decisions about whether to expand or downsize. And with downsizing, what normally happens is costs and spending are cut, and payroll costs are certainly not left unaffected.

It is therefore easy to understand how important it is for a company to calculate the level of provisions –and therefore a large part of its current assets– accurately and in time. In this way it can also calculate future cash flows which are vital to viability and profitability. This entire process, of course, in an environment of uncertainty such as the current one, makes this an exceptionally difficult and demanding exercise. 

In many cases companies opt to extend credit to customers or restructure debts to keep a loan agreement in place or to continue trading. Even arrangements of this type have an impact on the calculations of potential credit losses and must be recorded in accordance with the provisions of IFRS 9. The method for recognising expected credit losses must also take serious account of the significant increase in credit risk (SICR) attributed to the economic uncertainty caused by the COVID-19 pandemic. Details about this approach have been issued by the IFRS Foundation. 

Before the COVID-19 pandemic, businesses normally calculated provisions using the simplified method, employing basic rules relating to maturity and repayment –or not– of customer balances. Despite that, IFRS 9 always stipulated that proportionate, if not greater, importance should be attached to the application of a forward-looking expected credit loss model. And it is precisely this part of the standard, under current circumstances, that is perhaps the most important tool for accurately determining the actual ‘health’ of each and every company’s trade receivables in good time. So businesses need to stop using the pre-crisis methodology for recognising expected credit losses ‘in a mechanical fashion’. 

In conjunction with the problems already recorded to date from implementing IFRS 9, businesses now face the following challenges: 

  • how to estimate the rise in credit risk arising during the expected life of trade receivables under current conditions. Both the risk assessment and the measurement of expected credit losses should be based on reasonable, well-documented information available to the business.
  • how to assess the impact of the healthcare crisis –and consequently the financial crisis– on the company’s debtors with whom it does business. The results from the suspension or closure of customers’ businesses should be taken into account, while also bearing in mind the possible positive impact of support packages from governments and organisations on economic activity. 
  • how to export data from computer systems, and format and keep it in a separate work environment (with additional uncertainty about how it is to be maintained, in excel format for example) so that the necessary calculations can be made. Frequently, such data is kept in separate databases and systems, ownership of the information is fragmented between different divisions within the business and all the above often lead to improper use of the wealth of available information and to inaccurate or erroneous conclusions being drawn.
  • how staff can complete these particularly demanding tasks within very tight deadlines. It’s exceptionally difficult to support an activity like this in times like these, with many staff working from home and extra care being needed to ensure businesses can continue to perform their vital core functions. 
  • how to clearly document the results taking into account all the aforementioned parameters. The disclosures set out in the financial statements must document this and make it clear to users (investors, shareholders, banks, auditing bodies) that the business has made sure that it takes into account all factors affecting its economic activity during this period and the impact on its customer base and the “health” of its trade receivables. It must also be able to determine future cash flows which will ensure the uninterrupted operation of the business, the limitation of losses and/or continuation of its profitability as well as the expansion of its activities. 

The question which one might reasonably ask is how will businesses manage to rise to all these challenges in an environment of uncertainty as their operations shrink. Fortunately, the good news is that in our times technology has provided solutions and answers to even the most complex issues. The use of applications for processing and analysing high volumes and different types of data (big data analytics) as well as Artificial Intelligence (AI), in parallel with the use of the entire wealth of available information within our business, now allows us to easily and rapidly devise statistical and econometric predictive models designed to be implemented to suit the needs, activity and clientèle of each and every business. 

New technologies also allow remote access to business information and data. All of this with minimum requirements in terms of technological investment and absolute security thanks to the use of cloud-hosted applications which now to a large extent support functions that were traditionally performed using a business’ own in-house infrastructure and resources. 

One could summarise the advantages and benefits of using technology to comply with IFRS 9 in the following ways:

  • Transparency and security in maintaining data, information and calculations.
  • No IT system needs to be developed since simple primary raw data derived from computer systems is used.
  • All data (internal information, market conditions) is taken into account in generating the final results. At this time in particular, this may well be the most important advantage. 
  • Statistical and econometric models can be tailored to each and every business. – Existing historical data can be used and can also be projected into the future by creating scenarios to model changes in economic activity and market prospects.  
  • The results are documented in the financial statements. Critical factors for adequately documenting the results of applying IFRS 9 are statistical and econometric models based on historical data and market parameters, as well as the provision of explanations about the value judgements made and the scenarios on which they are based. 

Businesses have solutions available to them that allow them to respond to the challenges posed by this difficult situation. Solutions that allow them to implement IFRS 9 so that the standard does not become a “new virus”. At the same time, it is particularly important to point out that the results of proper implementation of IFRS 9, in addition to ensuring regulatory compliance, also have multiplier benefits for businesses since (a) it leads to an evaluation of the entire customer base and the quality of the business’ assets and (b) it is a powerful weapon for determining the actual financial position of the business and for planning future steps to ensure it continues as a going concern, to safeguard the health of its cash flows, and to increase its profitability. 

The Opinion was published in the Greek financial information portal Capital.gr

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