In response to our article on 17 May on “Substance over form – when to apply it?” we have had questions from practitioners about the meaning of the last sentence underlined in the example below: Calculating the impairment of receivables
In the Standard of GRAP on Financial Instruments (Revised in 2019) an entity is required to identify impairment losses based on what it believes its exposure to credit losses will be over a period of time. The expected losses are calculated based on the cash flows that an entity expects to receive and when it expects to receive them. While there are a number of assumptions that management makes about the receipt of cash flows, the underlying cash flows used in the calculation are based on what is contractually agreed. Also, the period over which the cash flows are calculated cannot exceed the contractual period of the instrument. The combination of the English language and financial instruments demonstrates the complexity that can arise in accounting.
When measuring the impairment of receivables, entities would consider what cash flows it expects to receive and when. The “when” could extend beyond the initial contractual terms particularly in cases where the instrument is credit impaired. Consider an example where a municipal debtor is in liquidation. In this instance, the amount due to the entity will be based on the contractual cash flows, but clearly the cash flows will be received based on the completion of legal proceedings that would extend beyond the contractual period of the instrument. In these situations, it is possible that the contractual cash flows may not be fully recovered if the liquidators decide that Xc will be received for each Rand.
The sentence in the last example was intended to illustrate that there may be instances when broader contractual elements may need to be considered together in assessing impairment. This could include the period of the contractual cash flows of an instrument, along with other contractual elements such as commitments and options that could affect the assessment of the contractual period. For example, in considering the contract period of a loan granted to another party, the period of a loan commitment, the period over which cash flows are due, and options for extension, may be factors in determining the contract period for impairment purposes. Whether or not the cash flows will be received within that contract period may indicate an impairment based on the timing of collection.
The table below may assist deciding what to use when assessing impairment:
Calculating impairment of receivables | Stage of financial asset | Stage 1 | Stage 2 | Stage 3* | | Credit risk | Did not increase significantly since initial recognition | Increased significantly since initial recognition | Credit impaired | | Loss allowance | 12 months expected credit losses | Lifetime expected credit losses | Lifetime expected credit losses | | Period over which to calculate loss allowance | Forward looking - 12 months | Forward looking – Lifetime of receivable (contractual period + consider extension options) | Forward looking – Lifetime of receivable (contractual period + consider extension options + consider other factors/periods as a result of credit impaired receivable) |
*Note: Stage 3 does not apply to receivables. |
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