Key takeaways
- IFRS 9 and EAS 47 require expected — not incurred — credit losses, reflecting reasonable and supportable forward-looking information.
- Trade receivables often qualify for the simplified approach; loans and other financial assets usually require the general three-stage approach.
- PD, LGD and EAD must be estimated from data you can defend, reconciled to the ledger.
- Documentation is not optional — auditors and regulators test the model's logic, not just its output.
Why ECL is different
Before IFRS 9, credit losses were recognised when there was objective evidence of impairment. IFRS 9 — and its Egyptian equivalent, EAS 47 — changed this to an expected credit loss (ECL) model: entities must recognise losses based on the probability of default over a defined horizon, weighted by forward-looking scenarios. The result is earlier recognition and significantly more judgement.
Simplified vs general approach
| Approach | Applies to | Measurement |
|---|---|---|
| Simplified | Trade receivables and contract assets (and optionally lease receivables) | Always lifetime ECL — often via a provision matrix |
| General (three stages) | Loans, debt investments, intercompany loans, cash and other financial assets | 12-month ECL in Stage 1; lifetime ECL in Stages 2 and 3 |
The building blocks
Probability of Default (PD)
PD is the likelihood that a borrower defaults over a given horizon. It can be estimated from internal default history (for example through migration or roll-rate analysis), external ratings, or market data. Through-the-cycle PDs must be adjusted to point-in-time estimates that reflect current and expected conditions.
Loss Given Default (LGD)
LGD is the share of the exposure that will not be recovered after default, taking into account collateral, recoveries and the time value of money. A common error is to use a collection-efficiency ratio as a proxy for LGD — these are not the same concept.
Exposure at Default (EAD)
EAD is the amount outstanding at the time of default, including expected drawdowns on undrawn commitments and accrued interest.
Forward-looking information
Macroeconomic variables — such as GDP growth, inflation or unemployment — are linked to default rates through a statistical or expert-based relationship. Multiple scenarios (typically base, upside and downside) are weighted by probability. The direction and strength of each relationship must make economic sense; a model in which rising unemployment reduces defaults will not survive audit.
Staging and significant increase in credit risk
Under the general approach, exposures move from Stage 1 to Stage 2 when credit risk has increased significantly since initial recognition, and to Stage 3 when they are credit-impaired. Days-past-due is a common backstop (more than 30 days for Stage 2, more than 90 days for default is a rebuttable presumption), but entities should also consider qualitative indicators and relative changes in PD.
Common weaknesses we find in validations
- Data that doesn't reconcile to the general ledger or the ageing report
- Historical windows that are too short or unrepresentative
- Incorrect sign or implausible sensitivity of macroeconomic variables
- LGD proxies that do not measure loss severity
- No back-testing of prior estimates against actual losses
- Intercompany balances and cash excluded without analysis
- Weak documentation of management overlays
What a defensible model looks like
- Clear segmentation based on shared credit risk characteristics.
- Data reconciled to the ledger, with documented exclusions.
- Transparent calculations that a reviewer can follow and re-perform.
- Forward-looking adjustments with economic rationale.
- Back-testing and a process for annual recalibration.
- A methodology paper approved by management.
How ASA can help
ECL is one of our specialist areas. We design methodologies, build models, and independently validate existing ones — ending each validation with a clear, documented conclusion. International accounting networks in Egypt and Saudi Arabia engage us as ECL specialists on their client engagements.
This article is for general information only and does not constitute professional advice. Thresholds, rates and procedures change — please contact us or refer to the latest official sources before acting.