IFRS 9 replaced IAS 39's incurred-loss model with a forward-looking expected credit loss (ECL) model — a loss allowance is recognised before a default actually happens, based on reasonable and supportable information about the future, not just historical experience. Which of the two available approaches applies depends on the type of financial asset.
The three-stage general approach
For most financial assets — loans, debt investments, most receivables outside the simplified-approach categories below — IFRS 9 uses a three-stage model:
- Stage 1 — credit risk has not increased significantly since initial recognition. Recognise 12-month ECL (the portion of lifetime losses expected from default events possible within 12 months). Interest revenue is calculated on the gross carrying amount.
- Stage 2 — credit risk has increased significantly since initial recognition, but the asset is not yet credit-impaired. Recognise lifetime ECL. Interest revenue is still calculated on the gross carrying amount.
- Stage 3 — the asset is credit-impaired (objective evidence of default or significant financial difficulty). Continue recognising lifetime ECL, but interest revenue is now calculated on the net carrying amount (amortised cost less the loss allowance).
What "significant increase in credit risk" actually means
This is a relative test, not an absolute one: it compares the risk of default at the reporting date to the risk of default at initial recognition — it is not simply "is this asset risky." A loan that was high-risk from day one and remains equally high-risk has not necessarily migrated to Stage 2; a loan that started very low-risk and has deteriorated meaningfully may have, even if its absolute risk level is still moderate. There is a rebuttable presumption that credit risk has increased significantly when contractual payments are more than 30 days past due.
The simplified approach for trade receivables
For trade receivables and contract assets that do not contain a significant financing component, the simplified approach is mandatory: measure the loss allowance at an amount equal to lifetime ECL from initial recognition, with no staging assessment at all. For trade receivables with a significant financing component, and for lease receivables, the simplified approach is available as a policy choice.
Building a provision matrix
A provision matrix is the standard practical expedient for the simplified approach:
- Group receivables by shared credit risk characteristics — customer type, geography, product line, or credit rating, whichever actually correlates with historical loss patterns in your business
- Within each group, bucket by days past due (current, 1-30, 31-60, 61-90, 90+)
- Calculate a historical loss rate for each cell, from actual write-off experience over a representative period
- Adjust each rate for current and forward-looking macroeconomic factors that are reasonably expected to affect collectability — this step is what distinguishes IFRS 9 from a purely backward-looking bad-debt estimate, and it is not optional
- Apply the adjusted rates to the current outstanding balance in each cell
Where this typically goes wrong
- Using historical loss rates unadjusted for forward-looking information — a common shortcut that doesn't meet the standard's actual requirement
- Applying the general three-stage model to trade receivables that should be on the mandatory simplified approach
- Assessing "significant increase in credit risk" against an absolute risk threshold instead of the required relative comparison to initial recognition
- Calculating Stage 3 interest revenue on the gross carrying amount instead of net of the loss allowance
- Grouping receivables with genuinely different loss patterns into one provision matrix cell purely for convenience