A bank that lends ₦100 million does not wait for a customer to default before it recognises a loss. Under the older rule, losses were recognised only when a loss event had occurred, which meant that losses were booked late, after the crisis had started.
International Financial Reporting Standard (IFRS) 9 Financial Instruments replaces that with an expected credit loss model: the entity recognises an allowance for the credit losses it expects, from the day it acquires the asset, and increases it when credit risk rises. This topic covers what an expected credit loss is, the three-stage general approach, the simplified approach for trade receivables and the provision matrix, and how the allowance is presented.
The next topic covers presentation and disclosure of financial instruments.
In the diets reviewed for this page, questions on this topic appear as an allowance for receivables set as a percentage of the balance inside the main accounts question (November Diet, 2021, Question 1 and May Diet, 2023, Question 1), rather than as a full expected credit loss question. Read financial liabilities, amortised cost and derecognition first.
In 30 seconds
An expected credit loss is the probability-weighted estimate of credit losses: the present value of the cash shortfalls over the expected life of the asset. The general approach has three stages. Stage 1: no significant increase in credit risk since initial recognition: allowance for 12-month expected losses, and interest on the gross carrying amount. Stage 2: a significant increase in credit risk: lifetime expected losses.
Stage 3: credit-impaired: lifetime losses, and interest on the net carrying amount. For trade receivables without a significant financing component, the simplified approach always uses lifetime losses, usually through a provision matrix. The allowance is deducted from the gross carrying amount, and the charge is in profit or loss.
What an expected credit loss is
A credit loss is the difference between all the contractual cash flows due to the entity and all the cash flows the entity expects to receive, discounted at the original effective interest rate. An expected credit loss is the weighted average of credit losses, with the probabilities of default as the weights.
It is an unbiased, probability-weighted amount determined by evaluating a range of possible outcomes, using reasonable and supportable information, available without undue cost, about past events, current conditions and forecasts of future conditions. The entity does not wait for a loss event.
For example, an exposure may produce a shortfall of nil with a probability of 60%, ₦10m with 30% and ₦40m with 10%. The expected credit loss is 0.3 × ₦10m + 0.1 × ₦40m = ₦3m + ₦4m = ₦7m, even though the single most likely outcome is a loss of nil. For a loan, a common way to estimate it is the probability of default × the loss given default × the exposure at default.
The model applies to financial assets at amortised cost, debt instruments at fair value through other comprehensive income, lease receivables, contract assets under IFRS 15, and loan commitments and financial guarantee contracts. It does not apply to equity investments or assets at fair value through profit or loss.
The general approach: three stages
- Stage 1. Credit risk has not increased significantly since initial recognition (or the asset has low credit risk). The entity recognises 12-month expected credit losses: the part of lifetime losses from defaults possible in the next 12 months. Interest 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. The entity recognises lifetime expected credit losses: losses from all possible defaults over the expected life. Interest is still on the gross carrying amount. A presumption is that credit risk has increased significantly if payments are more than 30 days past due.
- Stage 3. The asset is credit-impaired (for example, there is a default or significant financial difficulty). Lifetime expected losses are recognised and interest income is calculated on the net carrying amount (gross less allowance).
For example, a loan with an exposure of ₦100,000,000 has a 12-month probability of default of 2% and a loss given default of 50%. The Stage 1 allowance is ₦100m × 2% × 50% = ₦1,000,000. If credit risk rises significantly and the lifetime probability of default is 10%, the Stage 2 allowance is ₦100m × 10% × 50% = ₦5,000,000.
If the loan becomes credit-impaired with a gross carrying amount of ₦100m and an allowance of ₦40m, interest at the effective rate of 10% is recognised on the net amount of ₦60m, that is ₦6,000,000, not ₦10,000,000. An asset moves back to an earlier stage if credit risk improves.
The simplified approach
For trade receivables or contract assets that do not contain a significant financing component, the entity must use the simplified approach: it recognises lifetime expected credit losses at all times, without tracking stages. For trade receivables and contract assets with a significant financing component, and for lease receivables, it may choose the simplified approach as a policy.
The provision matrix
A provision matrix is a practical way to apply it. The entity groups receivables by age (or by customer type), applies a loss rate from its historical experience to each band, adjusted for current conditions and forecasts, and sums the results. For example, receivables of ₦40,000,000 and loss rates:
| Band | Gross ₦ | Loss rate | Allowance ₦ |
|---|---|---|---|
| Not yet due | 25,000,000 | 0.5% | 125,000 |
| 1 to 30 days overdue | 8,000,000 | 2% | 160,000 |
| 31 to 60 days | 4,000,000 | 6% | 240,000 |
| 61 to 90 days | 2,000,000 | 15% | 300,000 |
| Over 90 days | 1,000,000 | 40% | 400,000 |
| Total | 40,000,000 | 1,225,000 |
If the opening allowance was ₦900,000, the charge to profit or loss is ₦1,225,000 − ₦900,000 = ₦325,000 (Dr Impairment loss, Cr Loss allowance). Receivables are shown at ₦40,000,000 − ₦1,225,000 = ₦38,775,000.
Presentation
- For assets at amortised cost, the loss allowance is deducted from the gross carrying amount in the statement of financial position. The impairment loss (or gain on reversal) is shown in profit or loss.
- For debt instruments at fair value through other comprehensive income, the allowance is recognised in other comprehensive income and does not reduce the carrying amount, which stays at fair value.
- When an asset is written off because there is no reasonable expectation of recovery, the gross carrying amount and the allowance are reduced together. Later recoveries are credited as impairment gains.
- Disclosures include the inputs and assumptions, the reconciliation of the allowance by stage, and the credit risk exposure. Banks regulated by the Central Bank of Nigeria also apply its prudential guidelines, and any excess of the regulatory provision over the accounting allowance is usually transferred to a regulatory reserve in equity.
The ideas in more depth
Why expected, not incurred
Waiting for a loss event meant that provisions were recognised too little and too late. By recognising expected losses from day one, the entity charges the cost of credit risk over the life of the asset, and users see the effect of deteriorating economic conditions earlier.
Why interest changes in Stage 3
Once an asset is credit-impaired, part of the carrying amount is not expected to be recovered. Interest on the full gross amount would overstate income, so the effective rate is applied to the net amount.
Sources and references
- IFRS 9 Financial Instruments: impairment, the general approach, the simplified approach, measurement of expected credit losses, and presentation.
These points are stated as at 5 November 2026.
Worked examples
Example 1: a provision matrix. Trade receivables are ₦40,000,000, aged and with loss rates as in the table above. The opening allowance is ₦900,000. Required: the charge and the net receivables.
- Allowance.
₦125,000 + ₦160,000 + ₦240,000 + ₦300,000 + ₦400,000 = ₦1,225,000. - Charge.
₦1,225,000 − ₦900,000 = ₦325,000. - Net receivables.
₦40,000,000 − ₦1,225,000 = ₦38,775,000.
Example 2: the stages. A loan of ₦100,000,000 has a loss given default of 50%. The 12-month probability of default is 2% and the lifetime probability 10%. Required: the allowance in Stage 1 and Stage 2.
- Stage 1.
₦100m × 2% × 50% = ₦1,000,000. - Stage 2.
₦100m × 10% × 50% = ₦5,000,000.
Example 3: a probability-weighted loss. There is a 60% chance of no shortfall, 30% of ₦10m and 10% of ₦40m. Required: the expected credit loss.
- Calculation.
0.6 × nil + 0.3 × ₦10m + 0.1 × ₦40m = ₦7m.
How to answer in the exam
- Name the approach. Trade receivables: simplified, lifetime losses. Loans: three stages.
- Compute the matrix. Band, balance, rate, allowance, total. Then the charge as the difference from the opening allowance.
- Present it. Deduct the allowance from the gross balance; the charge is in profit or loss.
- State the stage consequences. The basis of loss and the base for interest.
Common mistakes in the exam
- Charging the whole closing allowance instead of only the movement.
- Using 12-month losses for trade receivables under the simplified approach.
- Waiting for default before recognising any allowance.
- Computing Stage 3 interest on the gross amount.
- Applying the loss rate to the total instead of to each band.
- Reducing the carrying amount of a debt instrument at fair value through other comprehensive income by the allowance.
Quick revision
- Expected credit loss: probability-weighted present value of cash shortfalls.
- Stage 1: 12-month; Stage 2: lifetime; Stage 3: lifetime and interest on net.
- Simplified approach: lifetime always; provision matrix.
- Allowance deducted from gross; charge in profit or loss; movement only.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. An expected credit loss is:
- The loss when a customer defaults
- The largest possible loss
- The probability-weighted estimate of credit losses, the present value of cash shortfalls
- The average past loss
Show the answer
C. It is an unbiased, probability-weighted amount.
Question 2. In Stage 1 the entity recognises:
- 12-month expected credit losses
- Lifetime expected credit losses
- No allowance
- Written-off losses
Show the answer
A. Credit risk has not increased significantly since initial recognition.
Question 3. Stage 2 applies when:
- The asset is bought
- Credit risk has increased significantly since initial recognition, and lifetime losses are recognised
- The customer defaults
- The asset is sold
Show the answer
B. Interest is still on the gross amount.
Question 4. In Stage 3, interest income is calculated on:
- Face value
- The gross carrying amount
- Cost
- The net carrying amount, after the allowance
Show the answer
D. The asset is credit-impaired.
Question 5. For trade receivables without a significant financing component the entity uses:
- 12-month losses only
- The incurred loss model
- The simplified approach, with lifetime expected credit losses
- Cash accounting
Show the answer
C. No stage tracking is needed.
Question 6. A provision matrix uses:
- Historical loss rates for aged bands, adjusted for current conditions and forecasts
- A single rate on total receivables
- The directors’ estimate only
- The tax rules
Show the answer
A. Each band has its own rate.
Question 7. For an asset at amortised cost, the loss allowance is:
- Shown as a liability
- Deducted from the gross carrying amount
- Shown in equity
- Ignored
Show the answer
B. The impairment loss is in profit or loss.
Question 8. For a debt instrument at fair value through other comprehensive income, the loss allowance:
- Reduces the carrying amount
- Is not recognised
- Is shown as a liability
- Is recognised in other comprehensive income and does not reduce the carrying amount
Show the answer
D. The carrying amount stays at fair value.
Question 9. The charge to profit or loss each year is:
- The whole closing allowance
- The whole opening allowance
- The movement in the allowance
- Nil
Show the answer
C. Closing allowance less opening allowance, plus any write-offs.
Question 10. Under the expected credit loss model, a loss is recognised:
- Before a loss event, based on expectations
- Only after default
- Only on write-off
- Only on sale
Show the answer
A. From initial recognition.
Section B style: written questions
Question 11 (10 marks). (a) Define an expected credit loss. (3 marks) (b) Describe the three stages of the general approach. (5 marks) (c) State how trade receivables are treated. (2 marks)
Question 12 (15 marks). Receivables are ₦50,000,000: not yet due ₦30,000,000 (loss rate 1%), 1 to 30 days ₦10,000,000 (3%), 31 to 60 days ₦6,000,000 (8%) and over 60 days ₦4,000,000 (30%). The opening allowance is ₦1,500,000. (a) Prepare the provision matrix. (8 marks) (b) Calculate the charge to profit or loss. (3 marks) (c) Show the receivables in the statement of financial position. (2 marks) (d) Explain why the simplified approach is used. (2 marks)
A further written question
Question 13 (20 marks). A bank has a loan with an exposure of ₦50,000,000 and a loss given default of 40%. The 12-month probability of default is 3% and the lifetime probability is 12%.
(a) State the three stages and the basis of loss for each. (6 marks)
(b) Calculate the allowance in Stage 1 and in Stage 2. (6 marks)
(c) Another loan has a gross carrying amount of ₦80,000,000, an allowance of ₦30,000,000 and an effective rate of 10%. It is credit-impaired. Calculate the interest income. (4 marks)
(d) State TWO differences from the previous incurred loss model. (4 marks)
Model answers
Show the model answer to Question 11
(a) An expected credit loss is the weighted average of credit losses (1), with the probabilities of default as weights (1), the credit loss being the present value of the difference between the contractual cash flows due and those the entity expects to receive (1).
(b) Stage 1: credit risk has not increased significantly since initial recognition; 12-month expected losses; interest on gross carrying amount (1.5). Stage 2: credit risk has increased significantly; lifetime expected losses; interest on gross (1.5). Stage 3: credit-impaired; lifetime expected losses; interest on the net carrying amount (2).
(c) Trade receivables without a significant financing component use the simplified approach (1), recognising lifetime expected credit losses at all times, usually through a provision matrix (1).
Show the model answer to Question 12
(a)
- Not yet due ₦30,000,000 × 1% = ₦300,000 (2).
- 1 to 30 days ₦10,000,000 × 3% = ₦300,000 (2).
- 31 to 60 days ₦6,000,000 × 8% = ₦480,000 (2).
- Over 60 days ₦4,000,000 × 30% = ₦1,200,000 (2).
- Total allowance ₦2,280,000.
(b) Closing allowance ₦2,280,000 less opening ₦1,500,000 = ₦780,000 charged to profit or loss (3).
(c) Receivables ₦50,000,000 less allowance ₦2,280,000 = ₦47,720,000 (2).
(d) Trade receivables are short-term with no significant financing component, so lifetime losses are recognised without the need to track changes in credit risk (2).
Show the model answer to Question 13
(a) Stage 1: no significant increase in credit risk; 12-month expected losses (2). Stage 2: significant increase in credit risk; lifetime expected losses (2). Stage 3: credit-impaired; lifetime expected losses, with interest on the net carrying amount (2).
(b)
- Stage 1: ₦50,000,000 × 3% × 40% = ₦600,000 (3).
- Stage 2: ₦50,000,000 × 12% × 40% = ₦2,400,000 (3).
(c)
- Net carrying amount ₦80,000,000 − ₦30,000,000 = ₦50,000,000 (2).
- Interest income 10% × ₦50,000,000 = ₦5,000,000, not ₦8,000,000 on the gross amount (2).
(d) (2 marks each, any two) Losses are recognised from initial recognition on expectations, not after a loss event; the amounts reflect probability-weighted outcomes and forecasts of future conditions; lifetime losses are recognised when credit risk rises significantly, before default.
Pathfinder on IFRS 9 (iii): simple expected credit loss
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
The compulsory accounts question increases the allowance for trade receivables to a stated percentage of the balance. The other adjustments belong to other topics.
Revise first: The simplified approach
The compulsory accounts question writes off a customer balance and makes an allowance of a stated percentage on the continuing trade receivables. The other adjustments belong to other topics.
Revise first: The simplified approach
Source: ICAN Pathfinder, Financial Reporting. Diets covered: Every diet in the Pathfinder, from November Diet, 2021 to May Diet, 2026, was reviewed here. The diets listed above include this topic within a longer question..
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