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Services / 10 — Financial instruments & IFRS 9
Classification and measurement, expected credit loss modelling, fair valuation under IFRS 13, hedge accounting and IFRS 7 disclosure — for Pakistani, Gulf and international reporting.
Expected credit loss and fair value are the most judgement-heavy numbers in a set of financial statements, which makes them the most argued over. The difference between a model that is accepted and one that is contested is almost never the mathematics. It is whether the reasoning is documented well enough for somebody else to follow.
Send us the model and the audit query. We will tell you whether the challenge is about methodology, documentation or inputs — they need different answers, and the wrong one costs a reporting cycle.
Our auditor says our provision is not IFRS 9 compliant.
A percentage applied to ageing brackets is not an expected credit loss model, however long it has been accepted.
We built a model in Excel and cannot explain it any more.
Models that only their author understands fail the first time the author is unavailable.
We have interest-free loans to related parties on the balance sheet.
Below-market and interest-free lending requires fair value measurement at initial recognition, and the difference has to go somewhere.
We issued convertible instruments to an investor.
Convertibles usually contain separable components, and getting the split wrong distorts both equity and profit.
We hedge foreign currency but do not apply hedge accounting.
Economic hedging without hedge accounting produces volatility in profit that the hedge was meant to remove.
Our Gulf subsidiary needs an ECL model for local reporting.
Receivables portfolios in Saudi Arabia and the UAE, modelled to IFRS as endorsed in the relevant jurisdiction.
We granted share options and do not know how to value them.
Option valuation requires a defensible model and documented assumptions, not a nominal figure.
A buyer's advisers are questioning our provisioning.
Under-provisioning found in diligence is treated as an earnings adjustment, and it is priced.
Technical accounting work delivered with the auditor's questions already in view.
Establishing the right measurement category before anything else follows from it.
The general approach, for portfolios where a provision matrix is not sufficient.
For trade receivables, contract assets and lease receivables — where most corporates actually sit.
Valuation with the hierarchy level established and the inputs sourced and referenced.
Where the instrument does not fit a standard template.
The mechanics that quietly misstate profit when they are done by convention rather than by standard.
Documentation prepared at inception, because it cannot be applied retrospectively.
Including review of models prepared by someone else.
Almost none of these are arithmetic. Nearly all are judgements that were made but never written down.
| The query | What sits behind it |
|---|---|
| The provision matrix is just last year's percentages | Historical loss rates are the starting point, not the answer. IFRS 9 requires them to be adjusted for current conditions and forward-looking information. A matrix carried forward unchanged for three years is the single most common finding we see. |
| Segmentation is not explained | Receivables have been grouped — by customer type, product or geography — with no documented basis for why those groupings share credit risk characteristics. |
| Forward-looking information is asserted, not evidenced | The model says macroeconomic factors were considered. Nothing shows which factors, what source, what weighting, or what the effect was. |
| Staging criteria are undefined | Under the general approach, the trigger for a significant increase in credit risk must be defined in advance. Deciding case by case at reporting date is not a staging framework. |
| Related-party balances are excluded without reason | Intercompany and shareholder receivables are frequently assumed to carry no credit risk. That assumption requires support, particularly where the counterparty is loss-making. |
| The fair value hierarchy level is not stated | Level 3 measurement carries specific disclosure obligations. Valuations presented without an explicit level determination invite the auditor to assume the most onerous. |
| Unobservable inputs have no source | Discount rates, growth assumptions and credit spreads appear in the model with no reference to where they came from or why they are appropriate. |
| Nobody can rebuild the model | The spreadsheet works, and the person who built it has left, and the logic is undocumented. At that point the number cannot be supported regardless of whether it is right. |
Methodology, judgements, inputs and their sources documented as the model is built. Documentation assembled afterwards reads as justification rather than reasoning, and auditors can tell the difference.
Loss history, macroeconomic data, discount rates and credit spreads traced to a source. Unobservable inputs identified as unobservable rather than presented as facts.
Logic separated from data, assumptions in one place, no hard-coded values buried in formulas. The test is whether a reviewer with no prior involvement can follow it — because that is exactly who will.
A second qualified professional reviews the model logic and the judgements before it leaves. Modelling errors are systematic rather than random, which is what makes single-reviewer work dangerous here.
Which assumptions actually move the answer, and by how much. This is a disclosure requirement, and it is also the fastest way to find out whether the model is stable.
A trading company with two hundred customers does not need a bank's PD and LGD framework. Over-engineering a model is not conservatism — it is a maintenance burden that produces its own errors.
These are the firm's controls applied to modelling work specifically. The full set, applied to every engagement of any type, is published.
IFRS 9 gives two routes to expected credit loss. Most corporates need the second one, and many are applying neither properly.
Trading, manufacturing, services and construction businesses applying the simplified approach — the largest group by number, and the one most often carrying a non-compliant matrix.
Shareholder loans, intercompany balances and concessional lending, where initial fair value measurement and credit risk assessment are frequently ignored entirely.
Lending and financing operations requiring the general approach, staging criteria and a documented PD, LGD and EAD framework.
Convertibles, preference shares, options and derivatives, where classification between liability and equity determines both the balance sheet and reported profit.
Saudi and UAE reporting entities, including IFRS as endorsed in the Kingdom of Saudi Arabia, delivered from Islamabad alongside their Pakistan reporting.
Where a parent requires IFRS 9 numbers, or the equivalent under FRS 102 or ASC 326, prepared to the group's timetable and format.
Valuation and expected credit loss modelling involve significant judgement. Where we act as your statutory auditor, we do not perform this work in a way that would create a self-review threat under the ICAP Code of Ethics — for public interest entities, material subjective valuations are provided only to non-audit clients.
We will tell you which side of that line your engagement falls on before we quote, rather than after you have engaged us. Where we cannot act, we will say so and explain why.
Generally no, not on its own. Historical loss experience is the starting point, but IFRS 9 requires it to be adjusted for current conditions and reasonable, supportable forward-looking information. A matrix carried forward unchanged for several years resembles the old incurred-loss approach and is the most common non-compliance we are asked to remediate.
The general approach uses a three-stage model — twelve-month expected credit loss while the exposure is performing, moving to lifetime loss once credit risk has increased significantly. The simplified approach recognises lifetime expected credit loss from the outset with no staging assessment, and is available for trade receivables, contract assets and lease receivables. Most corporates qualify for and should be using the simplified approach.
Intercompany and shareholder balances are within the scope of IFRS 9 and are not automatically risk-free. The assumption that they are needs support — particularly where the counterparty is loss-making, where repayment is not demanded, or where the balance has been outstanding for years. This is an area auditors increasingly challenge.
Financial instruments are measured at fair value on initial recognition, which for a below-market or interest-free loan is not the amount advanced. The difference has to be accounted for according to its substance — frequently as a capital contribution or distribution — and the loan is subsequently measured at amortised cost using the effective interest rate. Getting this wrong misstates both equity and finance income.
No. Hedge accounting requires formal designation and documentation at inception of the hedging relationship. If the documentation was not prepared then, hedge accounting cannot be applied to that period — which is why the documentation matters more than the hedge itself from an accounting standpoint.
This is common and it is recoverable. We rebuild the model with documented logic and sourced inputs, reconciling to the prior position so the movement is explainable. Where the previous model was wrong, we quantify the effect and advise on whether it is a correction of error or a change in estimate — which have different accounting and disclosure consequences.
Yes, and independent review is often the more efficient engagement. We assess methodology, documentation and inputs against the standard, identify what an auditor is likely to challenge, and set out what needs strengthening — without rebuilding work that is already sound.
Model construction and valuation engagements are fixed-fee against a defined scope, established after an initial review of the portfolio and the current position. Independent review of an existing model is normally a smaller fixed fee. Recurring recalibration and annual update work can be scoped as an annual engagement.
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A partner will tell you whether the issue is methodology, documentation or inputs — and what it takes to close it before the next reporting date.