Change in ECL Methodology | Policy or Estimate under Ind AS

1. Query

Alpha Limited (hereinafter referred to as “the company”), is engaged in providing engineering consultancy services and undertaking small construction projects. The company transitioned to Indian Accounting Standards (Ind AS) in 2017 and, since then, has been recognising expected credit loss (ECL) on its trade receivables in accordance with Ind AS 109, Financial Instruments.

For the purpose of estimating ECL, the company has been following a provision matrix (grid-based approach), wherein trade receivables are classified into ageing buckets and provisioning rates are applied based on historical loss experience. This approach primarily relies on past trends and management estimates without incorporating advanced statistical techniques or forward-looking macroeconomic factors.

The company now proposes to replace this approach with a more sophisticated actuarial valuation model, to be performed by an independent expert. The proposed model incorporates probability-weighted outcomes, time value of money, forward-looking information such as inflation and economic growth indicators, and statistical tools including regression analysis and roll-rate methodologies. The company believes that this approach would result in more reliable and relevant measurement of credit losses.

The company is of the view that this transition represents a fundamental change in the measurement basis of ECL, as it involves a shift from a relatively simple estimation approach to a scientifically robust valuation framework. Accordingly, it proposes to treat this change as a change in accounting policy under Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors.

In this background, the issue for consideration is whether the change from a provision matrix approach to an actuarial valuation model for measuring ECL constitutes a change in accounting policy requiring retrospective applicationor a change in accounting estimate to be applied prospectively?

2. Relevant Provisions

Ind AS 8 – Accounting Policies, Changes in Accounting Estimates and Errors

Para 32 of Ind AS 8

An accounting policy may require items in financial statements to be measured in a way that involves measurement uncertainty—that is, the accounting policy may require such items to be measured at monetary amounts that cannot be observed directly and must instead be estimated. In such a case, an entity develops an accounting estimate to achieve the objective set out by the accounting policy. Developing accounting estimates involves the use of judgements or assumptions based on the latest available, reliable information. Examples of accounting estimates include:

(a) a loss allowance for expected credit losses, applying Ind AS 109, Financial Instruments……

Para 34A of Ind AS 8

The effects on an accounting estimate of a change in an input or a change in a measurement technique are changes in accounting estimates unless they result from the correction of prior period errors.

Para 36 of Ind AS 8

The effect of change in an accounting estimate, other than a change to which paragraph 37 applies, shall be recognised prospectively by including it in profit or loss in:

(a) the period of the change, if the change affects that period only; or

(b) the period of the change and future periods, if the change affects both.

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