ECL on factored receivables: dilution risk and debtor concentration · IFRS 9

In plain words

A factoring company can lose money on an invoice because the customer cannot pay, or because the invoice was wrong or the goods came back. Only the first is a credit loss; the second is usually money the business that sold the invoice must give back. Factors often depend on a few big customers, so each one is checked on its own. Because invoices are short, a year's expected loss and a lifetime's expected loss are usually the same.

Why it matters

A factor loses money on invoices in two different ways: the debtor cannot pay (credit risk), or the invoice turns out to be worth less than its face because of credit notes, returns, disputes or set-off by the debtor (dilution). Dilution is not a credit loss on the debtor; it is usually a claim on the client, whose own credit quality then matters. Factored books are also concentrated on a few large debtors, so a portfolio-average loss rate can hide a large exposure. Because most invoices are due within 90 or 120 days, 12-month and lifetime ECL are often the same amount, which shifts the focus from staging to getting PD, LGD and concentration right.

Diagnostic questions

Does the ECL model separate expected dilution from expected credit losses, and who bears dilution under the contract? Are dilution claims on clients tracked as separate receivables with their own ECL? Is ECL on large debtors measured individually, using debtor-specific PDs (external ratings, payment behaviour, sector), rather than through a portfolio average? Are government and government-related debtors with long payment delays assessed for SICR or credit-impairment based on credit risk, not merely on days past due caused by administrative delay? Is the simplified approach being applied without checking whether the factor's purchased receivables qualify for it? Are invoices bought while already overdue identified as possibly purchased or originated credit-impaired?

Recognition

Identify the counterparty for each exposure (see BANK-074): debtors for purchased receivables, the client for recourse loans and for dilution and warranty claims.
Treat expected dilution borne by the client as part of the factor's exposure to the client; where dilution occurs, reduce the purchased receivable and recognise a claim on the client, or deduct it from the reserve (BANK-076).
Where the factor itself bears dilution, it reduces the expected contractual cash flows of the receivable and is reflected in the gross carrying amount, not presented as a credit loss.
Measure ECL individually for large debtors and collectively for granular ones, with groups formed on shared credit risk characteristics such as sector, rating and payment behaviour.
Apply the general approach unless the factor concludes that its receivables qualify for the simplified approach; for receivables with a remaining life under 12 months the 12-month and lifetime measures coincide, but staging still drives disclosure.
Assess the 30-day and 90-day past-due presumptions in the light of debtor payment patterns; rebut them only with evidence that the delay is not credit-related.
Identify invoices that are credit-impaired at purchase and account for them as POCI where relevant.

Measurement

ECL for each debtor is PD over the remaining life of the invoices (which, for short invoices, is the same as the 12-month PD) multiplied by LGD and exposure, probability-weighted across scenarios. For credit-impaired debtors, ECL is the difference between the gross carrying amount and expected recoveries discounted at the effective interest rate. For dilution claims on clients, ECL reflects the client's PD and the reserve or other amounts that the factor can set off. Concentration is captured through individual assessment of large names and through scenario design, for example a sector downturn affecting several debtors at once.

Presentation & disclosure

Disclose: (1) how dilution and credit risk are distinguished in measuring ECL; (2) concentration of credit risk by debtor, sector and client; (3) the approach used (general or simplified) and the reasons; (4) credit risk exposure by grade or days-past-due band and by stage; (5) the loss allowance reconciliation; (6) collateral and credit enhancements, including reserves and credit insurance, and their effect on ECL.

Common mistakes

Recording credit notes and disputes as impairment losses
ignoring dilution claims on weak clients
applying one loss rate to a book dominated by a few debtors
treating long but routine delays by government-related debtors as automatic default, or ignoring genuine deterioration because 'government always pays'
adopting the simplified approach for purchased receivables without considering whether they qualify
assuming that because 12-month and lifetime ECL coincide, staging and SICR need not be assessed
failing to identify invoices bought when already credit-impaired

Simple example

A Riyadh factor holds non-recourse purchased receivables at 31 December, all with remaining terms under 90 days (so 12-month and lifetime PD coincide). The client bears dilution.
Debtor A (government-related): SAR 30,000,000 x PD 0.5% x LGD 40% = SAR 60,000
Debtor B (private contractor): SAR 15,000,000 x PD 2% x LGD 50% = SAR 150,000
Debtor C (credit-impaired, 150 days past due): gross SAR 5,000,000, expected recoveries SAR 3,000,000, ECL = SAR 2,000,000
During December, invoices of SAR 1,000,000 on Debtor D were cancelled by credit note. Under the contract the client must refund the factor:
Dr Receivable from client - dilution claim 1,000,000
Cr Purchased receivables - Debtor D 1,000,000
The factor holds a reserve of SAR 600,000 for this client that it may set off; the net exposure of SAR 400,000 has an expected loss of 50%: ECL = SAR 200,000.
Total ECL = 60,000 + 150,000 + 2,000,000 + 200,000 = SAR 2,410,000 (opening allowance nil).
Dr Impairment loss on factoring assets (P&L) 2,410,000
Cr Loss allowance - purchased receivables 2,210,000
Cr Loss allowance - receivable from client 200,000
(The SAR 1,000,000 credit note is dilution, not an impairment loss; only the expected loss on the client claim is ECL.)

Professional judgment

Judgment is needed to separate dilution from credit loss when a debtor disputes an invoice to delay payment, to set PDs for unrated private debtors, to assess whether long payment cycles of government-related debtors are credit-related, and to decide whether the simplified approach is available. The simplified approach applies to trade receivables that result from transactions within the scope of IFRS 15; whether a factor can use it for receivables arising from its clients' sales, rather than from its own revenue contracts, is debated, and many factors apply the general approach. A factor that applies the simplified approach should document its reasoning. Concentration overlays may be needed where a single sector, such as construction, dominates the book.

Source basis

IFRS 9 · Financial Instruments

Paragraph references

IFRS 9.5.5.15–5.5.16IFRS 9.5.5.17IFRS 9.5.5.11IFRS 9.B5.5.37IFRS 9.5.5.13–5.5.14

Verified against the official standard texts used in the IFRS Expert skill.

IFRS 9 Financial Instruments

Issued: 24 July 2014 · Effective: 1 January 2018

Related issues

Educational and navigation content only. Not professional advice. Does not reproduce official IFRS/IAS text. Consult the authoritative standards and qualified professionals; professional judgment may still be required.