ECL is the probability weighted estimate of potential credit losses. Credit loss is the shortfall or loss from the contractual cash inflows that are originally expected. Since ECL is stated at present value, credit loss is discounted at the original effective interest rate. It sounds simple, however, every element is subject to different level of assessment and estimation. The ultimate aim is to estimate an expected value. Incorrect or judgmental application of key variables usually lead to significant variance with actual result.
The importance of proper ECL estimation should not be underestimated. It is one of the key focuses of inspection by the FRC (source: Annual Inspection Report, 3 Jun 2021).
We, an independent consultant who supports auditors and company’s management on ECL assessment, shall continue to strengthen the efforts and independent analysis on reasonableness of key assumptions and inputs. The key areas should include:
- Evaluate the appropriateness of management’s rebuttal of the presumption that default occurs no later than when a financial asset is 90 days past due.
- Credit quality of receivable balances either by specific credit assessment or by provisional matrix in a pooled basis
- Assessment of loss given default
- Assessment of forward looking factors