Question

IFRS 9 classifies financial assets into several categories: at amortized cost, at fair value through profit or loss or at fair value through other comprehensive income.

How do you classify trade receivables and how do you measure them initially, especially when they are not interest bearing?
 

Answer

In general, under IFRS 9 you should classify trade receivables as at amortized cost, because trade receivables usually meet 2 criteria for amortized cost classification:

  1. They are held within a business model whose objective is to hold financial assets to collect contractual cash flows – in this case, companies usually hold receivables to collect them; and
  2. The cash flows arising from the financial assets on specified dates are solely payments of principal and interest on the principal amount outstanding – this is met for most trade receivables.

Of course, if you hold trade receivables to trade them, then they would not have met the 2 criteria for amortized cost classification.

All financial assets shall be measured initially at fair value (plus transaction cost if asset is not at FVTPL).

The exception is trade receivables without significant financing component – you should measure them at their transaction price.

The receivables contain significant financing component if the timing of payments provides the customer or the supplier some significant benefit of financing and is further described in IFRS 15. If the receivables are due in 12 months or less than 12 months after their creation, they do NOT contain significant financing component and can be measured at their transaction price.

Please see IFRS 9 par. 5.1.3, IFRS 15 par. 60-65 for your reference.
 

Example

On 1 January 20X1, ABC sold goods to one of its customers on credit. The cash-selling price is CU 9 500. How should ABC measure the receivable resulting from this sale if:

  1. The receivable is due in 3 months and the transaction price is CU 9 500
  2. The receivable is due in 24 months and the transaction price is CU 10 500?

In both cases, the receivable is a financial instrument at amortized cost. Initial measurement depends on whether the receivable contains significant financing component or not:

  1. Due in 3 months:
    The receivable does not contain any significant financing component because it is due in less than 12 months and the transaction price is the same as the cash-selling price.

    In this case, the receivable is measured at the transaction price. The journal entry is:

    • Debit Receivables: CU 9 500

    • Credit Revenues from sales of goods: CU 9 500

  2. Due in 24 months:
    The receivable contains significant financing component because it is due in more than 12 months and the transaction price is higher than the cash-selling price.

    As the receivable contains significant financing component, it must be measured at fair value – in this case, it is the present value of cash flows discounted at the rate prevalent in the similar transactions.

    Let’s assume that the difference between the transaction price and the cash-selling price reflects the rate that would be reflected in a separate financing transaction between the customer and the supplier.

    Therefore, the fair value of the trade receivable is CU 9 500.

    Initially, ABC accounts for:

    • Debit Receivables: CU 9 500

    • Credit Revenues from sales of goods: CU 9 500

    3. Subsequently, ABC must recognize an interest in profit or loss using the effective interest method.

    In this case, the annual effective interest rate is 5.1315% (apply formula IRR in Excel to the series of cash flows: 9 500, 0, -10 500).

    At the end of year 20X1, ABC recognizes an interest of CU 487,49 (CU 9 500*5.1315%):

    • Debit Receivables: CU 487,49

    • Credit Profit or loss – interest revenue: CU 487,49

    At the end of year 20X1, ABC recognizes an interest of CU 512,35 (CU (9 500+487,49)*5.1315%):

    • Debit Receivables: CU 512,51

    • Credit Profit or loss – interest revenue: CU 512,51

    Thus the carrying amount of the receivable before cash receipt is CU 9 500+CU 487,49+CU 512,51 = CU 10 000.

    When the customer pays, ABC’s journal entry is:

    • Debit Cash: CU 10 000

    • Credit Receivables: CU 10 000