Trading Perspectives Special edition: Important upcoming accounting changes

November 2017

Aon Risk SolutionsAon Credit Solutions

Table of Contents

IFRS 9 - Financial Instruments 1

IFRS 15 - Revenue from contracts with customers 3

References 5

About Aon Credit Solutions 5

Key contacts 6

1

IFRS 9 - Financial Instruments

In focus

Recognition and measurement, impairment, de-recognition and general hedge accounting.

The new IFRS 9 rules effective January 2018, and equivalent US GAAP standards (ASU 2016-13) effective in 2019, are aimed at

increasing the accuracy and transparency of how credit risk is represented on a company’s Balance Sheet and P&L. Both new

standards include requirements around the use of both historic as well as forward looking credit information in order to calculate

the provisions for credit losses (Expected Credit Losses).

Under the new regulations, companies will have to start making bad debt provisions for possible future credit losses in the first reporting period – even if it is highly likely that the asset will be fully collectible.

IFRS 9 requires an entity to base its measurement of expected credit losses on reasonable and supportable information that is available without undue cost or effort, including historical, current and

forecast information.

Expected Credit Losses (ECL) is a probability weighted estimate of a credit loss. The ECL should be

forward looking and consider current and future projections, not solely historical data. The ECL has to be

revised if any new information is made available.

The ECLs are calculated by: i) identifying scenarios in which a receivable (or loan) defaults; ii) estimating the cash shortfall

that would be incurred in each scenario if a default were to happen; iii) multiplying that loss by the probability of the default

happening; and (iv) summing the results of all.

Estimated future cash flows at initial recognition $100 million

Estimated future cash flows if default occurs $10 million

Cash shortfall $90 million

Probability of default 0.5%

Expected credit loss $450k

For ease of illustration this example assumes only one default scenario. Under the accounting standards, companies would need

to model multiple scenarios in order to define the right bad debt provision levels.

2

Related Credit Solutions

Your company is planning for the implementation of the accounting standard changes and it is likely that the provisioning of

doubtful receivable will increase as compared to current levels, especially due to the fact that probabilities of default will need

to be applied across the trade receivables ledger. Your company is looking for opportunities around balance sheet optimisation,

reporting efficiencies and cost savings.

Quantifying the (new) amount of trade provisions required. Aon has experience in modelling expected credit losses based on client information available.

Optimising the credit risks. Our teams can perform actuarial analysis to help assess the financial statements impact of purchasing credit insurance. This would include considerations around optimal

structure and potential costs.

Coordinating with your auditors. Aon teams have experience in communicating on credit risk financial statement treatment with our clients’ external auditing firms.

IFRS 9 - Financial Instruments

How may credit solutions help your company?

Risk modelling illustration

Buyer A

ReceivablesLoss Given

Default

Gross Loss Net Loss to ABCfrom Buyer A

Buyer B

Receivables

Default (yes/no)

Loss Given Default

Gross Loss

Sales volumes

Receivables

Gross LossNet Loss to ABC

from Buyer C

ScenarioGenerator

Buyer C

Default (yes/no)

Default (yes/no)

Sales volumes

Sales volumes

Rating of Buyer B

Rating of Buyer A

Probability of default

Probability of default

Net Loss to ABCfrom Buyer B

Loss Given Default

Probability of default

Rating of Buyer C

100,000trials

ExpectedCredit Loss

3

IFRS 15 - Revenue from contracts with customers

Nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts.

The IASB and the FASB have jointly developed new revenue standards, IFRS 15/ASC 606 Revenue from Contracts with Customers,

which will replace all existing IFRS and virtually all US GAAP revenue recognition requirements. These have a 1 January 2018

effective date.

The unit of account for revenue recognition under the new standard is a performance obligation. A

contract may contain one or more performance obligations.

Revenue will be recognised when an entity satisfies each performance obligation by transferring

control of the promised goods or services to the customer. Goods or services can transfer at a point in

time or over time depending on the nature of the arrangement. Specific criteria are provided for when a

performance obligation is satisfied over time.

Depending on an entity’s existing business model and revenue recognition practices, the new standard

could have a significant impact on the amount and timing of revenue recognition, which in turn could

impact key performance measures. Bad debt reserves are likely to be larger and more volatile.

In focus

Under the new accounting method, a company selling a 3 year software license should account for the licenses and services

together as a single performance obligation. Revenues related to the 3 year client contract may be fully recognised in the first

year if:

The multi-year contract cost of the service or product is not variable or subject to discounts or change;

and/or

The vendor is providing the license software and Post Contract Services exclusively to the buyer.

4

Related Credit SolutionsYour company sells a 3 year software license to a buyer. The agreement also includes Post-Contract Customer support (PCS),

meaning access to future updates of the software throughout the agreement. Under the new standards, revenues from the

licenses will be fully recognised in year 1. The PCS will be recognised separately on a year by year basis.

Credit protection for multi-year contracts. A “risk attaching” credit insurance policy will cover current and non-current (future) recognised revenue for the entire length of the contract upfront.

Especially, unearned, but recognised revenue relative to the non-current portions of the multi-year

contract will be covered.

Bad Debt Reserve. The new standards may lead to companies to increase their bad debt reserves to

cover the length of the contract. The flow-on-effect will impact key performance indicators, particularly

the return on equity metric. Credit insurance can serve as contingent capital which will allow your company to reduce its allowance for bad debt reserve associated with these long term deals.

Competitiveness. In a highly competitive environment, credit Insurance can enable your company to offer improved commercial terms to clients, whilst being able to mitigate the related credit risks..

How may credit solutions help your company?

5

Referenceshttps://www.pwc.com/us/en/cfodirect/assets/pdf/in-depth/2014-01-revenue-from-contracts-with-customers.pdf

http://www.pwc.com/gx/en/audit-services/ifrs/publications/ifrs-9/ifrs-9-understanding-the-basics.pdf

http://www.ey.com/Publication/vwLUAssets/Financial_instruments:_A_summary_of_IFRS9_and_its_effects/$FILE/ey-ifrs-9-

financial-instruments.pdf

https://home.kpmg.com/xx/en/home/services/audit/international-financial-reporting-standards/revenue/ifrs15-transition-toolkit.

html

About Aon Credit SolutionsAon is a leading international credit insurance broker providing our clients with key solutions against non-payment risks, while

facilitating their business growth and improving access to trade finance. Our local specialised teams are united and coordinated

at a country, regional and global level by experienced market thought leaders.

We are passionate about leveraging credit insurance to support our client’s business growth. Our objective is to be regarded

by our clients as their preferred broking partner and trusted risk advisor, fully committed to delivering a proposition that is built

around traditional values of personal service, combined with access to the full breadth and depth of Aon’s global resource and

capabilities, including our constant monitoring of regulatory challenges and trends.

Globalcredit broker in

terms of premiumplacement

No. 1

$725bnof trade

supported

Managed Premium

$800mTrusted advisor

57countries

490+people100+

locations

IntegratedMulti-Debtor &

Single Risk

6

About Aon

Key contacts

Fraser Bunn Associate Director Aon Credit Solutions US t +(1) 305 961 5936 m +(1) 786 375 7448 fraser.bunn@aon.com

Remco Beuvens Chief Development Officer Aon Credit Solutions EMEA t +31 (0) 10 448 7879 m +31 (0) 655 163 026 remco.beuvens@aon.nl

Innokenty Smorchkov Actuarial Consultant Aon Global Risk Consulting t +41 58 266 86 41 m +41 78 765 39 63 innokenty.smorchkov@aon.ch

Helen Clark Head of Asia Aon Credit Solutions t +65 62 39 7604 m +65 91 78 9032 helen.m.clark@aon.com

© Aon UK Limited 2017. All rights reserved.

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