Accessing Customer Credit Rating using Risk-Based Impairment

Explain the process of credit-risk-based impairment using Advanced Valuation.

The key components of Credit-Risk-Based Impairment includes:

• Credit Rating: The system allows for the assessment of a customer's credit rating, which represents the estimated ability of a customer to meet financial commitments.
• Risk Classification: This involves classifying as per the risk involved like low, moderate, and high risk.
• Credit Risk Models: Calculates Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD). These are then used as elements to calculate Expected Credit Loss (ECL).
• Impairment Calculation: Based on ECL calculation, impairment figure is generated which is a measure of credit loss risk that needs to be mentioned in the financial statements.
• Reporting: The system allows for regular and ad-hoc reporting of risk details and impairment values.

The use of the Credit-Risk-Based Impairment under Advanced Valuation ensures that businesses are effectively measuring and managing their credit risk whilst complying with International Financial Reporting Standard 9 (IFRS 9) regulations, improving credibility and minimizing potential business losses.

The template Post Credit-Risk-Based Impairment Fiori App Schedule General Ledger Jobs was developed to fulfill the impairment model of IFRS 9.

This job calculates a loss allowance for expected credit losses on trade receivables and G/L account balances, for which there are increases in the credit risk of the business partner on the key date. It posts the results as impairment losses or creates posting proposals for impairment for the creation of your financial statements.

For each country you can define if the calculation of the impairment is based on the net or gross amount of the receivable.

The process for Credit-Risk-Based Impairment starts from the contracts with the business partners and the posting of GL documents by accounting personnel for the contracts (Invoices, payments, credit memo). For Credit Risk Assessment, the Collection Specialists need to maintain the Risk Classes in the master data of those Business Partners with contracts. After activation of Advanced Valuation, BPC experts need to set up the Impairment Rules and Steps, then assign it to the corresponding Accounting Principle and maintain the respective Aging Increment, Probability of Default, and the G/L accounts for Impairment. The last step is calculating the Credit Loss Allowance amount by using the template Post Credit-Risk-Based Impairment in the Fiori App Schedule General Ledger Jobs.

The loss allowance is calculated using a formula:

Probability of Default are defined based on:

• Aging increments of the open items
• Risk class of the business partner

The longer a certain amount has been open, the riskier the business partner, the higher is the probability of default, thus there will be more loss allowance calculated and booked to the profit and loss account.

You only have to set up profit and loss G/L accounts as the postings are always made to the account to be valuated, plus postings are made directly to the reconciliation accounts.

Also, the Post Credit-Risk-Based Impairment integrates the data of the Write Off Receivables app. When you've used the Write Off Receivables app, to write off receivables, you carry out Post Credit-Risk-Based Impairment as the next step. Credit-risk-based impairment recognizes, and corrects the write-off postings and thus avoids wrong P&L and balance sheet results.

That means that you always have to carry out Post Credit-Risk-Based Impairment after you've done the last write-off in the Write Off Receivables app.