Aakvatech Limited - IFRS 9 - Expected Credit Loss management in ERPNext

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1. Conceptual Mapping: IFRS 9 ↔ ERPNext

Before implementation, it’s important to align IFRS 9 concepts with ERPNext objects.

IFRS 9 Concept	ERPNext Equivalent
Financial Asset	Customer, Sales Invoice, Loan
Exposure at Default (EAD)	Outstanding Invoice Amount / Loan Outstanding
Probability of Default (PD)	Derived from historical payment behavior
Loss Given Default (LGD)	Recovery assumptions (write-offs, collateral, % loss)
Credit Risk Segmentation	Customer Group, Territory, Payment Terms, Risk Rating
Stage 1 / 2 / 3	Custom credit risk stage on Customer / Loan

ERPNext does not ship with a full IFRS 9 engine out of the box, but it provides all the data hooks required to build one.

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2. Step 1: Segment Receivables (Credit Risk Bucketing)

Objective (IFRS 9)

Group exposures with similar credit risk characteristics.

How to do it in ERPNext

Standard ERPNext Configuration

Use one or more of the following:

• Customer Group (e.g., Retail, SME, Enterprise)
• Territory
• Payment Terms
• Sales Partner
• Customer Credit Limit

Recommended Custom Fields

Add custom fields on Customer:

• credit_risk_rating (Low / Medium / High)
• ifrs9_stage (Stage 1, Stage 2, Stage 3)
• days_past_due_bucket (0–30, 31–60, 61–90, >90)

These fields can be:

• Updated manually by credit officers, or
• Auto-updated via Server Scripts based on overdue analysis.

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3. Step 2: Determine Exposure at Default (EAD)

Objective (IFRS 9)

Estimate outstanding exposure at the point of default.

ERPNext Implementation

Trade Receivables (Simplified Approach)

• Use:

  • Sales Invoice.outstanding_amount

• Pull data via:

  • Accounts Receivable Report
  • Custom SQL or Script Report

Loans (General Approach)

• Use:

  • ERPNext Loan Management module
  • Loan Repayment Schedule
• EAD = Outstanding Principal + Accrued Interest

ERPNext already stores this data accurately — no customization required here.

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4. Step 3: Calculate Historical Default Rates (PD Foundation)

Objective (IFRS 9)

Estimate PD using historical default experience.

ERPNext Data Sources

• Sales Invoices
• Payment Entries
• Overdue Days
• Bad Debt Write-Offs

Practical Method in ERPNext

Define “Default”

Typically:

• Invoice overdue > 90 days
• OR written off as bad debt

Steps

1. Create a Script Report:

   • Count total invoices issued per period
   • Count invoices that crossed default threshold

2. Group results by:

   • Customer Group
   • Aging bucket
   • Year / Quarter

Example PD Formula

Marginal PD (Year t) =
Number of invoices defaulted in Year t
÷
Number of invoices alive at start of Year t

ERPNext does not calculate PD natively — this is usually done via:

• Script Reports
• External BI tools (Power BI, Excel) connected to ERPNext

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5. Step 4: Marginal vs Conditional PD in ERPNext

Marginal PD

• Calculated year-by-year using historical data
• Stored externally or in a custom DocType (e.g., IFRS PD Table)

Conditional PD

• Derived using:

Conditional PDₜ = Marginal PDₜ / (1 − Cumulative PDₜ₋₁)

ERPNext Role:

• Storage & retrieval
• Apply PD dynamically during ECL calculation

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6. Step 5: Incorporate Forward-Looking Information

Objective (IFRS 9)

Adjust PD for macroeconomic expectations.

ERPNext Implementation Options

Option A: Manual Adjustment (Common)

• Create a DocType:

  • Economic Overlay
  • Fields: GDP Factor, Inflation Factor, Industry Stress Factor
• Apply a multiplier:

Adjusted PD = Historical PD × Overlay Factor

Option B: Automated (Advanced)

• Integrate external economic indicators via API
• Periodically update PD multipliers via scheduled jobs

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7. Step 6: Loss Given Default (LGD)

ERPNext Handling

ERPNext does not model LGD directly, but you can implement:

Simple LGD

• Fixed percentage per segment (e.g., 40%, 60%)

Advanced LGD

• Use:

  • Historical recoveries
  • Write-off ratios

• Store LGD in:

  • Customer Group
  • Risk Rating
  • Custom LGD Matrix DocType

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8. Step 7: Expected Credit Loss (ECL) Calculation

Formula

ECL = PD × LGD × EAD

ERPNext Execution

Implementation Pattern

1. Create a custom DocType:

   • IFRS 9 Provision

2. For each reporting date:

   • Pull open invoices

   • Determine:

     • Stage
     • PD
     • LGD
     • EAD

3. Compute ECL via:

   • Server Script
   • Scheduled Job
4. Store results for audit trail

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9. Step 8: Accounting Entries (Provision Posting)

ERPNext Accounting Flow

Use Journal Entry automation:

• Debit: Impairment Loss (P&L)
• Credit: ECL Provision (Balance Sheet)

ERPNext supports:

• Reversal
• Recalculation each period
• Delta posting (only change in provision)

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10. Stage-Based Approach in ERPNext

IFRS 9 Stage	ERPNext Logic
Stage 1	Not overdue / low risk → 12-month ECL
Stage 2	Significant increase in credit risk → Lifetime ECL
Stage 3	Credit impaired (>90 DPD) → Lifetime ECL + interest on net

Stages can be:

• Auto-assigned via overdue days
• Overridden manually with audit justification

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11. Auditability & Compliance

ERPNext Strengths:

• Full transaction history
• Immutable ledger
• Versioned custom fields
• Document attachments (model assumptions, overlays)

Best Practice:

• Store PD, LGD, and assumptions per period
• Never overwrite historical provisions

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12. Summary Architecture

ERPNext Core
 ├── Customers / Invoices / Loans
 ├── Aging & Overdue Data
 ├── Journal Entries
 └── Credit Limits

Custom IFRS 9 Layer
 ├── Risk Segmentation
 ├── PD & LGD Tables
 ├── Economic Overlays
 ├── ECL Calculation Engine
 └── Provision Posting Logic

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Key Takeaway

ERPNext provides all required data and accounting controls for IFRS 9. Achieving full compliance requires structured configuration, custom reporting, and light automation, not replacement of the ERP.