“GIVE US THE RATE!” — WHY ALLOWANCE FOR CREDIT LOSSES DOESN’T WORK LIKE DEPRECIATION RATES by Elles Mukunyadze

One of the most common questions we receive from public sector entities grappling with IPSAS implementation is this: “Can you just give us a rate we can use for our provision for credit losses — like the ZFRM gives us depreciation rates for fixed assets? “

It is a fair question. The Zimbabwe Financial Reporting Manual (ZFRM) has been incredibly helpful in giving practical guidance, particularly on property, plant, and equipment — specifying useful lives and depreciation rates for different asset classes so that entities do not have to start from scratch. The expectation, understandably, is that the same logic should apply to credit losses. If there is a rate for a building or a motor vehicle, surely there must be a rate for trade receivables or loans?

The short answer is: it does not work that way. And this article explains why — and more importantly, what you actually need to do instead.

The Ellchart team can help you build Expected Credit Loss (ECL) models for the different financial instruments on your balance sheet — receivables, loans, advances, guarantees, and more. We can also train your finance teams to build and maintain these models internally. Reach out to us at.

ellchart.ac.zw
marketing@ellchart.com
+263781591780

1️⃣ Why There Are No Standard Rates for Credit Losses
Depreciation rates work because the pattern of consumption of a physical asset is largely predictable. A building loses value over time through wear and tear. A motor vehicle has an estimable useful life. These patterns are observable across many entities and contexts, so benchmark rates are a practical and defensible shortcut.

Credit losses are different. They depend on the specific creditworthiness of your debtors, the nature of the financial instruments you hold, the economic environment in which those debtors operate, and the historical repayment behavior of your specific debtor book. A Ministry of Health may have very different receivable recovery patterns from a local authority or a revenue authority. A loan to a parastatal carries different risk from a loan to a community group.

Applying a blanket rate would produce numbers that are either grossly overstated or dangerously understated, neither of which serves faithful financial reporting. IPSAS 41 Financial Instruments requires entities to exercise genuine judgement and build estimates grounded in evidence — not apply a shortcut that was never designed for this purpose.

2️⃣ What IPSAS 41 Requires: The Expected Credit Loss (ECL) Framework
IPSAS 41 (the public sector equivalent of IFRS 9) requires entities to recognise an Allowance for Expected Credit Losses (ECL) on financial assets measured at amortised cost, as well as on lease receivables, contract assets, and certain loan commitments and financial guarantee contracts.

The ECL model is forward-looking. Unlike the old incurred loss approach — where you only recognised a loss after something had actually gone wrong — ECL requires you to anticipate losses before they crystallise, based on reasonable and supportable information about past events, current conditions, and forecast economic conditions.

ECL is calculated as:

ECL = PD × LGD × EAD

Where:
• PD — Probability of Default: the likelihood that a debtor will fail to meet their contractual obligations
• LGD — Loss Given Default: the proportion of the exposure you would lose if a default actually occurs (after recoveries and collateral)
• EAD — Exposure at Default: the outstanding balance at the point of default

Each of these inputs is specific to your debtor book. There is no universal PD, LGD, or EAD that applies to all entities.

3️⃣ The General Model (Three-Stage Approach)
IPSAS 41 establishes a General Model which classifies financial assets into three stages based on how their credit risk has changed since initial recognition:

• Stage 1 — Performing assets: Credit risk has not increased significantly since initial recognition. The ECL allowance is based on 12-month ECL — the expected credit losses arising from default events possible within the next 12 months.
• Stage 2 — Underperforming assets: Credit risk has increased significantly since initial recognition, but no objective evidence of impairment exists yet. The ECL allowance is based on lifetime ECL — expected losses over the remaining life of the instrument.
• Stage 3 — Credit-impaired assets: There is objective evidence that a credit loss event has already occurred (e.g. the debtor is in default, has been placed under administration, or is in active dispute). ECL is based on lifetime ECL , and interest income is now calculated on the net carrying amount (after the allowance), not the gross balance.

The key trigger for movement between stages is whether credit risk has increased significantly — a judgement call that requires entities to monitor debtor behaviour, macroeconomic indicators, and any other relevant forward-looking information on an ongoing basis.

Example — Government Loan Book

Suppose a government entity has a loan portfolio of $10,000,000. Based on its assessment:
• $7,500,000 is in Stage 1 (PD = 1.5%, LGD = 40%, 12-month horizon): ECL = $45,000
• $1,800,000 is in Stage 2 (PD = 12%, LGD = 50%, lifetime): ECL = $108,000
• $700,000 is in Stage 3 (LGD = 70%, lifetime): ECL = $490,000
Total ECL Allowance: $643,000

Journal Entry:
• Dr Impairment Loss / Credit Loss Expense $643,000
• Cr Allowance for Credit Losses $643,000
This is presented as a contra-asset, reducing the gross carrying value of the loan portfolio on the balance sheet.

4️⃣ The Simplified Model — When Can You Use It?

Recognising that the three-stage model requires significant data and systems infrastructure, IPSAS 41 allows certain financial assets to be assessed using a Simplified Model . Under this model, an entity always recognises a lifetime ECL from the date of initial recognition — without the need to track stage migration.

The Simplified Model is permitted (and in some cases required) for:
• Trade receivables and contract assets that do not contain a significant financing component — these must use the simplified approach
• Trade receivables with a significant financing component , lease receivables, and contract assets — entities may elect the simplified approach as an accounting policy choice
The most common practical tool under the Simplified Model is the Provision Matrix . This involves grouping receivables by shared credit risk characteristics — for example, by debtor type, age of debt, or geographical region — and applying a historically-observed loss rate to each group, adjusted for forward-looking factors.

Example — Provision Matrix for Rates and Charges Debtors (Local Authority)
Provision Matrix — Rates & Charges Debtors (Local Authority)

 

1. 1. Current (0–30 days)
      Balance: $850,000 | Loss Rate: 1% | ECL: $8,500

1. 1. 31–60 days
      Balance: $320,000 | Loss Rate: 5% | ECL: $16,000

1. 1. 61–90 days
      Balance: $180,000 | Loss Rate: 15% | ECL: $27,000

1. 1. 91–180 days
      Balance: $90,000 | Loss Rate: 35% | ECL: $31,500

1. 1. Over 180 days
      Balance: $60,000 | Loss Rate: 75% | ECL: $45,000
      ─────────────────────────────
      Total Gross Receivables: $1,500,000
      Total ECL Allowance: $128,000

The loss rates in the matrix are not invented — they are derived from your entity’s own historical write-off data, adjusted where necessary for current conditions (e.g. high inflation, debtor unemployment trends, or a significant change in debtor mix).
Even under the Simplified Model, a blanket rate applied to all receivables regardless of age or debtor type would not satisfy IPSAS 41. The standard requires differentiation and evidence.

5️⃣ Building Your ECL Model: Where to Start
For entities that are building ECL models for the first time, the following steps provide a practical starting framework:
• Step 1 — Identify and classify your financial assets: Separate loans, trade receivables, lease receivables, advances, and guarantees. Each class may require a different modelling approach.
• Step 2 — Gather historical data: Analyse your debtor book over the past three to five years. What is your actual write-off experience? What percentage of amounts outstanding at each age band were eventually recovered or written off?
• Step 3 — Assess forward-looking adjustments : Consider the current economic environment. In a high-inflation, low-growth economy like Zimbabwe, historical default rates may understate future risk. Adjust your base rates accordingly.
• Step 4 — Choose your model : Apply the General Model for loans and longer-term financial instruments. Apply the Simplified Model (Provision Matrix) for trade receivables and similar short-term assets.
• Step 5 — Document your assumptions : IPSAS 41 requires disclosure of the methods, inputs, and assumptions used in determining ECL. Your model must be defensible to auditors and transparent to financial statement users.
• Step 6 — Review and update regularly : ECL is not a once-off exercise. It must be recalculated at every reporting date, with assumptions revisited in light of new information.

Wrap-Up
The desire for a simple, prescribed rate for credit losses is understandable — and it reflects the practical pressures facing public sector finance teams navigating IPSAS implementation. But IPSAS 41’s Expected Credit Loss framework is deliberately entity-specific for good reason: a rate that is right for one entity’s debtor book could be dangerously wrong for another’s.

The good news is that the process is structured and learnable. The General Model gives you a rigorous, three-stage framework for loans and complex instruments. The Simplified Model — particularly the Provision Matrix — gives you a practical, data-driven approach for trade receivables. Both require you to engage with your own data, apply your own judgement, and document your own assumptions.

This is not a shortcut problem to be solved with a table of rates. It is a financial management capability to be built. And it is a capability worth building well — because the allowance for credit losses directly shapes the credibility of your balance sheet and the reliability of your reported surplus or deficit.

The Ellchart team is ready to walk alongside you in that process.

Elles Mukunyadze is a Chartered Accountant CA(Z), Registered Public Auditor, and Managing Director of Ellchart Business School and Ellchart Chartered Accountants. He specialises in IPSAS implementation, public sector financial reporting, and infrastructure finance advisory.