Plain definition
Expected credit losses are an allowance for expected shortfalls in collecting contractual cash flows from financial assets such as trade receivables, measured using the applicable requirements and forward-looking information. The allowance recognises credit risk before a specific customer is conclusively in default. It is not a guess based only on last year’s bad-debt percentage, and it does not mean every customer in the allowance will fail to pay.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
A company has of receivables. Based on aging, customer risk, recent defaults, and a worsening market forecast, it estimates expected credit losses of . It records a allowance and reports net receivables of . Collection staff still pursue the gross ; the allowance informs the expected recoverability and profit view.
| Gross receivables | |
|---|---|
| Expected credit-loss allowance | |
| Net receivables |
The model, segmentation, historical data, forward-looking adjustments, and write-off policy depend on the portfolio and applicable requirements. An allowance must be updated when evidence changes.
Why it matters
Without an allowance, revenue and receivables can look strong while credit risk has already risen. An unsupported large allowance can become a profit-smoothing reserve and hide the performance of collections.
Practical consequence
Build a receivables-risk schedule segmented by aging, customer type, geography or product where relevant, dispute status, payment behaviour, and forward-looking drivers. Reconcile it to the ledger, challenge assumptions with sales and collections owners, compare estimates with actual write-offs, and document governance over model changes.