An executory contract is a type of contract that has not yet been fully performed by both parties involved. Under International Financial Reporting Standards (IFRS) 9, executory contracts are considered as financial assets or liabilities and are treated accordingly in the balance sheet. In this article, we will explore what an executory contract is, how it is accounted for under IFRS 9, and what the implications are for companies.
What is an Executory Contract?
An executory contract is a contract in which one or both parties have not yet fully performed their obligations. This means that there are still outstanding obligations that must be fulfilled by one or both parties. Examples of executory contracts include rental agreements, employment contracts, and supply agreements. These contracts are often long-term and involve a significant financial commitment from both parties.
Accounting for Executory Contracts under IFRS 9
Under IFRS 9, an executory contract is treated as a financial asset or liability depending on whether it gives rise to a receivable or payable. The accounting treatment of executory contracts differs depending on whether they are classified as a financial asset or liability.
If an executory contract gives rise to a receivable, it is treated as a financial asset and is accounted for using the expected credit loss (ECL) model. This means that the value of the receivable is measured at its present value, taking into account the probability of default, expected credit loss, and time value of money. The ECL model is used to estimate the amount of credit losses that are expected to occur over the life of the receivable.
On the other hand, if an executory contract gives rise to a payable, it is treated as a financial liability and is accounted for using the fair value model. This means that the value of the payable is measured at fair value, which is the amount that would be paid to transfer the liability to a third party.
Implications for Companies
The accounting treatment of executory contracts under IFRS 9 has some significant implications for companies. For example, if a company has a large number of executory contracts that give rise to receivables, it may need to increase its provisions for doubtful debts to account for the expected credit losses. This could have a negative impact on the company`s financial performance.
In addition, companies may need to adopt new accounting policies and procedures to comply with the requirements of IFRS 9. This could require significant resources and expertise, particularly for companies with a large number of executory contracts.
Conclusion
Executory contracts are a common type of contract that can have significant financial implications for companies. Under IFRS 9, these contracts are treated as financial assets or liabilities and are accounted for using different models depending on whether they give rise to a receivable or payable. Companies that have a large number of executory contracts should be aware of the implications of these contracts for their financial statements and may need to adopt new accounting policies and procedures to comply with IFRS 9.