Key Points
- EAD captures the full balance a borrower will likely owe when default occurs.
- For revolving facilities, EAD often exceeds the current drawn balance by 20–50%.
- Underestimating EAD inflates profits by understating the expected credit loss provision.
- The auditor tests EAD inputs as part of evaluating management's ECL model assumptions.
What is Exposure at Default (EAD)?
EAD sits alongside probability of default (PD) and loss given default (LGD) in the expected credit loss formula: ECL = PD x LGD x EAD. For a fixed-term loan with no undrawn commitment, EAD equals the amortised cost balance at the reporting date. The calculation gets harder when the borrower holds a revolving credit facility or an undrawn loan commitment, because IFRS 9.5.5.20 requires the entity to include amounts it expects the borrower to draw before defaulting.
Practitioners apply a credit conversion factor (CCF) to the undrawn portion. IFRS 9.B5.5.31 expects the CCF to reflect historical drawdown behaviour observed in the period leading up to past defaults. A CCF of 60% on a €5M undrawn commitment adds €3M to the EAD, which feeds directly into the lifetime ECL calculation for Stage 2 and Stage 3 exposures. ISA 540.13(a) requires the auditor to evaluate whether the entity's method for producing this estimate is appropriate, which in practice means testing both the CCF assumption and the data behind it.
Worked example: Groupe Lefèvre S.A.
Client: Belgian holding company, FY2025, revenue €185M, IFRS reporter. Groupe Lefèvre holds a receivables portfolio and has extended a revolving credit facility to its operating subsidiary.
Step 1 — Identify the exposure components
The facility has a €10M limit. At 31 December 2025, €6M is drawn and €4M remains undrawn.
Step 2 — Determine the credit conversion factor
Management's ECL model applies a CCF of 55% to undrawn commitments, based on five years of internal drawdown data for comparable facilities that subsequently defaulted.
Step 3 — Calculate EAD
Drawn balance (€6M) plus expected drawdown on the undrawn portion (€4M x 55% = €2.2M) gives an EAD of €8.2M.
Step 4 — Feed EAD into the ECL formula
Management applies PD of 3.8% and LGD of 40%. ECL = €8.2M x 3.8% x 40% = €124,640.
Conclusion: Groupe Lefèvre's EAD of €8.2M produces a defensible ECL of €124,640 because the CCF rests on entity-specific historical data covering a full credit cycle, which satisfies the IFRS 9.B5.5.31 requirement for reasonable and supportable information.
Why it matters in practice
Teams frequently set the CCF at zero for undrawn commitments on the assumption that the entity can cancel the facility before the borrower draws further. IFRS 9.5.5.20 requires inclusion of amounts the entity expects the borrower to draw, regardless of contractual cancellation rights, unless the entity has both the legal right and operational practice of revoking facilities before drawdown. ISA 540.13(b) requires the auditor to challenge this assumption rather than accept it at face value.
Auditors sometimes test EAD by recalculating the drawn balance at the reporting date without verifying the CCF input. The drawn balance is an observable fact. The CCF is where estimation risk concentrates, and FRC thematic reviews of ECL models have repeatedly flagged insufficient challenge of credit conversion factors as a practice gap.
EAD vs drawn balance
| Dimension | EAD | Drawn balance |
|---|---|---|
| What it measures | Total expected exposure at the point of default, including future drawdowns | The amount currently outstanding on the facility |
| Inputs required | Drawn balance plus CCF applied to undrawn commitments | Loan administration system balance only |
| Where estimation risk sits | In the CCF assumption and the behavioural data behind it | No estimation risk (observable at reporting date) |
| Effect on ECL if wrong | Understated EAD directly understates the loss provision | Does not capture the undrawn commitment exposure |
For a fully drawn term loan with no undrawn commitment, EAD equals the drawn balance. The distinction matters only when the borrower has access to additional funds that the entity cannot unconditionally prevent from being drawn.
Related terms
Frequently asked questions
Does EAD apply only to banks?
No. IFRS 9.5.5.17 applies to any entity that holds financial assets measured at amortised cost or fair value through other comprehensive income, including corporates with intercompany loans, lease receivables, and trade receivable portfolios. Any entity running an ECL model needs an EAD input for each exposure.
How do I audit the credit conversion factor in an EAD model?
Test three things: the historical dataset management used to derive the CCF (completeness, period covered, exclusions), the segmentation of facilities into pools with similar drawdown behaviour, the sensitivity of the ECL to a ±10% shift in the CCF, and whether the CCF was updated for current conditions. ISA 540.18 requires the auditor to evaluate whether management's assumptions are reasonable given the available evidence.