Interest free loan
5 September 2010
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6 Comments
Holding company has transfered money to subsidary as a long term loan without any interest.
How it should be presented as per IFRS. Should we show as equity loan without any discounting/with discounting? or we need to show as long term loan with or without discounting.
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In my view you should increase your financial receivable in the holding statement. In this case, you should discount your financial receivable in order to show the implicit asset related to interest.
In the other side, in order to increase subsidiary equity the holding company should approve that the amount trasfered is related to “equity increase”…in this case, holding company should increase the value of the subsidary in BS.
In case your financial agreement does not contain a specific maturity date, but the holding company may ask for reimbursement at any date, in this case, considering that the duration of the loan is under the control of the holding company, the management should presume if the financial loan is current or not current, applying different accounting treatments as required.
All the best
In the consolidated financial statements, the loan payable and receivable are eliminated on consolidation.
In separate financial statements of holding company:
Let’s assume that the loan will be classified as “loans and receivables” under IAS 39.
Therefore, the loan must be measured initially at fair value (which would include any transaction costs.)
The effective interest rate is that which discounts the expected future cash flows to that fair value.
Definitions of amortized cost and effective interest rate are in para. 9 of IAS 39. Lots of guidance on effective interest method.
Patricia
Unfortunately, you have just waded into some murky IFRS waters.
Obviously, the simple answer is to discount the loan using a valuation technique taking into account recent arm’s length market transactions between knowledgeable, willing parties (as per IAS 39.AG74).
Note: I realize that (the amended by IFRS 9) IAS 39 only applies to the loan received (the financial liability), but IFRS 9 (applicable to the loan given), not only refers to AG79 in B5.1, but is only mandatory after 1 January 2013 (if it becomes mandatory in the EU at all), though early application is permitted (which is why I had to mention it).
Up to now, the accounting treatment is clear as an unmuddied stream.
Both parties measure the loan at present value with an arm’s length rate and amortize the discount with the effective interest method.
BTW, an “equity loan” is an oxymoron. Either it is a loan (a liability) or a capital investment (equity). It cannot be both at the same time.
Things start to get cloudy if management decides it does not want to discount the loan.
Now the question becomes: is the discounting of intra-company loans mandatory under IFRS or not?
IFRS states that preparing consolidated financial statements involves combining “the financial statements of the parent and its subsidiaries line by line by adding together like items of assets, liabilities, equity, income and expenses. In order that the consolidated financial statements present financial information about the group as that of a single economic entity”.
This will, quite obviously, make the loan disappear (a single economic entity can neither lend itself money nor charge itself interest).
This implies that the interest charged is irrelevant. Whether zero or a million percent, it will have absolutely no influence on the consolidated financial statements.
This is also why US GAAP (835-30-15-3) specifically exempts transactions between parent and subsidiaries when it comes to discounting.
But IFRS is not US GAAP (not in this case).
The reason is that IAS 24.3 “requires disclosure of related party relationships, transactions and outstanding balances, including commitments, in the consolidated and separate financial statements of a parent, venturer or investor presented in accordance with IAS 27 Consolidated and Separate Financial Statements. This Standard also applies to individual financial statements.”
So, if the subsidiary prepares individual financial statements per IFRS, it has to disclose the loan.
But, fortunately, disclosure is not the same as discounting.
If the parent discloses providing a zero interest loan to its subsidiary, IAS 24 is (technically) happy.
Also important is the reference to IAS 27.
Paragraph 3 of that standard states that it “shall also be applied in accounting for investments in subsidiaries, jointly controlled entities and associates when an entity elects, or is required by local regulations, to present separate financial statements.”
But this is the where things start to get murky because, at this point, IFRS and local legislation start to interact.
Not that I have anything against local legislation, but local legislation differs country-by-country, region-by-region and, as an IFRS accountant, my obligation is to be an expert in IFRS, not the local law of the 20, 30 or 40 countries where our company does business.
But, fortunately, I do not have to be. All I have to do is answer one simple question:
Does the subsidiary produce its own, individual financial statements per IFRS?
If the answer is yes, I am obligated to disclose the loan and I should discount it using a reasonable rate (a rate consistent with IAS 39.AG74).
Note: while I am not (technically) obligated to discount or use a reasonable rate, I am obligated to disclose the nature of the related party relationship and provide details about its terms and conditions. If I account for the loan at “arm’s length”, I can state this fact and also keep my explanation fairly brief. Otherwise, they can get complicated.
If the answer is no, I don’t have to do anything. Not according to IFRS anyway.
Caveat: because IAS 24 isn’t exactly a paradigm of clear and concise standard writing (and even IAS 27, which seems clear to me, causes some people trouble), the above should be taken as one possible interpretation of IFRS requirements.
Not that I am saying it’s the wrong interpretation. Far from it.
What I am saying is that, time-to-time, one does run into professional service providers (even big firm auditors, who should know better) that consider “entity” (as understood by IFRS) to be a synonym for “legal entity” (as defined by national legislation).
These providers then conclude that IFRS “requires” disclosure of transactions between a legal-entity parent and legal-entity subsidiary.
Since an IFRS entity is clearly an entity producing a report per IFRS (regardless of legal structure), these opinions are obviously wrong.
The problem is, time-to-time, even wrong opinions are formed by people given the legal right to form opinions. Usually, these people can be convinced to see their error and are willing to correct it. Other times, they all uppity and defensive, and decide to show their clients that their opinions (even the bad ones) have to be taken seriously.
What to do in situations like this?
Personally, I would consider switching professional service providers.
After all, paying good money for bad opinions is just plain silly.
In the Separate Financial Statements:
1. Discount the loan using market rate of interest
(Para 43 and Application guidance B5.1, IAS 39)
2. Classify the differential as investments. (AG 64 of IAS 39)
3. Test the investment for impairment. (IAS 39)
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