Accounting for Interest-Free Loans

Posted on 26th November 2018
Accounting-for-Interest-Free-Loans.pdf (92 downloads) - 13 MB

Let’s say Company A lends €100,000 to Company B repayable in full upon maturity, in 3 years time, at 0%, when the market interest rate is 8%.

Situation 1: Assume this is done ex-gratia by Company A, that is Company A attaches no conditions with this interest-free loan.

Situation 2: Assume Company A provides this interest-free loan in return of free-of-charge marketing services supplied by Company B over the same three-year period.

The loan must be recorded at fair value by discounting it to its present value at the market rate at the loan’s inception at 8%. This means that the loan must be initially recognised at the value of €79,383 under both IFRS and GAPSME.

Situation 1

Company A will be receiving no interest in return, which means that it should recognise a loss of €20,617 immediately in the first year, representing the loss that the company is suffering from lending the money at 0% rather than investing it in a worthwhile investment.

On initial recognition, the double entry is as follows:

DEBIT Loan Receivable €79,383
DEBIT Interest Expense      €20,617
CREDIT Cash   €100,000

Subsequently, the loan is carried at amortised cost by unwinding the discount over three years:

BAL B/D EIR @ 8% Cash Flow BAL C/D
79,383 6,351 85,734
85,734 6,859 92,592
92,592 7,407 100,00

Year 1

DEBIT Loan Receivable €6,351
CREDIT Interest Income €6,351
Being unwinding of discount – year 1 (EUR79,383 x 8%)

Year 2

DEBIT Loan Receivable €6,859
CREDIT Interest Income €6,859
Being unwinding of discount – year 2 (EUR85,734 x 8%)

Year 3

DEBIT Loan Receivable €7,407
CREDIT Interest Income €7,407
Being unwinding of discount – year 3.
DEBIT Cash €100,000
CREDIT Loan Receivable €100,000
Being repayment of loan upon maturity.

Situation 2

Company A is granting an interest-free loan and in return will be receiving marketing services over three years. This time the €20,617 is charged to profit or loss over three years, instead of charging it immediately to profit or loss. The charges over profit or loss over the three year represent the value of the marketing services provided by Company B and should be classified as such.

On initial recognition, the double entry is as follows:

DEBIT Loan Receivable €79,383
DEBIT Deferred Expense (Prepayment) €20,617
CREDIT Cash €100,000

Subsequently, marketing expenses are recognised:

Year 1

DEBIT Loan Receivable €6,351
CREDIT Interest Income €6,351
Being unwinding of discount – year 1.
DEBIT Marketing Expense €6,351
CREDIT Deferred Expense €6,351
Being marketing expense – year 1.

Year 2

DEBIT Loan Receivable €6,859
CREDIT Interest Income €6,859
Being unwinding of discount – year 2.
DEBIT Marketing Expense €6,859
CREDIT Deferred Expense €6,859
Being marketing expense – year 2.

Year 3

DEBIT Loan Receivable €7,407
CREDIT Interest Income €7,407
Being unwinding of discount – year 3.
DEBIT Marketing Expense €7,407
CREDIT Deferred Expense €7,407
Being marketing expense – year 3.
DEBIT Cash €100,000
CREDIT Loan Receivable €100,000
Being repayment of loan upon maturity.

The accounting treatment of long term loans may vary in accordance with the nature of the arrangement. In this article we have seen how the effect of the discounting can either be treated as charge to profit or loss in the first year or recognised as an asset (prepayment) which would then be released to profit or loss over a period of time. Nonetheless, the effect of the discounting may also be recognised as an investment, a contribution in equity, a dividend, or perhaps directors’ fees or even employee expense.

A seminar on long-term loans and bonds will be held on 10th and 17th December 2018 discussing the following:

  1. Loans with employees;
  2. Loans with key management personnel;
  3. Loans between group companies;
  4. Loans with unrelated companies;
  5. Loans with random payments;
  6. Loans without repayment;
  7. Loans with variable interest-rates;
  8. Bonds.

For further information visit our website http://cpa-forum.com/courses/

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