Provision of financing to related companies

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Giannos
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Provision of financing to related companies

Post by Giannos »

I have a question about the provision of interest free financing between related companies, which have no equity relationship between them.
It is clear by IFRS 9 that when a parent gives an interest free loan to its subsidiary or at an interest rate which is lower than the market rate, the present value of the loan should be calculated using the current market interest rate and the difference between the present value of the loan and its nominal value (the equity component) should be capitalized on the value of the investment in subsidiary in the books of the parent company and subsidiary should recognize this equity component of the loan in its equity. What happen in the cases when a company A gives an interest free loan to a company B and these companies have no equity relationship between them, but both of the companies belongs to the same shareholder?
If I understand correct, company A should post the difference between the present value of the loan and its nominal value to its expenses at the time of the provision of the loan, since there is no equity relationship with company B. Company B should recognize in the difference between the present value and the nominal value of the loan (i.e. the "equity" component) as income in its books. Can you please let me know whether my above understanding is correct?

Thank you.
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Marek Muc
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Re: Provision of financing to related companies

Post by Marek Muc »

If both companies have the same parent, it is still an equity transaction for both companies, i.e. and indirect transaction with owners in their capacity as owners. So no P&L impact.
Giannos
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Re: Provision of financing to related companies

Post by Giannos »

What happen if the shareholder of both of the companies is a physical person?

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JRSB
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Re: Provision of financing to related companies

Post by JRSB »

Easiest answer is to charge market interest..

Perhaps the arrangement would be deemed as a distribution to that person and equivalent contribution by them to the other company..
Giannos
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Re: Provision of financing to related companies

Post by Giannos »

The distribution between the companies should be recognized through profit and loss account. Right?
JRSB
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Re: Provision of financing to related companies

Post by JRSB »

No I don't see why it would be P&L.
Giannos
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Re: Provision of financing to related companies

Post by Giannos »

How else can you recognize it, given there is no formal direct ownership relation between the two companies?
Will you create a "dummy" investment in the books of the lender?

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Marek Muc
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Re: Provision of financing to related companies

Post by Marek Muc »

It doesn't really matter that the controlling shareholder is a physical person.

You don't create an investment. The lender recognises a debit to equity representing de facto distribution to owner (through fellow subsidiary)
Giannos
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Re: Provision of financing to related companies

Post by Giannos »

So company A should debit the "equity component" in its equity in a separate reserve and company B should recognize a credit in its equity as "contribution from shareholder". Am I right?

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Marek Muc
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Re: Provision of financing to related companies

Post by Marek Muc »

Yes, but it doesn't have to be a separate reserve, it may as well be a distribution against retained earnings.
Giannos
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Re: Provision of financing to related companies

Post by Giannos »

Thank you a lot Mark. Now is very clear!!
JRSB
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Re: Provision of financing to related companies

Post by JRSB »

Now you need to work out what the market rate of interest would have been....
Giannos
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Re: Provision of financing to related companies

Post by Giannos »

I think that the company's external borrowing rate would be appropriate OR alternatively the interest rate for bank/external loans for similar type of loans in the country of operation of the Company. Do you agree with this?
JRSB
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Re: Provision of financing to related companies

Post by JRSB »

If the external debt has similar characteristics (size, security, repayment) then that sounds perfect.
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