Interest-free loans or loans at below-market interest rate

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Marek Muc
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Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

Recently we've seen a few questions about a spreadsheet template for interest-free loans or loans at below-market interest rate. I guess these loans have become more popular during the pandemic. I prepared a simple page with two excel examples. Have a look and let me know what you think, and whether it's worth adding something to that page.

https://ifrscommunity.com/knowledge-bas ... ate-loans/
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Re: Interest-free loans or loans at below-market interest rate

Post by JRSB »

Handy.
I guess the issue re common control is that in so many cases it's non-contractual are repayment timings are unknowable, so just chucked at cost to current asset/liability....
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Re: Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

Right, things can get blurred under common control. I guess you have two choices in such a case:
1. Treat such a loan as repayable on demand and therefore proceeds = fair value or
2. Consider the loan to be in substance equity contribution in full

What are your observations in practice?
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Re: Interest-free loans or loans at below-market interest rate

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Almost always #1 (or with an undertaking not to recall within 365 days....).

And almost always without ECL.
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Re: Interest-free loans or loans at below-market interest rate

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In mining sector I have seen a fair few of #2.
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Re: Interest-free loans or loans at below-market interest rate

Post by nauman »

Marek Muc wrote: 22 Dec 2020, 22:07 Right, things can get blurred under common control. I guess you have two choices in such a case:
1. Treat such a loan as repayable on demand and therefore proceeds = fair value or
2. Consider the loan to be in substance equity contribution in full

What are your observations in practice?
Mostly no. 1 but to avoid classifying it as a current liability in books of borrower (in case borrower needs to manage its ratios) we issue a separate undertaking saying that the loan wont be recalled for payment within 12 months from balance sheet / FS approval date.
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Re: Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

I see. And presumably you also conclude that the effect of time value of money is immaterial for such a period and don't do any discounting even if the loan is interest free?

PS. Nice to see you posting again :)
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Re: Interest-free loans or loans at below-market interest rate

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Nauman, yes that's what I wrote too - on our side nothing is discounted if < 1 yr, and so this scenario is taken to be 1 day of discounting....
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Re: Interest-free loans or loans at below-market interest rate

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Hm, I'm lost a bit, what do you mean by 1 day of discounting? If the borrowing is classified as non-current, you've got at least 12 months worth of discounting right?
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Re: Interest-free loans or loans at below-market interest rate

Post by JRSB »

Just as a real-world approach, if a payment due in 364 days is not discounted as it's current - the extra day is seen as 1 day of discounting. I would imagine that anyone who presents as non-current on the basis of an undertaking not to recall for a year doesn't even ask themselves if it needs to be discounted.
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Re: Interest-free loans or loans at below-market interest rate

Post by Anush.grigoryan »

Marek Muc wrote: 22 Dec 2020, 19:42 Recently we've seen a few questions about a spreadsheet template for interest-free loans or loans at below-market interest rate. I guess these loans have become more popular during the pandemic. I prepared a simple page with two excel examples. Have a look and let me know what you think, and whether it's worth adding something to that page.

https://ifrscommunity.com/knowledge-bas ... ate-loans/
Very interesting article! What if the situation is the following. Entitiy A is a Parent of Entity B.Entity B has an investment in associate in Entity C. What if the Entity A gives below market rate loan to Entity C? How to treat the difference between PV and noninal- investment, deferred expense or one-off loss on origination?
The same question is about Entity C- is the diff equity or deferred income or gain on origination?
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Re: Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

Haven't you just posted this question as a separate topic? :roll:
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Re: Interest-free loans or loans at below-market interest rate

Post by Leo »

Thank you Marek for this very interesting post !

But what about the subsequent accounting schemes, does the parent need to adjust investment in S every year ? And does the parent has to update the controlling interest in S every year ? Thanks

Nowadays, the market interest rates are so low that I've never seen the method in your article, It's always at cost. I suppose that in the future, when the market interest rate jumps above 5%, then intercompany loans will be a hot topic.

Thanks !
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Re: Interest-free loans or loans at below-market interest rate

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the investment in S isn't adjusted in subsequent years (except for standard events like disposal or impairment)

yeah I guess the impact of discounting will become more significant in the coming years
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Re: Interest-free loans or loans at below-market interest rate

Post by Aady001 »

I am just wondering if it's an interest-free loan / or a loan at a lower interest rate than the market, to a non-related party i.e. not under common control.
Then, in that case, should we not treat it as a compound financial instrument and recognise equity (delta between PV of loan and amount received) for lender.
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Re: Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

that's a too general scenario to analyse IMO
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Re: Interest-free loans or loans at below-market interest rate

Post by Aady001 »

Maybe, but since the equity so created does not get eliminated at consol and stay with the Company till perpetuity I thought this could be a good insight to add.
Also, how the receiver of the instrument will account for it if its not under common control.

In short, i think the above transaction, if it's not under common control, should also be explained to give a holistic view.
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Re: Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

first you would need to understand what's the substance of such an arrangement
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Re: Interest-free loans or loans at below-market interest rate

Post by Leo »

@Aady001, I,m sorry, I don't understand why when it's not under common control or related party, the loan should be treated as a compound financial instrument for the lender ? You would reduce the Equity of the lender right ?

Why can't we recognise the difference directly in P&L for the lender/borrower or in differed income or expenses for lender/borrower ?

Thank you in advance for your opinion

Note :

B5.1.2 If an entity originates a loan that bears an off‑market interest rate (eg 5 per cent when the market rate for similar loans is 8 per cent), and receives an upfront fee as compensation, the entity recognises the loan at its fair value, ie net of the fee it receives. [Refer: paragraph 5.1.1]
B5.1.2A The best evidence of the fair value of a financial instrument at initial recognition is normally the transaction price (ie the fair value of the consideration given or received, see also IFRS 13). If an entity determines that the fair value at initial recognition differs from the transaction price as mentioned in paragraph 5.1.1A, the entity shall account for that instrument at that date as follows:
(a)at the measurement required by paragraph 5.1.1 if that fair value is evidenced by a quoted price in an active market [Refer: Basis for Conclusions paragraphs BCZ5.2–BCZ5.7 and IFRS 13] for an identical asset or liability (ie a Level 1 input) [Refer: IFRS 13 paragraphs 76–80] or based on a valuation technique that uses only data from observable markets. An entity shall recognise the difference between the fair value at initial recognition and the transaction price as a gain or loss.
(b)in all other cases, at the measurement required by paragraph 5.1.1, adjusted to defer the difference between the fair value at initial recognition and the transaction price. After initial recognition, the entity shall recognise that deferred difference as a gain or loss only to the extent that it arises from a change in a factor (including time) that market participants [Refer: IFRS 13] would take into account when pricing the asset or liability.
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Re: Interest-free loans or loans at below-market interest rate

Post by Aady001 »

My bad Leo, instead of issuer i wrote lender
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Re: Interest-free loans or loans at below-market interest rate

Post by Leo »

Hi Aady,

By issuer you mean borrower right ? I think the treatment is the same then mentioned in B5.1.2A, what's your opinion ?

Thanks !
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Re: Interest-free loans or loans at below-market interest rate

Post by Aady001 »

Hi Leo,
I believe that such instruments should be treated as compound financial instruments by the issuer.
Here reference of para AG37 of IAS 32 can be drawn, wherein the non‑cumulative preference shares are to be treated as compound financial instruments with the liability component being the present value of the redemption amount.
I believe in substance both interest-free loans and NCRPS should be guided by the same principle.

However, the above position needs to be reassessed when such arrangements are with customers of the Company or with the Government.
In such cases, it may take the color of deferred income or government grant
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Re: Interest-free loans or loans at below-market interest rate

Post by Leo »

Hi Aady001,

When there is a interest free, or below the market loan issued by the borrower, to no related parties. I don't think it's a compound financial instrument, because the terms are straight forward and I can't think of any derivatives element in it. Maybe it could be in Equity by substance ? But not Equity from the compound financial instrument's perspective.

I think when such a loan is issued by the borrower, it's a liability. At initial recognition, the difference should go to P&L if it's in a quoted market, if not, then, in a differed asset/liabilities account ?

What do you think ?

Have you already seen some real life cases in practice that you can share please ?

Thank you very much !
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Re: Interest-free loans or loans at below-market interest rate

Post by Leo »

Hi Marek,

I have a question regarding the definition of fair value in B.5.1.1 IFRS9, why can't we consider the fair value being :

"Fair value is defined as ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date"

Why should we measure another fair value based on the market conditions if it's below it ?
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Re: Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

there's one definition of fair value only, but different ways of measuring it depending on the type and specifics of a financial instrument being measured
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Re: Interest-free loans or loans at below-market interest rate

Post by Leo »

Understand. thanks a lot !
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Re: Interest-free loans or loans at below-market interest rate

Post by Leo »

Hi Marek,

Does this case apply when the sub is wholly owned by the parent ? what happens if the shareholders gave a syndicated loan to the sub ?
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Re: Interest-free loans or loans at below-market interest rate

Post by Marek Muc »

Not sure what 'this case' means. Start a new topic please Leo
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