Parent guarantee

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JRSB
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Parent guarantee

Post by JRSB »

I'm looking at a set of listed group accounts.

The parent company has guaranteed a loan taken out by a subsidiary.

the note says "The facility was guaranteed by the Company; this guarantee has been treated as an insurance contract under IFRS 4."

It doesn't say more (nor in policies) - so just wondered what the financial reporting implications of this in the parent's accounts are?

Something for knowledge base? (If not already there somewhere) :oops: Or is this just an off balance sheet commitment just for disclosure? https://ifrscommunity.com/knowledge-bas ... ommitments
Leo
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Re: Parent guarantee

Post by Leo »

Is it a facility loan concluded between sub and banks, with guarantee from the parent ?

Why Ifrs4? that's the first time I've heard of it. It's quite common for parent to guarantee the loans of the subs, but I can't think how it can be linked to IFRS 4.

I've always disclosed it in notes "Commitments and contingencies".
JRSB
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Re: Parent guarantee

Post by JRSB »

I assume it is deemed that the parent is providing an insurance contract for the sub. ? by underwriting?

Yes a basic RCF between sub and external bank.
Kalan
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Re: Parent guarantee

Post by Kalan »

Hi! IMO parent would need to recognize the liability at fair value (yeah, I khow, noone does that but still IFRS 9 require explicitly). The amount can be quite high - e.g. in some countries banks issue guarantee for 3-5% of the amount. And this can even survive consolidation - e.g. if the subsidiary has negative net assets and IAS 36 cannot provide more impairment - so eventually the parent will have to pay for the debts from own funds and the losses of the group will exceed those recognized under IAS 36 and IAS 37
Leo
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Re: Parent guarantee

Post by Leo »

I understand what you say in the individual statements of the parent. But I don't understand it from consolidation point of view.

It should be eliminated at the conso level otherwise you'll have the loss twice ?
JRSB
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Re: Parent guarantee

Post by JRSB »

Kalan wrote: 19 Jun 2022, 14:42 Hi! IMO parent would need to recognize the liability at fair value (yeah, I khow, noone does that but still IFRS 9 require explicitly). The amount can be quite high - e.g. in some countries banks issue guarantee for 3-5% of the amount. And this can even survive consolidation - e.g. if the subsidiary has negative net assets and IAS 36 cannot provide more impairment - so eventually the parent will have to pay for the debts from own funds and the losses of the group will exceed those recognized under IAS 36 and IAS 37
that would be the case if there was an indicator of default and therefore the guarantee being triggered. Or are you saying IFRS 4 requires a guarantor/insurer to recognise the full potential outflow as a liability, as well as the borrower? Seems odd.
DJP
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Re: Parent guarantee

Post by DJP »

You have an accounting policy choice to apply IFRS 17 (if you consider it to be an insurance contract) or treat it as a financial guarantee under IFRS 9. The election can be made on a contract by contract basis.

(Refer to IFRS 9 2.1 (e))

I am assuming that this contract is between the Parent an the Sub. Therefore, in the consolidated accounts the only thing that is presented is a borrowing from the bank.
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Re: Parent guarantee

Post by Leo »

And from IAS27 point of view, if no occurrence of default by the sub, there is no obligation for the parent to book anything right ?
DJP
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Re: Parent guarantee

Post by DJP »

I'm afraid I am not an IFRS 17 expert. If this was treated as a financial guarantee I could give you an answer. But I would expect something to be booked.
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Marek Muc
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Re: Parent guarantee

Post by Marek Muc »

JRSB wrote: 18 Jun 2022, 20:29 Something for knowledge base? (If not already there somewhere) :oops:
There's some general discussion here, but definitely not exhaustive:

https://ifrscommunity.com/knowledge-bas ... guarantees
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Re: Parent guarantee

Post by Marek Muc »

Kalan wrote: 19 Jun 2022, 14:42 And this can even survive consolidation - e.g. if the subsidiary has negative net assets and IAS 36 cannot provide more impairment
Are you sure about this? The loan liability is already recognised in consolidated balance sheet, so you would double count it if you also kept the liability resulting from the related fiancial guarantee
Leo
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Re: Parent guarantee

Post by Leo »

Hi DJP, do you mind sharing with us a case that a financial guarantee resulted in an accounting entry even there is no occurrence of default please. And what would it be, thank you so much !
JRSB
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Re: Parent guarantee

Post by JRSB »

Seems like we need an insurance expert here! As a guess, wouldn't the insurer 'predict' their expected exposure (rather than the full potential amount as suggested before), so provide in that way, which would be similar to an IFRS 9 exposure based on a guarantee.
DJP
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Re: Parent guarantee

Post by DJP »

If there is no default, most likely the premium "paid" for the guarantee less the cumulative amount of recognised income will be higher than the expected credit loss on the guarantee, and that's what the parent should be showing.

However, most of the time no premium is paid for these guarantees. In these cases you need to determine if the amount is material. If material, the parent shall record deferred income, which is then recognised in P&L over the life of the guarantee. The counter-booking is an accounting policy choice: you can either see it as a capital contribution in the sub, or you can just take it to P&L immediately. The initial amount of the premium should be determined by assessing what the expected credit loss on this guarantee at that point is.

Subsequently, you need to calculate the expected credit loss on the guarantee and compare it to the initial premium less cumulative recognised income. The higher amount is presented.
JRSB
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Re: Parent guarantee

Post by JRSB »

Sorry DJP, assume no premium is paid for the parent to give the guarantee. Are you saying the premium that would have been paid on market terms to insure the sub's exposure then comes in as investment in sub/P&L expense? Why deferred income?
DJP
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Re: Parent guarantee

Post by DJP »

Yes.

Well, the DR is investment (or an expense in PL -- policy choice), and the CR is deferred income (according to IFRS 15 you will be recognising that income over the life of the guarantee).

(This is an interpretation and treatment I've seen at one of the Big 4)
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Re: Parent guarantee

Post by Leo »

Sub contracts a loan of 1 millions with bank, and parent give guarantee against a premium of 1 000 USD per month

In such case, I understand that premium is 1000/months. So what's cumulative amount if recognised income then ?
DJP
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Re: Parent guarantee

Post by DJP »

Again, you have a choice here.

1) just book the initial premium received (1,000); or

2) recognise the present value of the future premiums (gross receivable)
Leo
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Re: Parent guarantee

Post by Leo »

https://www.cpdbox.com/financial-guarantees-ifrs-9/

@DJP, I think she meant ECL on the loan when she wrote that, is it ECL on the loan or ECL on the guarantee, or we are talking about the same thing here ?
DJP
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Re: Parent guarantee

Post by DJP »

It's the ECL on the guarantee (i.e. the expected cash out flow for the issuer of the guarantee).

The loan is guaranteed by the Parent company. So the ECL for the lender should take that into consideration and alledgedly is much lower.
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Re: Parent guarantee

Post by JRSB »

ok, I thought the 'value' would be the market rate for an insurance premium but based on that link it's the amount the sub's borrowing rate is reduced by virtue of the guarantee. So that amount is effectively a contribution. why are you suggest it's income in parent? (as if it was a deemed dividend - the value is passing from parent to sub). some difficult things to ascertain here - I imagine the parent guarantee if often not used to reduce the borrowing rate - it's used because the loan wouldn't otherwise be offered at all as presumably that sub has insufficient collateral itself.

PS still interested in the implications of it being IFRS 4 per original post.
DJP
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Re: Parent guarantee

Post by DJP »

It's the same thing. The insurance premium or financial guarantee fee (whatever you want to call it) is based on the expected credit loss on this contract. It is income for the parent as it would be income for a third party willing to provide such guarantee. The difference is on the debit side of things -- for a third party this would be a receivable, but for the parent company is either an expense or a capital contribution because the sub will not be paying for it.

I'm afraid I cannot help regarding IFRS 4/17
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Re: Parent guarantee

Post by JRSB »

ok so the parent is providing a service, hence income, but then not getting paid, hence equal expense (or investment addition). This element won't ever be material then, if the policy is to expense it?

Then the issue is to look at ECL on the exposure, perhaps alongside any ECL on any loan to sub, since all based on sub's ability to repay.

I'm not sure I've ever seen accounts where the parent-only notes disclosed an ECL on a guarantee, but there must be some out there.
DJP
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Re: Parent guarantee

Post by DJP »

It can be material and still you can decide to expense it. It's really a policy choice because IFRS is silent on the accounting treatment for the issuer of a financial guarantee regarding the debit side of things.

And yes, there are cases out there :) but finding separate accounts with this type of transactions is a bit more difficult as the guarantee may be issued by an intermediate parent company (usually a cash-rich entity within the group).
Leo
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Re: Parent guarantee

Post by Leo »

Just want your opinion here :

Case 1, an entity X issue a financial guarantee to a third party to secure a loan with banks. The terms is a 2 year loan of 1 million with premium fees of 100K USD per year.
So, step 1, entity X assess the fair value of the financial guarantee, which takes into account any future cash flows on the contract, let's say 200K USD (for simplification)
Entity X book the following entry at initial recognition :
Debit : Receivables on premium from financial guarantee (Balance sheet) : 200K USD (IFRS9)
Credit : Liabilities from financial guarantee (Balance sheet) : 200K USD (IFRS15)

Recognition of the premium related to year 1 :
Debit : Liabilities from financial guarantee (Balance sheet) : 100K USD (IFRS15)
Credit : Premium (P&L) : 100K USD (IFRS15)

Record of payment :
Debit : Cash (Balance sheet) : 100K USD (IFRS9)
Credit : Receivables on premium from financial guarantee (Balance sheet) : 100K USD (IFRS9)

At year end 1 : assess the higher of ECL (IFRS9) vs the amount initially recognised (fair value) less, the cumulative amount of income recognised in accordance with IFRS15
Which is to compare ECL vs 100 KUSD (amount left in Liabilities from financial guarantee)
If ECL is higher, let's say 500K USD, then, Entity X would :
Debit : P&L ECL loss 400K USD (IFRS9)
Credit : Liabilities from financial guarantee (Balance sheet) : 400K USD (IFRS9)

If at year end 2, It turned out that the loan was reimbursed in full, then Entity X would :
Debit : Liabilities from financial guarantee (Balance sheet) : 400K USD (IFRS9)
Credit : P&L write off ECL loss 400K USD (IFRS9)

The same applies if it's to a sub
Last edited by Leo on 21 Jun 2022, 17:38, edited 4 times in total.
Leo
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Re: Parent guarantee

Post by Leo »

Case 2, an entity X issue a financial guarantee to a sub to secure a loan with banks. The terms is a 2 year loan of 1 million without premium fees.
So, step 1, entity X assess the fair value of the financial guarantee, which takes into account the loan at amortised cost if entity X hasn't given its guarantee.
Imagine that it turned out that sub would borrow at a higher interest rate, and the delta is 200K USD

Entity X book the following entry at initial recognition :
Debit : Investment in sub (Balance sheet) or loss in P&L : 200K USD
Credit : Liabilities from financial guarantee (Balance sheet) : 200K USD (IFRS15)

Recognition of the premium related to year 1 :
Debit : Liabilities from financial guarantee (Balance sheet) : 100K USD (IFRS15)
Credit : Premium (P&L) : 100K USD (IFRS15)

At year end 1 : assess the higher of ECL (IFRS9) vs the amount initially recognised (fair value) less, the cumulative amount of income recognised in accordance with IFRS15
With is to compare ECL vs
100 KUSD (amount left in Liabilities from financial guarantee)
If ECL is higher, let's say 500K USD, then, Entity X would :
Debit : P&L ECL loss 400K USD (IFRS9)
Credit : Liabilities from financial guarantee (Balance sheet) : 400K USD (IFRS9)

If at year end 2, It turned out that the loan was reimbursed in full, then Entity X would :
Debit : Liabilities from financial guarantee (Balance sheet) : 400K USD (IFRS9)
Credit : P&L write off ECL loss 400K USD (IFRS9)

To conclude : the only difference between case 1 and case 2 is that in case 2, the guarantee was given to sub free of charge, so, accountingly, it's recorded as an investment at initial recognition.
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