Non-market rate loans under FRS 102 – repayable on demand?

Non-market rate loans under FRS 102 - repayable on demand?

There are few areas in FRS 102 capable of eliciting such strong emotion from a room of otherwise cool and collected accountants than the accounting for below-market-rate loans. At the risk of being unpopular, I'll start the blog by saying this:

'we'll either end up accounting for these loans as a current liability (which we probably don't want to do) without the need for funny double entries...or we'll end up with a non-current liability accounted for at present value with funny double entries (which we also probably don't want to do).'

In this blog, let's focus on the first thing we don't want to do. We'll deal with some of the eyebrow-raising present value double-entry in a later blog.

Is this loan repayable on demand?

Where we have a loan and interest isn't being charged at a market rate; the chances are that under FRS 102 we're looking at having to account for the loan at the present value of future payments discounted at a market rate of interest.

However, let's take it back a step. Lots of loans made to and from entities are legally repayable on demand. For example, let's say there is a loan of a million pounds made by a director to a company with no interest being charged and no formal agreement in place. In the absence of a formal agreement, the loan would be repayable on demand. The same holds in many group borrowing scenarios.

So, what happens if it is repayable on demand?

This repayable on demand creditor would still be accounted for by the company at the present value future payments but because it's repayable on demand, the present value is still a million pounds (ie a pound paid on demand today has a present value of one pound).

It should be noted, though, that as there is not an unconditional right to defer settlement, the company would classify the liability as repayable within one year. This includes situations where the director is happy to sign a 'comfort letter' stating that they have no intention of recalling the loan in the next 12 months - whilst this letter might be useful in coming to conclusions on going concern, legally it wouldn't hold much water - and wouldn't normally provide that unconditional right to defer settlement.

What are the options here?

Well, there might be a few:

  • We might decide that now is the time to get the paperwork in order and formalise the loan. This option brings us into the realms of the 'funny double entry' and a greater likelihood of the 'financing' element being material. We'll look at this in a future blog.
  • We might decide that this loan isn't really ever getting paid back and is effectively capital, again putting the paperwork in place to reflect this.
  • We present the liability as less than one year and put a note in the accounts to say that although it's legally repayable within a year, the director has no intention of recalling it (as we have a piece of paper that says so).
  • For anyone reading who has been dying to dust off their present value tables - not used since a dim and distant exam back in 1976 - fear not; next month we'll look at the weird and wonderful world of non-market rate loans under FRS 102 that aren't repayable on demand. How exciting.

    If you have been affected by any of the issues raised in this in the above blog post, you may be interested in the following:

    • Staff Education Note 16: Financing Transactions - the FRC's go-to guide for accounting for financing transactions under FRS 102.
    • Corporation Tax treatment of interest-free loans and other non-market loans (Draft) - Draft guidance from HMRC on the tax implications of these transactions.
    • Explanatory Note Clause 23: Loan relationships: non-market loans (Finance Bill 2016) - a note of the proposed amendments due to take effect from 1 April 2016.

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