Part 7- Intercompany loans

Intercompany loans will generally fall within the scope of section 11- “Basic Financial Instruments” of FRS 102. For more complex loan arrangements, section 12 “Other Financial Instruments” will apply. Under section 11 a financing transaction is initially measured “at the present value of the future payments discounted at a market rate of interest for a similar debt instrument”. Subsequent to this, the loan is measured “at amortised cost using the effective interest method” . This will ensure that an interest charge is recognised systematically over the life of the loan, giving a rate of return similar to that of a bank loan.

Effective Interest Method

“The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability (or a group of financial assets or financial liabilities) and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period, to the carrying amount of the financial asset or financial liability. The effective interest rate is determined on the basis of the carrying amount of the financial asset or liability at initial recognition. Under the effective interest method: (a) the amortised cost of a financial asset (liability) is the present value of future cash receipts (payments) discounted at the effective interest rate; and (b) the interest expense (income) in a period equals the carrying amount of the financial liability (asset) at the beginning of a period multiplied by the effective interest rate for the period.” The above treatment will be significantly different from the current GAAP whereby the company receiving the loan recognises a creditor and the company making the loan will recognise a debtor. Under FRS 102, if a company is in receipt of an inter-group loan under terms which differ from the market interest rate then there may be significant implications for the measurement & recognition of their balances with other group companies.

What questions do you have?

We are happy to help. Please post your comment below or contact our friendly and knowledgeable team on 01 677 9000.  To keep in touch, connect with us on Linkedin. If this article helped you, please share it with other businesses.