FRS 102: accounting for director loans and inter-group loans

When is a loan from a director a financial instrument?

FRS 102 deals with accounting for financial instruments in section 11 ‘basic financial instruments’ and section 12 ‘other financial instruments’.

Loans payable by the entity or receivable by the entity with a fixed interest rate or with no interest would normally be treated as basic financial instruments and come within section 11 of FRS 102.

FRS 102 explains how these loans should be accounted for both in terms of the initial recognition and how they should be treated in subsequent reporting dates.

Paragraph 11.13 deals with the initial measurement. This splits the treatment into the following three categories:

• If the arrangement is a financing transaction, the entity shall measure the financial asset or financial liability at the present value of the future payments discounted at the market rate of interest for a similar debt instrument.
• Financial assets and liabilities that are measured at fair value through profit and loss. When such assets and liabilities are initially recognised, it is for the entity to decide whether or not to treat them as such designated items to be valued at fair value with changes in value going to profit or loss (paragraphs 11.27 to 11.32).
• Other financial assets or financial liabilities should initially be measured at the transaction price (including transaction costs).

Paragraphs 11.14 to 11.32 deal with the subsequent measurement. These paragraphs have the following treatments for loans (or debt instruments):

• If the arrangement is a financing transaction, the entity shall measure the debt instrument at the present value of the future payments discounted at a market rate of interest for a similar debt instrument.
• Debt instruments that are payable or receivable within one year shall be measured at the undiscounted amount of the cash or other consideration expected to be paid or received.
• Debt instruments that meet the conditions in paragraph 11.8(b) of FRS 102 shall be measured at amortised cost using the effective interest method (paragraphs 11.15 to 11.20 provide guidance on this).

For a long-term loan at a market rate of interest made to another entity, a receivable is recognised at the amount of the cash advanced to that entity plus transaction costs incurred by the entity.

1. For goods sold to a customer on short-term credit, a receivable is recognised at the undiscounted amount of cash receivable from that entity, which is normally the invoice price.
2. For an item sold to a customer on two years’ interest-free credit, a receivable is recognised at the current cash sale price for that item (in financing transactions conducted on an arm’s length basis the cash sales price would normally approximate to the present value). If the current cash sale price is not known, it may be estimated as the present value of the cash receivable discounted using the prevailing market rate(s) of interest for a similar receivable.
3. For a loan received from a bank at a market rate of interest, a payable is recognised initially at the amount of the cash received from the bank less separately incurred transaction costs.
4. For goods purchased from a supplier on short-term credit, a payable is recognised at the undiscounted amount owed to the supplier, which is normally the invoice price.
5. A director/shareholder lends the company a substantial amount interest free for a fixed term of three years. A creditor would initially be measured as the present value of the future payments discounted at the market rate of interest for a similar debt instrument.

Summary of accounting treatment

Some loans will initially be measured at ‘the transaction price’ and some will be measured at the ‘present value of the future payments discounted at a market rate of interest’.

At subsequent reporting dates, some loans will be measured at the ‘undiscounted amount of cash or other consideration expected to be paid or received’, whereas others will be measured at the ‘present value of the future payments discounted at a market rate of interest’.

When loans are measured at ‘the transaction price’ or the ‘undiscounted amount of cash or other consideration expected to be paid or received’ then there is no difference between the cash value and the recorded measurement of the loan.

However, a difference may arise if the amount paid or received or carrying value of the loan is different to the ‘present value of the future payments discounted at a market rate of interest’.

Clearly where ‘terms’ exist the transactions will follow the requirements. Where terms do not exist written or verbal, for example a loan from a director with no terms that has been outstanding for a considerable time judgement will be required on the appropriate treatment following discussion with the director.

Here are seven further worked examples which consider these issues.

You can view relevant extracts from FRS 102

The tax treatment of these loans is dealt with in HMRC guidance in CFM33176 while this article in Taxation also explains the tax treatment of these loans.

Article from ACCA In Practice