FRS102 which is now the UK’s main reporting standard has some really odd rules and in my view the rules for interest free loans are complete madness!
Take a simple example of a £5,000 interest-free loan repayable in three years’ time:
if the market rate for such a loan was, say, 7% then the present value of the loan would be £4,081 (£5,000 x 1/(1.07)3).
Unfortunately, FRS 102 does not contain any requirements about how the above financing shortfall of £919 should be accounted for on initial recognition. It is therefore necessary to consider the particular facts in order to determine the accounting treatment.In simple terms, the financing shortfall of £919 is either interest income or an interest expense when the loan is made. That then reverses as interest receivable or payable as the discounting unwinds.
FRED 67 proposes a number of amendments to FRS 102, in response to calls from stakeholders, intended to simplify it and make it more cost-effective. This includes permitting small entities to initially measure a loan from a director who is a natural person and a shareholder in the small entity (or a close member of the family of that person) at transaction price. FRS 102 currently requires such loans to be initially measured at present value, with the discount rate being a market rate of interest for a similar debt instrument.