How can an interest free loan be worth less than the amount borrowed? FRS102 Reply

what

This has to be complete madness! but its absolutely correct under new accounting rules – FRS102.

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.

– See more at: http://www.icaew.com/en/members/practice-resources/icaew-practice-support-services/practicewire/news/frs-102-and-interest-free-loans#sthash.tm8iReHG.dpuf

This is crazy, because we all know the value of the loan is £5,000, it’s not £4,081!
It will cause problems particularly with…
  • Parent – Subsidiary Loans
  • Subsidiary to Subsidiary Loans
  • Loans with Directors and Shareholders
There are some special rules for Public benefit entities.
I wonder whether it’s easier to simply always charge interest, rather than get into complicated discounting rules!
steve@bicknells.net
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