Our 'IFRS Viewpoint' series provides insights from our global IFRS team on applying IFRSs in challenging situations. Each issue will focus on an area where the Standards have proved difficult to apply or lack guidance. This issue provides a framework for accounting for loans made by an entity to a related party that are at below-market levels of interest. Common examples of such loans include:
Loans are one type of financial instrument. As such they are governed by IFRS 9 (2014) 'Financial Instruments' which requires all financial instruments to be initially recognised at fair value. This can create issues when loans are made at below-market rates of interest, which is often the case for loans to related parties.
Normally the transaction price of a loan (ie the loan amount) will represent its fair value. For loans made to related parties however, this may not always be the case as such loans are often not on commercial terms. Where this is the case, the fair value of the loans must be calculated and the difference between fair value and transaction price accounted for. This IFRS Viewpoint provides a framework for analysing both the initial and subsequent accounting for such loans.
Where related party loans are made on normal commercial terms, no specific accounting issues arise and the fair value at inception will usually equal the loan amount.
Where a loan is not on normal commercial terms however, the 'below-market' element of the transaction needs to be evaluated and separately accounted for.
The diagram illustrates the framework for analyzing loan transactions. The first step is to determine if the loan is on normal commercial terms. If not, the 'below-market' portion indicates part of the transaction price should be accounted for separately. This separate element must be recorded under the relevant standard. For example, a loan to an employee with an interest rate lower than the market rate means the difference between the loan amount and fair value is considered an employee benefit, and should be accounted for under IAS 19.
Where the 'below-market' element of the loan is not directly addressed by a Standard, reference should be made to the IASB's Conceptual Framework for Financial Reporting (the Conceptual Framework) in determining the appropriate accounting. For example, for reasons we will explain, in the case of a loan from a parent to a subsidiary that pays interest at less than the market rate, the difference between the loan amount and the fair value (discount or premium) will typically be recorded as
Having separately accounted for this element of the loan, the remaining loan receivable or payable should be accounted for under IFRS 9. IFRS 9 sets out the classification and measurement requirements for the loan receivable or payable as well as the impairment requirements for the receivable.
