Interest free loan with no fixed repayment term

Scenario: In June 2006, XYZ Co. obtained an interest free loan amounting to USD 50 million from a third party with no fixed repayment terms. Under the terms of the loan agreement, the loan is to be repaid in annual installments, each equal to 60% of XYZ’s annual profit, commencing from the year ended 31 December 2007. The total payments made until 2008 amounted to USD 20 million and the installments due until the current year are classified in the statement of financial position as short-term obligations.

Treatment: The fair value of the loan is not equivalent to its carrying value due to the fact that it is non-interest bearing. However, as there is no repayment date, a fair value cannot be reasonably determined. Kindly help provide basis/clarifications if this is applicable. thanks.

Scenario: In June 2006, XYZ Co. obtained an interest free loan amounting to USD 50 million from a related party transaction with no fixed repayment terms. Previously, before FRS 113 was implemented, this was classify in Non-Current Liability under loans. With the effect of FRS13 on 1 Jan 2013, the need to FV this is required. May I ask how should I disclose this in the financial statments to:

1) Measured it at cost

2) Measured it at FV, how should we go about doing it?

Since this is a related party transaction, I would need more information to provide an answer.

Is the related party a group company (parent, sister, subsidiary?) or an individual?

What was the purpose of the loan?

Why was it interest free?

Does the company publish audited financial statements per IFRS?

Is the company publicly traded and, if so, on which market?

Hi

The separate financial statements of a holding company in terms of IFRS (still on IAS 39) refers:

1. The holding company received a $1 million loan from a wholly owned subsidiary.

2. Terms = No interest and no repayment date.

3. Holding company does not expect to repay within 12 months after y/e and received a letter from the subsidiary confirming that it gives the holdco the unconditional right to refuse payment for 12 months after y/e

4. The separate financial statements show the loan payable as non-current.

5. The holdco's cost of marginal debt (i.e. interest if new debt is sought), cost of current debt and general risk return rate for the company (considering it's risk in relation to its peers) are 10%, 8% and 7%, respectively.

$1 mil discounted for 12 months:

10% - 909,909

8% - 925,925

7% - 934,580

Questions:

1. Is the loan correctly classified as non-current

2. What should the measurement of the loan be, in the light of the inability to determine the repayment date.

3. Would the treatment differ if the loan was granted to the sub, by the holdco?

From a practical perspective, it does not make any difference how the transaction is accounted for since, unless separate individual financial statements are published (which is not required by IFRS), this transaction would be eliminated in consolidation.

If separate financial statements were presented, as this is a related party transaction with terms that are not even close to arm's length, it would should be presented at nominal value with the following disclosures:

IAS 24.18: If an entity has had related party transactions during the periods covered by the financial statements, it shall disclose the nature of the related party relationship as well as information about those transactions and outstanding balances, including commitments, necessary for users to understand the potential effect of the relationship on the financial statements. These disclosure requirements are in addition to those in paragraph 17. At a minimum, disclosures shall include:

(a) the amount of the transactions;

(b) the amount of outstanding balances, including commitments, and:

(i) their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and

(ii) details of any guarantees given or received;

(c) provisions for doubtful debts related to the amount of outstanding balances; and

(d) the expense recognised during the period in respect of bad or doubtful debts due from related parties.

Assuming a current/non-current balance sheet is presented, it should be presented current.

It makes no real difference who loaned to whom, since a loan of this nature makes no economic sense and thus would only occur between related parties.

Unfortunately, IFRS does not provide guidance for transactions that make no economic sense (that, or you have failed to provide all the relevant facts).

Since no sane person would provide an interest free loan with an uncertain payment term of his or her free will, the transaction was either between related parties or some additional benefit was involved (but not disclosed) or it was an attempt at a fraud or something similar.

In any event, IFRS requires both the financial asset (loan given) and financial liability (loan received) to be initially measured at fair value (IFRS 9.5.1.1*).

It makes no allowance for “a fair value [that] cannot be reasonably determined”, so the choice is simple: either determine fair value or be in violation of IFRS.

Then, since no fixed payment term exists (ruling out amortized cost accounting), both the asset and liability will have to be remeasured to fair value each balance sheet date. And again, “fair value cannot be reasonably determined” is not an excuse.

It’s either that, or document and disclose the related party relationship/transaction, in which case both asset and liability can be reported at nominal value.

*Note: I am citing the newly released IFRS 9, which now also includes guidance for liabilities, even though it has not been endorsed for use in the EU. But, since old IAS 39 provides comparable guidance, the accounting would be the same regardless.

Great answer. Exactly what we in South Africa interpret the treatment to be.

These loans are usually loans from shareholders.

A matter that also needs to be considered is the current non-current classification.

The liability should be current based on the fact that IAS 1.69(c) provides specific guidance on the classification of a liability as a ‘current liability’ when the entity does not have the unconditional right to defer settlement of the liability for at least twelve months after the reporting period. The asset, however, may be able to be classified as either current or non-current based on the fact that the lender ('loan provider') may base its decision on when the asset is expected to be realised. As the lender may 'theoretically' demand payment at any time it chooses (this must be determined on a case-by-case basis, possibly considering common law in the respective jurisdiction), it could make a reasonably judgement as to when it will make such a call. This will impact the valuation and classification/presentation as current/non-current.

I have another question, related to this issue. As an auditor, would you qualify your audit opinion (due to an assessment that the AFS is materially misstated, does not comply with IFRS or does not fairly present) on the IFRS AFS in the following situations (with reasons please):

- A company fails to classify a loan payable (no contractual terms of repayment) as current, i.e. it is presented at nominal value as a non-current liability. The nominal amount is material, but the fair value is undetermined.

- A company fails to classify a loan receivable (no contractual terms of repayment) as current, i.e. it is presented at nominal value as a non-current asset. The nominal amount is material, but the fair value is undetermined.

I realise the extent to which it may impact the liquidity ratio would be a consideration. So, let's assume it would not seriously impact such a ration due to high stock, debtors or the like.

Oh, this is my first post :)

Allan

These are highly theoretical questions.

Most commercial loans have some stated, contractual repayment terms. 

As to qualifying my options, I have no idea.  There is simply not enough information given.

For all I know, instead of a loan, it could be a capital contribution, gift, grant, bribe or fraud attempt.

The only thing I can say for certain is that, as an auditor, a transaction like this would be a red flag requiring detailed examination of the both relationship between the parties and their motivation for entering into the agreement.

Without more detailed and accurate information, I would could not form an opinion one way or the other.

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