Let’s say Company A lends €100,000 to Company B repayable in full upon maturity, in 3 years time, at 0%, when the market interest rate is 8%.

Situation 1: Assume this is done ex-gratia by Company A, that is Company A attaches no conditions with this interest-free loan.

Situation 2: Assume Company A provides this interest-free loan in return of free-of-charge marketing services supplied by Company B over the same three-year period.

The loan must be recorded at fair value by discounting it to its present value at the market rate at the loan’s inception at 8%. This means that the loan must be initially recognised at the value of €79,383 under both IFRS and GAPSME.

Situation 1

Company A will be receiving no interest in return, which means that it should recognise a loss of €20,617 immediately in the first year, representing the loss that the company is suffering from lending the money at 0% rather than investing it in a worthwhile investment.

On initial recognition, the double entry is as follows:

DEBITLoan Receivable€79,383
DEBITInterest Expense     €20,617
CREDITCash  €100,000

Subsequently, the loan is carried at amortised cost by unwinding the discount over three years:

BAL B/DEIR @ 8%Cash FlowBAL C/D
79,3836,35185,734
85,7346,85992,592
92,5927,407100,00

Year 1

DEBITLoan Receivable€6,351 
CREDITInterest Income €6,351
Being unwinding of discount – year 1 (EUR79,383 x 8%)

Year 2

DEBITLoan Receivable€6,859 
CREDITInterest Income €6,859
Being unwinding of discount – year 2 (EUR85,734 x 8%)

Year 3

DEBITLoan Receivable€7,407 
CREDITInterest Income €7,407
Being unwinding of discount – year 3.
DEBITCash€100,000 
CREDITLoan Receivable €100,000
Being repayment of loan upon maturity.

Situation 2

Company A is granting an interest-free loan and in return will be receiving marketing services over three years. This time the €20,617 is charged to profit or loss over three years, instead of charging it immediately to profit or loss. The charges over profit or loss over the three year represent the value of the marketing services provided by Company B and should be classified as such.

On initial recognition, the double entry is as follows:

DEBITLoan Receivable€79,383  
DEBITDeferred Expense (Prepayment)€20,617  
CREDITCash €100,000 

Subsequently, marketing expenses are recognised:

Year 1

DEBITLoan Receivable€6,351 
CREDITInterest Income €6,351
Being unwinding of discount – year 1.
DEBITMarketing Expense€6,351 
CREDITDeferred Expense €6,351
Being marketing expense – year 1.

Year 2

DEBITLoan Receivable€6,859 
CREDITInterest Income €6,859
Being unwinding of discount – year 2.
DEBITMarketing Expense€6,859 
CREDITDeferred Expense €6,859
Being marketing expense – year 2.

Year 3

DEBITLoan Receivable€7,407 
CREDITInterest Income €7,407
Being unwinding of discount – year 3.
DEBITMarketing Expense€7,407 
CREDITDeferred Expense €7,407
Being marketing expense – year 3.
DEBITCash€100,000 
CREDITLoan Receivable €100,000
Being repayment of loan upon maturity.

The accounting treatment of long term loans may vary in accordance with the nature of the arrangement. In this article we have seen how the effect of the discounting can either be treated as charge to profit or loss in the first year or recognised as an asset (prepayment) which would then be released to profit or loss over a period of time. Nonetheless, the effect of the discounting may also be recognised as an investment, a contribution in equity, a dividend, or perhaps directors’ fees or even employee expense.

Are you uncertain about the correct way to account for your loan agreements?

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