To mark this momentous year for UK GAAP, I'm embarking on a mission to work my way through FRS 102, reading a portion on each working day of 2015 and writing a short blog entry on my thoughts and musings (be they few or many).
I've been dancing lightly around the fringes of s11 (not bad for a man of my waistband), but now it's time to get properly stuck in.
DAY 23 (10 Feb)
When is a debt instrument basic? As I outlined in my last post, this issue caused a revision to FRS 102. So let's look at the revised definition, starting with the return to the lender.
It stands to reason that a fixed-return (or a fixed-rate) loan is basic, and indeed it is. So is a loan with a 'positive variable rate'. But this latter term is precisely defined in the standard; it's a rate that varies over time and is linked to a single observable rate or inflation index such as the London Interbank Offered Rate or LIBOR (let's call this the 'target'). This link cannot be leveraged; ie the variable rate must track the target directly - it can't be set at twice the lender's standard variable rate, for instance.
What about compound loans? The revised definition is more precise than the original. The return can combine a fixed rate (either positive or negative) and positive variable rate. It cannot include a negative variable rate. The standard explains that LIBOR plus 200 basis points is fine since both the variable and fixed components are positive, and LIBOR less 50 points is also fine (since it is the fixed component, the 50 points, that is negative. What you can't do is combine a fixed rate (500 basis points) with a negative variable (..less LIBOR), because this would invert the relationship between the target (LIBOR) and the compound rate - one would decrease as the other increases, rather than a direct tracking relationship.
Tomorrow, we'll get onto other features of basic debt instruments.
P.S. If you missed yesterday's instalment click here