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). Still on basic financial instruments - today, financing transactions explored...
DAY 27 (24 Feb)
Yesterday, I noted that where a non-market rate of interest is charged in a financing transaction, there would be a difference between the transaction price (used for non-financing transactions) and the present value of cash flows.
It's worth pointing out that a 'non-market rate' is sometimes a market rate in cunning disguise. For example, a firm (let's call it 'SFD') sells sofas to the public at two years interest-free credit. However is it interest-free? What cash price could be haggled with the retailer? In many cases, the discounted deal one could get would approximate to the sticker price, discounted by two years at the market rate of interest! In fact this forms one of the examples in 11.13 - such sales should be recorded at the cash price, and if this is not known, then the present value of cash payments (discounted at market rate) is held to be a good estimate.
However, on occasion the transaction is genuinely not at market rate. For example, a long-term loan at zero interest of, say, £1m would (if recorded at a discounted present value) only equate to, say, £800K. The lender will record a debtor of £800K and a cash payment of £1m. What about the missing £200K?
The standard is silent on this issue. In some cases, the difference will be shown as a finance charge to the lender. Where the loan is made between group entities (especially by a parent to its subsidiary) it can be argued that the difference represents an investment in the accounts of the parent and a capital contribution in the accounts of the subsidiary. The FRC's Staff Education Note 2 on this subject is equally equivocal, and advises that entities 'should consider the particular facts of the underlying transactions in order to record it appropriately', without telling us what to do. Note that financing transactions will unwind as the present value is remeasured at each successive period end, the unwinding typically representing an interest credit to the lender.
If all that sounds like hard work, it's worth remembering that loans repayable on demand should be looked at from an arm's length perspective (ie would the lender require the debtor to settle immediately if circumstances dictated, were this an arm's length relationship?) and if so, the loan should be considered short-term (and thus not a financing transaction).
Tomorrow - on to amortised cost. Hurrah (I hear you cry)....
P.S. If you missed the last instalment please click here