Welcome to Query Of The Week
Recently we were contacted by an accountant whose client had raised a question which fell under Section 11 FRS 102. The client wanted to enter into an agreement to receive money from a connected company and wanted it to be shown in creditors greater than one year. They enquired as to the wording of the agreement and the accounting implications of this.
Financial Instruments Under S.11 FRS 102
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| CPD Allocation | 1 Hour |
| Fee | €20 (or 1 CPD Club point) |
| Presenter | John Murphy – OmniPro |
| Category | Financial Reporting |
Query Of The Week – Video Transcript
(Please note that this is a direct unedited transcript of the spoken word as recorded on the video)
Hello and welcome to this week’s query of the week. This week’s Query of the Week is a query we got from an accountant. So, his client came to him saying, “Look I’m entering into an agreement with a … to receive money from a connected company. I want this to be shown in creditors greater than one year. It’s going to be interest free. What way should I word the agreement so that it’s included in creditors greater than one year but has minimum accounting implications in relation to it?
So I suppose, probably the best way to structure that agreement is effectively to word the loan agreement such that it is repayable on demand but you must give notice of 12 months and one day. So I suppose, what does that mean in relation to Section 11 of the first one or two. So section 11.14 of the first one or two says if there’s a financing transaction, then you need the present value of the loan at the macro rate of interest.
So, in this particular case, looking at that loan, if there is a loan going to be received it’s going to be a financing transaction because it’s going to be interest free and it’s not repayable on demand. So, therefore we need the present value at the macro rate of interest. But if we put in the loan agreement the way I’ve just spoken about, you know, on demand but, you know, you’ve got a notice of 12 months and one day.
What it effectively means is that there’s a financing period of 12 months and one day. So I suppose if we look at the transactions here, maybe just on the screen. So let’s say we’ll have Company A. This is the company that’s receiving the loan. And let’s say, Company B is the company that’s giving the loan. So we’re doing the accounting and the queries in relation to Company A in this particular transaction. So, Company A has received the loan. We say they’ve received a loan of 100,000. So, it’s interest free and we want that to be shown in creditors greater than 1 year. So, in this particular case what we’re saying, if we do the loan agreement that whereby it’s on demand for notes be every 12 months and one day.
What we have to do there, for section 11.14 we have to present value the 100k in one year’s time at a macro rate of interest. So let’s say the macro rate of interest is 5%. One year’s time to present value, for talk’s sake, is 90k in this particular example. So what this means for the accounting for Company A would be that when we received the money in, we’ll debit our bank 100k and credit our loan 100k. We don’t have to do our present value. So, we’re saying it’s a loan and these are connected companies from the shareholders’ own Company B as well. So, our loan to reflect the present value is … We’re going to credit capital contribution with 10k and we’re debiting our loan with 10k.
So now we have the loan liability at 90k on the balance sheet at this point in time. We can show that within creditors greater than one year because we have that one from one day notice period. So effectively, that 90k will stay on that balance sheet. You will not have to unwind any interest until the date on demand has been given. So, until Company B says, “I want this loan repaid.” You will keep that 90k. When Company B says, “I want my loan repaid now.”
You will then start unwinding the difference between the 90k and the 100k into the P&L. So ordinarily if we had a loan agreement which said you know, it’s repayable in a year and a day, what we’d have to do every year would be you’d have to recognize the 90k, just like we did, but each year we’d have to unwind the interest. So we’d have to debit the interest into the P&L and credit our loan liability because of the fact that, you know, we’re unwinding it up today we have to repay it.
So that’d have to be a yearly thing whereas with this type of loan agreement, what it effectively means is you do present value in once off time on inception and you don’t have to unwind interest charge until actually, Company B demands repayment loan. So you can see it is a shortcut in that you don’t have to go and unwind interest each time. There’s only one calculation at the start and then it remains there until Company B demands that loan. I hope you found this Query of the Week helpful.