Intra-group loans under FRS 102
The issue of intra-group loans often raises its head when looking at the accounting treatment for financing transactions under FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. One of the most common questions asked is whether such loans are to be treated as current or non-current in the borrowing or lending company’s balance sheet. This article looks at the accounting aspects of intra-group loans in the individual financial statements of group members.
On consolidation, an intra-group loan becomes irrelevant as it will be eliminated in the group accounts (along with other intra-group transactions and balances) so that the group accounts reflect the economic substance of the group, which is that of a single reporting entity.
Intra-group loan with no formal loan terms
In many groups, intra-group loans are entered into for convenience. One group member may need access to finance, and another group member has that finance available, so a transfer is made from the lending group member’s bank account to the borrowing member’s bank account.
These types of loans will often not be covered by formal loan terms. Where the loan is not covered by formal loan terms, FRS 102 would regard the loan as being repayable on demand and hence the loan is shown as a current asset in the lending group member’s balance sheet and as a current liability in the borrowing group member’s balance sheet. The loan will generally not need to be discounted using an imputed market rate of interest because it will be repayable on demand.
Intra-group loan with formal loan terms
In some cases an intra-group loan may be subject to formal loan terms, even though the loan may be interest-free or has been provided to the borrower at a rate of interest which is below market rate. Where the loan is subject to loan terms and is below a market rate of interest, FRS 102 treats the loan as a ‘financing transaction’. The term ‘financing transaction’ is not a defined term in the glossary to FRS 102, but paragraph 11.13A states:
| An arrangement constitutes a financing transaction if payment is deferred beyond normal business terms or is financed at a rate of interest that is not a market rate, for example, providing interest-free credit to a buyer for the sale of goods or an interest-free or below market interest rate loan made to an employee. |
In a group context, the group must measure the financial asset and financial liability at present value using a rate of interest for a similar debt instrument; for example, a rate of interest which the bank would charge on an equivalent loan to the group member. The difference between the present value of the loan and the transaction price is known as a ‘measurement difference’.
When a measurement difference arises, it is recorded in the financial statements as follows:
| Relationship |
Measurement difference in the lender’s books (Dr) |
Measurement difference in the borrower’s books (Cr) |
| Parent lends to subsidiary |
Cost of investment |
Capital contribution (within equity) |
| Subsidiary lends to parent |
Distribution |
Income from subsidiary |
| Subsidiary lends to subsidiary (under the parent’s orders) |
Distribution |
Capital contribution |
| Subsidiary lends to subsidiary (not under the parent’s orders) |
Finance cost |
Finance income |
| Company to a director who is a shareholder |
Distribution |
N/A |
| Director who is a shareholder to the company |
N/A |
Capital contribution |
| Company to employee or to a director that is not a shareholder |
Payroll expense |
N/A |
| Example – Computing a measurement difference for a below market rate loan
On 1 January 2022, Topco lends £350,000 to its subsidiary with repayment taking place in two years’ time. The loan is covered by formal loan terms. The interest on the loan is 5% but if the company were to obtain a similar loan from its bank, it would be charged 10% interest. As the loan is below market rate, it constitutes a financing transaction. The equivalent interest rate is 10% and the present value of the loan is calculated as follows:
The measurement difference is the difference between the value of the loan (£350,000) and the present value (£319,629) which is £30,371. This measurement difference must be recorded in the individual financial statements of both the borrowing group member and the lending group member. The measurement difference represents the value of the benefit which the borrowing group member is receiving because the parent is providing it with a loan at a below market rate of interest. It also reflects the substance of the arrangement which is that the parent is providing the company with implicit financing as well as the underlying loan through the reduced rate of interest. The entries to record this transaction in the financial statements is as follows: Borrowing group member
Lending group member
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In the above example, the debit in the parent’s books is taken to cost of investment to reflect the fact that the parent has contributed to its subsidiary by agreeing to provide finance at a below market rate of interest. Conversely, the subsidiary has received a ‘transfer of value’ from its parent in the form of a loan at a below market rate so, in substance, has received a capital contribution.
Conclusion
In a lot of cases, intra-group loans will not be covered by formal loan terms and hence will simply be treated as current in the individual financial statements of both the lending group member and the borrowing group member. Where formal loan terms are entered into with an intra-group loan, the first thing to establish is whether the loan is being provided under normal market rates. If it is not, a market rate of interest will have to be established and then the loan discounted using this rate with the associated measurement difference being recorded in the financial statements.
The Financial Reporting Council have published a useful Staff Factsheet which illustrates the accounting treatment for these types of loans (among others) which helps to articulate some of the provisions in FRS 102, Section 11 Basic Financial Instruments.
Category: Accounting and standards, Audit
