Measuring a loan or investment when first recognised
Under IFRS 9 a loan or investment starts at fair value adjusted for transaction costs. How that works for fees and interest-free related party loans.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
The first figure recorded for a financial instrument tends to stay unexamined for years. A client draws down a bank loan, pays the arrangement fee from the same account, and the bookkeeper records the loan at the full amount borrowed and the fee as a bank charge. A shareholder lends the company money with no interest and no repayment date, and the loan account simply shows what was paid in. Both entries look sensible. Neither may be the amount IFRS 9 asks for.
Getting the opening figure right matters because everything after it, the interest recognised each year and the carrying amount at every year end, is built on it. This article covers when a client first recognises a financial asset or liability, what amount it uses, and what to do when the terms are not ordinary commercial ones.
Recognition when the client becomes party to the contract
IFRS 9 requires an entity to recognise a financial asset or financial liability when it becomes party to the contractual provisions of the instrument. That is the trigger: the contract, not the cash. A loan agreement signed in the last week of the year, with funds released in the first week of the next, raises the question of when the client actually became party to its provisions; the answer depends on the terms, so read them.
IFRS 9 has been effective for annual periods beginning on or after 1 January 2018 and specifies how financial assets and liabilities are classified and measured. Classification, which also happens at first recognition, is decided on the business model and the contractual cash flows and is covered in classifying a client's financial assets. Measurement is the companion question.
Fair value plus or minus transaction costs
Under IFRS 9, at initial recognition an entity measures a financial asset or financial liability at its fair value plus or minus, for an item not at fair value through profit or loss, transaction costs that are directly attributable to its acquisition or issue.
In practical terms:
- For a financial asset not at fair value through profit or loss, directly attributable costs are added. A legal fee paid to draw up a loan to a supplier forms part of the loan's opening carrying amount.
- For a financial liability not at fair value through profit or loss, directly attributable costs are deducted. The bank's arrangement fee reduces the opening carrying amount of the loan, and is then recognised over the loan's life through the interest charge rather than as a one-off bank charge.
- For an item at fair value through profit or loss, transaction costs are not added to or deducted from the carrying amount.
"Directly attributable" is the limit. A fee that would not have been paid without this instrument qualifies. The general cost of the finance director's time, or an annual account fee that would be charged anyway, does not.
In most arm's length transactions the fair value at initial recognition is simply the amount paid or received. A trade receivable from an ordinary sale and a bank loan at a market rate are both examples. The difficulty arises when the terms are not market terms.
Loans to and from related parties on unusual terms
Owner-managed groups are full of loans that no bank would offer: interest-free, with no fixed repayment date, sometimes with no written agreement at all. In those cases the amount lent may differ from the loan's fair value, and IFRS 9's requirement to measure at fair value means a difference has to be dealt with on day one.
How the difference is recorded depends on the substance of the arrangement, and the preparer must work out why the parties agreed those terms. A shareholder lending interest-free to their own company may in substance be contributing capital as well as lending. A parent lending cheaply to a subsidiary may be investing in it. Write down the reasoning, because a reviewer will ask, and the answer should be consistent from year to year and across the group.
These are related party transactions in any case. IAS 24 defines a related party transaction as a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged, so the lack of interest does not remove the loan from the related party note. Director and shareholder loans in particular are discussed in loans from directors and shareholders.
Recording the difference with an adjusting entry
A worked example in words. A company's two shareholders lend it the money for a new delivery truck, interest-free, repayable in one sum after several years under a signed agreement. The bookkeeper recorded the full amount as a loan. After reviewing the terms with the engagement partner, the preparer concludes that the loan's fair value is lower than the amount advanced and that the shareholders, in substance, also contributed capital. The adjusting entry reduces the loan to its fair value and records the difference in equity, and in later years interest is recognised as the loan's carrying amount moves back towards the amount repayable.
In Achekam, staff post such corrections as year-end adjusting entries in the Studio. If an entry later turns out to be wrong, it is reversed with a record of who did it and why, not deleted, so the file shows how the figure was reached. Keep the fair value calculation, the rate used and the reasoning about substance in the working papers next to the entry.
Policy and related party wording
The Studio's standard policy wording is based on IFRS for SMEs and is labelled for review before issue. Where the client reports under full IFRS, staff should write the financial instruments policy themselves, stating that financial assets and liabilities are recognised when the company becomes party to the contract, measured initially at fair value adjusted for directly attributable transaction costs where applicable, and then measured according to their classification.
The related party note should describe each loan's terms plainly, including that no interest is charged and no repayment date is set, alongside the balance. Notes take their figures from the mapped trial balance, and any term the trial balance cannot show stays marked "[to be completed]" until a person supplies it.
The IFRS Foundation's IFRS 9 page summarises how the standard requires financial assets and liabilities to be recognised, classified and measured. Before closing any file with a related party loan, go back to the loan's day-one figure and make sure it was measured, not just copied from the bank statement.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
