Recently, I was invited by a Big 4 firm in the Cayman Islands to develop and facilitate a seminar for their clients on IFRS 9 Financial Instruments. One of the issues they wanted me to speak about was the accounting for intercompany loans under IFRS 9. Easy enough, I thought, and agreed to include it my presentation.
Well, was I in for a treat! When researching this issue, I discovered that IFRS does not contain any specific guidance that is “on point” related to transactions with shareholders. Great! Furthermore, many intergroup loans:
- Do not have a written agreement;
- Have no (or a below market) interest rate; and/or
- Do not have a fixed repayment date.
As a result, many clients that enter into intercompany loans consider them due on demand, classifying them as debt. The question they wanted me to cover was whether such loans meet the tests within IFRS 9 to be accounted for at amortized cost.
Little did I know the accounting issues that I would uncover! This blog serves to document my research on the topic.
For purposes of this blog, let’s assume a Parent “lends” USD 1 million to its Subsidiary. Furthermore, let’s assume the “loan” does not have a written agreement, charge interest, or have a fixed repayment date.
Issue #1: Is the loan within the scope of IFRS 9?
The first “issue” is I noted was determining whether the intercompany loan is within the scope of IFRS 9 or not. As previously mentioned, there is no specific guidance related to transactions with shareholders. As a result, most accounting firms note entities should refer to the IASB Conceptual Framework and the substance of the transaction.
- If the intention of the Parent was to lend money and there exists a possibility the loan will be repaid, then the Subsidiary should record a liability and the Parent would record a loan receivable within the scope of IFRS 9.
- However, if the Subsidiary is not required to repay the amount under any circumstance and repayment is entirely at their discretion, or the intention of the Parent was to provide a capital contribution, then the substance of the transaction is a capital contribution. In this case, the Subsidiary would record the amount received within equity and the Parent would increase its investment in the Subsidiary. As a result, this capital contribution would be outside the scope of IFRS 9.
To make the determination as to whether it is a loan or a capital contribution, entities (and their auditors) should look at things such as past practice, payment history, and/or documented terms. For example, if the “loan” (or similar “loans”) have been outstanding for some time and repayment has not yet been received, the financing by the Parent would be more akin to a capital contribution rather than a loan within the scope of IFRS 9.
Issue #2: If within the scope of IFRS 9, how should the loan be classified and subsequently measured?
Under IFRS 9, a financial asset is classified and subsequently measured at amortized cost if it meets both the:
- Business model test; and
- “SPPI” contractual cash flow characteristics test.
Trade receivables and loan receivables with “basic” features are examples of financial instruments likely to be accounted for at amortized cost under IFRS 9.
Assuming the loan is within the scope of IFRS 9 and is repayable on demand of the Parent, the loan would appear to meet these tests and subsequent measurement at amortized cost would be appropriate. However, it would appear that the “repayable on demand” assumption would be something that should be documented between the parties!
Issue #3: How should this loan initially be measured under IFRS 9?
Under IFRS 9, there is an exception to initially recognize trade receivables without a significant financing component at transaction price instead of fair value. However, we have a loan and not a trade receivable. Therefore, it doesn’t qualify for this scope exception and must be initially measured at fair value.
Remember our loan did not charge interest. As a result, the loan receivable needs to be discounted using a market rate of interest to determine its fair value. Any difference between the loan’s fair value and the case disbursement (i.e. the “day 1 difference”) would most likely be added to the investment in the Subsidiary. The rationale for this treatment is that the Parent would never have made this “off-market” loan had it not had the relationship with the Subsidiary. Note, as this loan is repayable on demand, and assuming repayment was expected rather quickly, this “day 1 difference” is likely to be immaterial.
Issue #4: What about the other requirements of IFRS 9?
Here’s where it gets interesting! Since the loan is within the scope of IFRS, all the requirement of IFRS 9, including the new impairment guidance would need to be applied! Furthermore, intercompany loans don’t qualify for the simplified approaches to impairment available under IFRS 9. As such, the full impairment model will apply.
Under the full impairment model, the Parent would be required, on initial measurement, to determine the 12-month expected losses. Note this impairment loss should be added to the cost of the Subsidiary as the “day 1 difference” discussed above, but booked to profit and loss immediately. Subsequently, if the credit risk of the loan decreases significantly, additional impairment provisions would need to be considered. This becomes a challenge for intercompany loans because the Parent would need to determine how long the loan will remain outstanding (i.e. when will the loan be repaid) to determine the lifetime expected credit losses.
Hasn’t this been fun? Let’s switch it up a bit and give you a bonus issue!
Bonus Issue: Would the accounting discussed be the same if the loan were between two subsidiaries?
Generally, loans between fellow subsidiaries fall within the scope of IFRS 9. Such loans would likely meet the tests within IFRS 9 for subsequent measurement at amortized cost. In addition, the loan would initially be recorded at fair value. However, the difference between the loan’s fair value and the cash disbursed, the “day 1 difference,” would need to be immediately recorded in profit and loss as a “day 1 loss.” Finally, the full impairment model of IFRS 9 would apply, with any credit losses also recorded in profit of loss.
We hope this blog helps you navigate the issues surrounding intercompany loans under IFRS 9. As always, feel free to contact us if you have any questions.
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