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Terms of endearment

FRS 102 can still throw up fresh audit issues. Audit & Beyond considers some of the practical problems for auditors around loans to an entity from a director, shareholder or parent.

The introduction of FRS 102, the financial reporting standard applicable in the UK and Republic of Ireland, is creating some problems for auditors around loans to an entity from a director or shareholder or parent company (which this article will subsequently refer to as intercompany loans). Often, these are at 0% or below market terms, or terms are absent (unlike arms-length, third-party loans), and the accounting for this under FRS 102 can create issues for auditors.

ICAEW’s Technical Enquiry Service has created help sheets to explain differences in accounting treatments for intercompany loans under FRS 102. This article uses a worked example from FRS 102: Intercompany loans at non-market rates to highlight audit issues that may arise if: on 1 January, a company lends its subsidiary £5m at zero rate of interest. The loan is repayable on 31 December four years later. The market rate of interest for a similar debt instrument is 3%.

Under pre-FRS 102 UK GAAP, the accounting treatment for this could result in no interest being recognised. With FRS 102, a debt instrument at below market terms is initially recognised at the present value of the discounted cash flows: the £5m is discounted at 3% over the four-year term for the loan (the help sheet does the maths), which results in just over £4.4m for the initially recognised debtor (the lender) and the initially recognised creditor (the borrower). Then this is remeasured using the amortised cost method (the help sheet has workings for this and other intercompany loan scenarios).

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