When is a loan from a director a financial instrument?
FRS 102 deals with accounting for financial instruments in section 11 ‘basic financial instruments’ and section 12 ‘other financial instruments’.
Loans payable by the entity or receivable by the entity with a fixed interest rate or with no interest would normally be treated as basic financial instruments and come within section 11 of FRS 102.
FRS 102 explains how these loans should be accounted for both in terms of the initial recognition and how they should be treated in subsequent reporting dates.
Paragraph 11.13 deals with the initial measurement. This splits the treatment into the following three categories:
Paragraphs 11.14 to 11.32 deal with the subsequent measurement. These paragraphs have the following treatments for loans (or debt instruments):
For a long-term loan at a market rate of interest made to another entity, a receivable is recognised at the amount of the cash advanced to that entity plus transaction costs incurred by the entity.
Some loans will initially be measured at 'the transaction price' and some will be measured at the 'present value of the future payments discounted at a market rate of interest'.
At subsequent reporting dates, some loans will be measured at the 'undiscounted amount of cash or other consideration expected to be paid or received', whereas others will be measured at the 'present value of the future payments discounted at a market rate of interest'.
When loans are measured at 'the transaction price' or the 'undiscounted amount of cash or other consideration expected to be paid or received' then there is no difference between the cash value and the recorded measurement of the loan.
However, a difference may arise if the amount paid or received or carrying value of the loan is different to the 'present value of the future payments discounted at a market rate of interest'.
Clearly where ‘terms’ exist the transactions will follow the requirements. Where terms do not exist written or verbal, for example a loan from a director with no terms that has been outstanding for a considerable time judgement will be required on the appropriate treatment following discussion with the director.
Here are seven further worked examples that consider these issues.
You can view relevant extracts from FRS 102.
The tax treatment of these loans is dealt with in HMRC guidance in CFM33176 while an article in Taxation also explains the tax treatment of these loans.