Inter-company Loans – FAQ | IFRS

Inter-company loans

Inter-company loans (in the separate or individual financial statements)

See also Loans at below market interest rates and Loans to an employee for further discussions on related party loans.

The accounting for the below-market element of an inter-company loan in the separate or individual financial statements of the entities is not addressed by a specific Standard. As a result, the accounting for such transactions is conducted by applying the principles set out in the Conceptual Framework, in particular its definitions of assets, liabilities and equity. The effect of this in accounting for the below-market element relating to the following types of inter-company loans is discussed below in more detail:

  • fixed term loan from a parent to a subsidiaryInter-company loans
  • loans between fellow subsidiaries
  • loans from subsidiaries to parent
  • loans to related parties that are not repayable.

Fixed term loan from a parent to a subsidiary

Where a loan is made by a parent to a subsidiary and is not on normal commercial terms, the difference between the loan amount and its fair value should be recorded as:

  • an investment in the parent’s separate financial statements (as a component of the overall investment in the subsidiary)
  • a component of equity in the subsidiary’s individual financial statements (this is sometimes referred to as a capital contribution).

This is consistent with the principles set out in the Conceptual Framework which defines income as “increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants”. The definition of expenses similarly excludes distributions to equity participants. If a loan is made by a parent to a subsidiary on favourable terms, the substance of the transaction is that the subsidiary has received a contribution from the parent to the extent that the cash advanced exceeds the fair value of the subsidiary’s financial liability. Under the Framework this contribution is not income. This thinking also underpins the way to account for the below-market element of other inter-company loans.

Loans between fellow subsidiaries

Where a loan is made between fellow subsidiaries, additional analysis may be needed.

As in the other situations described above, the entities involved should assess whether the facts and circumstances indicate that part of the transaction price is for something other than the financial instrument. If it is, then the fair value of the financial instrument should be measured. Any difference between the fair value and the amount actually lent will often be recognised in profit or loss in accordance with IFRS 9’s general guidance in this area (IFRS 9 contains specific guidance on when such ‘day 1’ gains or losses should be recognised in profit or loss).

In some circumstances however it will be clear that the transfer of value from one subsidiary to the other has been made under instruction from the parent company. In these cases, an acceptable alternative treatment is to record any difference as a credit to equity (capital contribution) and for any loss to be recorded as a distribution (debit to equity).

Loans from subsidiary to parent

Where a loan is made by a subsidiary to its parent on terms that are favourable to the borrower, any initial difference between loan amount and fair value should usually be recorded:

  • as a distribution in the subsidiary’s individual financial statements and
  • as income in the parent’s separate financial statements.

Distributions received from a subsidiary will usually be recognised in profit or loss in the parent’s separate financial statements (an exception would be where the distribution clearly represents a repayment of part of the cost of the investment). Depending on the circumstances, the parent entity may also need to consider whether the distribution is an indicator of impairment in the investment in the subsidiary (interests in subsidiaries are generally outside the scope of IFRS 9 and therefore subject to the requirements of IAS 36 ‘Impairment of Assets’).

If the loan contains a demand feature, it should, as in other scenarios, be recorded at the full loan amount by the parent (the borrower).

Loans to related parties that are not repayable

Sometimes in a group situation, a parent may make an advance to a subsidiary (the advance may or may not be termed a ‘loan’) whereby the contractual terms state that the amount:

  • is not repayable or
  • is repayable at the discretion of the subsidiary in all circumstances (other than on liquidation).

In our view, this advance should be recorded as equity by the subsidiary (no discounting or amortisation is necessary) and as part of the net investment in the subsidiary by the parent (sometimes referred to as a ‘capital contribution’) for the same reasons as outlined in the section on ‘fixed term loans from a parent to a subsidiary’ above.

Related party disclosures

Inter-company loans meet IAS 24’s definition of related party transactions and the disclosures required by IAS 24 must therefore be given in sufficient detail to enable the effect of the loans on the financial statements to be understood. Where there are significant uncertainties, such as the expected terms of a loan, the disclosures should refer to this.

Example – Loan to a subsidiary at below-market interest rate

Parent company (P) makes a three year interest-free loan of CU100 to its subsidiary (S) on 31 December 20X0. The borrowing rate available to S in the market is 8%. The approach to be taken in accounting for the loan and the entries to be recorded in P’s and S’s separate financial statements are as follows:

Step 1: Assess whether the loan is on normal commercial terms

The loan is not on normal commercial terms as it pays no interest in contrast to a loan on market terms which would pay 8%.

Step 2: Split the loan into the below-market element and the loan element

The fair value of the financial element can be computed by discounting the future cash flows of CU100 at the market rate of 8% over three years, giving a figure of CU79. The difference between this amount and the CU100 transaction price of the loan is CU21 which represents the non-financial element of the loan.

Step 3: Account for the below-market element

The substance of the below-market element is a capital contribution by the parent to the subsidiary, leading to the following entries being recorded by the parent and the subsidiary on 31 December 20X0 in their separate or individual financial statements:

Amounts in CU

Parent

Subsidiary

Debit

Credit

Debit

Credit

Investment in subsidiary

21

Cash

21

21

Equity (capital contribution)

21

No further entries will be required in future periods in respect of this element of the loan.

Step 4: Account for the residual loan element

The remaining part of the loan, representing the fair value of the financial element of the loan on initial recognition is recorded as follows:

Amounts in CU

Parent

Subsidiary

Debit

Credit

Debit

Credit

Loan to subsidiary

79

Cash

79

79

Loan payable to parent

79

Subsequent accounting:

Assume for the purposes of the example, that the loan qualifies for amortised cost accounting. In subsequent periods it will be necessary to unwind the discount (the figure of CU21 in the example) using the 8% effective interest rate (the rate that exactly discounts estimated future cash payments through the life of the financial asset to its gross carrying amount). This results in cumulative interest income/expense of CU21 (CU6.5, CU7.0 and CU7.5 in years 1 to 3 respectively):

Year 1

Amounts in CU

Parent

Subsidiary

Debit

Credit

Debit

Credit

Loan to subsidiary

6.5

Interest income

6.5

Interest expense

6.5

Loan payable to parent

6.5

Year 2

Amounts in CU

Parent

Subsidiary

Debit

Credit

Debit

Credit

Loan to subsidiary

7.0

Interest income

7.0

Interest expense

7.0

Loan payable to parent

7.0

Year 3

Amounts in CU

Parent

Subsidiary

Debit

Credit

Debit

Credit

Loan to subsidiary

7.5

Interest income

7.5

Interest expense

7.5

Loan payable to parent

7.5

Having first done this, it will then be necessary for the parent company to recognise expected credit losses (IFRS 9 is clear that the effective interest rate is applied to the gross carrying amount of a financial asset – the amortised cost of a financial asset, before adjusting for any loss allowance).

Assume for the purpose of the example that the financial element of the loan receivable does not deteriorate significantly in credit quality subsequent to its initial recognition and that 12-month expected credit losses are recognised as opposed to lifetime expected credit losses. LIINNKKS

The lifetime expected credit losses are estimated to be CU3 at the end of year 1. This is revised to CU1.5 at the end of year 2, with the loan finally being repaid in full at the end of year 3.

20X1 – recognition of expected credit losses

Amounts in CU

Parent

Debit

Credit

Impairment loss in profit or loss

3

Receivable from subsidiary

3

20X2 – change in expected credit losses

Amounts in CU

Parent

Debit

Credit

Impairment loss in profit or loss IFRS 9 Inter-company loans and receivables

1.5

Receivable from subsidiary

1.5

20X3 – change in expected credit losses

Amounts in CU

Parent

Debit

Credit

Impairment loss in profit or loss

1.5

Receivable from subsidiary

1.5

20X3 – repayment of loan

Amounts in CU

Parent

Subsidiary

Debit

Credit

Debit

Credit

Cash

100

Loan to subsidiary IFRS 9 Inter-company loans and receivables

100

Cash IFRS 9 Inter-company loans and receivables

100

Loan payable to parent IFRS 9 Inter-company loans and receivables

100

Related party disclosures IFRS 9 Inter-company loans and receivables

Parent company: IFRS 9 Inter-company loans and receivables

In 20×0 parent company has granted a three year interest-free loan of CU100 to its subsidiary. The market rate at that moment was established at 8% p.a. The fair value of the loan is determined to be CU79 (CU100 discounted over three years at 8%). So the below-market element is CU21 and the residual loan element 79. The below-market element is recorded as an equity contribution (investment) in the subsidiary over the three year period.

Subsidiary: IFRS 9 Inter-company loans and receivables

In 20×0 subsidiary has received a three year interest-free loan of CU100 from its parent company. The market rate at that moment was established at 8% p.a. The fair value of the loan is determined to be CU79 (CU100 discounted over three years at 8%). So the below-market element is CU21 and the residual loan element 79. The below-market element is recorded as an equity contribution by subsidiary in equity over the three year period.

IFRS 9 Inter-company loans and receivables

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