Loans To An Employee – FAQ | IFRS

Loans to an employee

See also Loans at below-market interest rates and Inter-company loans for further discussions on related-party loans.

In contrast to the accounting for the below-market element of inter-company loans, the treatment of the below-market element of a loan to an employee is addressed by specific Standards. The effect of a below-market element in loans to an employee is starting with a general discussion on loans to employees, followed by a discussion for the following specific types of loans to employees:

  • loans to an employee linked to the entity’s shares
  • forgivable loans.

General discussion: Loans to employees

Where an entity makes a loan to an employee that is not on normal commercial terms, our view is that the initial difference between the transaction price of the loan and its fair value represents an employee benefit.

IAS 19 should, therefore, be applied to the initial difference or non-financial element of the loan. In applying IAS 19, our view is:

  • if the benefit (ie the favourable terms of the loan) is not dependent on future service by the employee, it should be recorded as an employee benefit expense when the loan is advanced
  • if benefit is linked to future employee service, the initial difference should be recognised as an expense over the service period. The amount recorded as an expense can be estimated as the difference between:
    • the interest income for the period based on the fair value of the loan asset and the amortised cost using the effective interest method
    • the interest actually charged to the employee.

Examples of situations in which the benefit is linked to future employee service include loans that:

  • are repayable if the employee leaves within a certain period or
  • revert to a market interest rate if the employee leaves within a certain period.

In these examples, although the employee receives the loan proceeds up front, the interest benefit is available only while the employee provides service to the entity. Accordingly IAS 19 requires an expense to be recognised when the employee provides services.

The allocation of the employee benefit expense under IAS 19 depends (amongst other things) on whether the benefit is considered long-term or short-term.

In our view, most low-interest loan arrangements involve the payment of benefits in each period in which service is rendered and are therefore short-term. Other subsidised goods and services are also typically considered to be short-term benefits. However, some arrangements might have conditions or features that make them long-term in nature.

Under short-term benefit accounting, the entity should recognise the undiscounted expense payable in exchange for employee services in each period. As discussed above, the cost to the entity in each period can be estimated as the difference between:Breach of Contract Breach of Contract Breach of Contract

  • the interest income for the period based on the fair value of the loan asset and IFRS 9’s amortised cost using the effective interest rate method
  • the interest payable by the employee.

Other methods of allocation might also be acceptable.

Loans to an employee linked to the entity’s shares

Loans linked to the entity’s shares in some way need careful analysis. This type of arrangement may (wholly or partly) be within the scope of IFRS 2. For example, a loan made to an employee to purchase shares of the entity, and which is secured only over those shares, may in substance represent the grant of a share option. A number of issues can arise in such situations, which are beyond the scope of this publication.

Forgivable loans

An employee loan might be forgivable (for example after a certain period of service or if performance targets are achieved). The terms and conditions of this type of arrangement should be evaluated to determine if it gives rise to any financial asset. The substance of such an arrangement might be that it is a prepaid employee benefit in its entirety. A loan that is forgiven after a certain period of service exceeding 12 months would be a long-term employee benefit.

Accounting for the residual loan element

Having separated the ‘below-market’ element of the transaction, the remaining part of the loan receivable is accounted for as a financial instrument under IFRS 9. Accordingly, the entity that has granted the loan will need to consider that Standard’s requirements on:

  • classification and measurement (in particular the impact of any complex loan terms on the ‘solely payments of principal and interest’ classification test)
  • impairment, including the recognition of expected credit losses.

Where there is a change to the terms of a loan to a related party at a below-market rate of interest, IFRS 9’s requirements on derecognition, including the guidance on modifications will also need to be considered.

Related party disclosures

Loans to employees 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 employee at below-market level of interest

An entity makes a 5 year, interest-free loan of CU10,000 to an employee. The loan remains available whether or not the employee remains in service. However, the employee is expected to remain in service. The market rate for a similar loan is 10%.

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

The loan is at a favourable rate of interest for the employee and is therefore not on normal commercial terms.

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

The fair value of the loan is estimated based on the future cash flow (CU10,000 in five years’ time) and the market interest rate (10%). This amount of CU6,209 represents the financial element of the loan. The balance of CU3,791 represents the below-market element of the loan.

Step 3: Account for the below-market element of the loan

As the loan continues to be available if the employee leaves within the 5 year loan term, there is no clear link between the interest benefit and any future service. The interest benefit of CU3,791 is therefore recognised as an expense over the five years the employee provides services to the employer. The journal entries over the five years are as follows:

Year 1

Amounts in CU

Debit

Credit

Cash

B/S

10,000

Loans and receivables

B/S

6,209

Employee benefit expense

PNL

758

Prepaid expenses

B/S

3,033

Loans and receivables

B/S

758

Interest income

PNL

758

Year 2

Amounts in CU

Debit

Credit

Employee benefit expense

PNL

758

Prepaid expenses

B/S

758

Loans and receivables

B/S

758

Interest income

PNL

758

Year 3

Amounts in CU

Debit

Credit

Employee benefit expense

PNL

758

Prepaid expenses

B/S

758

Loans and receivables

B/S

758

Interest income

PNL

758

Year 4

Amounts in CU

Debit

Credit

Employee benefit expense

PNL

758

Prepaid expenses

B/S

758

Loans and receivables The treatment of the below-market element of a loan to an em

B/S

758

Interest income The treatment of the below-market element of a loan to an em

PNL

758

Year 5

Amounts in CU

Debit

Credit

Employee benefit expense

PNL

759

Prepaid expenses The treatment of the below-market element of a loan to an em

B/S

759

Loans and receivables The treatment of the below-market element of a loan to an em

B/S

759

Interest income The treatment of the below-market element of a loan to an em

PNL

759

Cash The treatment of the below-market element of a loan to an em

B/S

10,000

Loans and receivables The treatment of the below-market element of a loan to an em

B/S

10,000

Related party disclosures

The company has granted a five year interest-free loan of CU10,000 to an employee. The market rate at that moment was established at 10% p.a. The fair value of the loan is determined to be CU6,209 (CU10,000 discounted over five years at 10%). So the below-market element is CU3,791 and the residual loan element 6,209. The below-market element is charged to profit or loss as employee benefits over the period of service of the employee because it is expected that the employee will stay in service in this period and recognised as interest income over the same period.

The treatment of the below-market element of a loan to an em

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