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FRS102 and non market rate loans

The need to discount non market rate loans for FRS102 is, undoubtedly a nuisance and arguably of little relevance to SME reporting.

Two thoughts and questions for the assembled wisdom of Aweb.

First, for a typical SME what is the market rate of interest? Do you take a view that it's bank rates plus something for risk premium, or of the other way and take a view that most participator lending is interest free - the reward is via dividend, capital growth, etc, and thus the market rate is 0% (ignore for a moment the tax implication that interest may be more efficient than dividend anyway in 16/17)

Secondly, is an incredit directors current account, say with some declared but indrawn dividend in it, maybe with some funds out in when the company was short, actually lending? Or is it just that, a current account?

I'm obviously looking at ways of not having to discount across a client portfolio of largely incorporated SMEs.

I would welcome thoughts.


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I think you are missing the most significant point, which is that the accounting method you describe does not apply to loans that are repayable on demand, which I imagine will be over 99% of DLA credit balances in owner managed companies.

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As John says, if the terms are repayable on demand, then FRS102 issues won't apply.

I've currently got a medium sized client (not far off large) in a massive bind. They've formalised very large unsecured loans from participators with very low interest rates and a set repayment date.

They are resisting any changes under FRS102 (actually generally... despite also having goodwill over 20 years they are unprepared to justify but that's another story) so it's been passed to the audit partner to consider what to do. Don't know the answer yet.....

As to what rate.... don't know. Looking on the internet, unsecured commercial loan rates seem to vary from anything between 10% and WONGA rates.

It's not all bad news however - the improvement on the balance sheet could be substantial even if the P&L reports a notional interest charge.

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A simple answer...
Indeed John, a significant point, and one we hadn't picked up.

Indebted to you for clarifying.

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Intra-group loans

The area that is concerning me here is around intra-group loans and the interaction between these rules and the legal definition of distributable reserves. We have a group in which the holding company does not trade, merely receives and pays dividends, but its cost of investments is funded by loans from the subsidiaries. These loans are documented to be interest-free and repayable at various times in the future. Each year the subsidiaries pay up their profits by dividends to the holding company, leaving little behind.

So now, on initial recognition, the interest element of these loans will be considered a distribution by the subsidiary and dividend received by the holding company. But the subsidiary might well not have sufficient distributable reserves to support the distribution - so how does that affect the legality of it? And is it distributable in the hands of the holding company? My guess is that it is only a "pseudo-distribution" and somehow does not affect either the subsidiary's level of distributable profits or the amount of dividend that the holding company can legally pay. But that's just my guess.

And is the holding company now trading by virtue of this phantom interest?

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I am sure Terry's point is well made, and I won't venture an answer except to say that if Terry's client can be persuaded to leave the loan repayment dates undocumented (which between a parent and its wholly owned subsidiary is in any event pointless) the whole problem disappears and the question he asks becomes purely academic. 

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Absolutely agree!

I absolutely agree John. And I'm sure that is exactly what will happen - I have the shredder already primed and ready. But the point was a general one that could apply in other situations too. I certainly wouldn't want that client, or anybody else, thinking that they could generate extra distributable profits by using such a mechanism. The FRC seem to be ducking the issue - "seek counsel's opinion" is their advice.

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