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But surely it is very rare indeed for loans between entities under common control, or between entities and their controllers to have fixed repayment dates. Whether any agreement as to fixed repayment dates in those circumstances should be taken any notice of is also a moot point.
So in practice having to deal with measurement differences in the way described above will surely be the exception rather than the rule. Am I missing something?
Not good
We have a lot of these as we have several "business angel "clients. I didn't realise we had to do this with companies under common control as well! Where does this end ? This just creates more work especially when we convert the client.
But see my point about the fact that in practice is will be a very rare thing indeed to have to do it where the lender and borrower are in effect the same person.
Sorry john
I don't think I was very clear.In our case it is not rare. We have a lot of clients that own different companies not in a group that may enter into loans with each other. a client might own 10 companies who all provide loans to each other over a 3 year period interest free. This gets caught under these new rules. I only thought it applied to groups but in our case a lot of ours are not groups but companies owned by one or more common parties.
Do you mean there are formal loan agreements specifying fixed repayment dates when both parties are controlled by the same person?
Yes
There has to be due to the way our client works. I've just had a chat with the tech advice line to see any ways around the issue but they basically say what this article says. I don't think we can rewrite history either and make the loans on demand which is what the technical advice line suggested as a workaround as the loan agreements are already in place. Looks like more work for us :-(
Well that's very unusual because such agreements are completely pointless when the debtor and creditor are, in effect, the same person.
So I think my general point is valid - that in practice these situations will be extremely rare, but you seem to have one of those extremely rare cases. I have never seen such a case in all my career.
Lawyers
I see your point John but it seems this is more to do with the legalities of the arrangements. The lawyers view the companies involved and the controlling party to be distinct in law so where say 2 companies enter into a loan the debtor and creditor aren't necessarily the same person. They're just controlled by the same person. I don't think they are that rare to be honest as I've dealt with a few of these over the years. It's just seems that going forward they will create more work. Oh well not far off retirement I suppose. Thanks for your input.
Yes of course they are separate legal persons. But think about it. Will the controller of both companies ever arrange for the creditor company to sue the debtor company for non-payment of the loan. Of course not. He would be sectioned within 5 minutes of he went down that route, and rightly so.
So I think you have lawyers just charging fees for producing useless and unnecessary documents.
Not sure
It's quite as simple as that John in our clients cases. We can only go off the facts for our client not what we might desire or focus on if's but's and maybe's. There are specific reasons why loan accounts have to have formal terms due to the relatively short term the controlling shareholders are in office compared to other companies.
In any event it doesn't alter the fact that these new rules will apply and will cause more headaches for us so we will have to grit our teeth and get on with it!
Lovely!
Once again the smaller companies are falling foul of the more complex financing arrangements of larger companies and the efforts of the accounting and regulatory bodies to keep up and report these arrangements. And who is going to pay for the extra work - I doubt very much whether the client will....at least not without a time consuming and trust-busting fight!
The biggest impact for our clients
will be that we either have to go through this calculation process, or shift the debt into current liabilities.
Not a difficult thing, but the call from the client saying that his credit rating has just collapsed because his latest accounts have been filed at Companies House will almost certainly be.
Yes the debt wont be called in because it would probably be that self destruct button for the company but the calculation will just make life more complicated and costly from the clients point of view, hardly what i would call progress...
Capital contribution/Distribution arguments
Another excellent article from Steve, so many thanks.
There is nothing explicit in FRS 102 that says we should treat the difference between the present value of the cash flows and the amount lent or borrowed as a distribution/capital contribution where the two parties are connected (while not disagreeing that it can be seen as a reasonable thing to do).
In fact many groups of companies have used the rules in IFRS (which in this case are the same as FRS 102) to create a non-trading loan relationship credit (profit) on lending interest free. This would then absorb brought forward non-trading loan relationship debit (loss) which would otherwise go unrelieved.
When the loan is unwound this creates an interest expense each year which is now a current year debit (loss) and (for example) could be group relieved.
This effectively converted a brought forward loss into current year losses and worked until Finance Act 2015 put a stop to it.
Malcolm
specifcs
Another excellent article from Steve, so many thanks.
There is nothing explicit in FRS 102 that says we should treat the difference between the present value of the cash flows and the amount lent or borrowed as a distribution/capital contribution where the two parties are connected (while not disagreeing that it can be seen as a reasonable thing to do).
In fact many groups of companies have used the rules in IFRS (which in this case are the same as FRS 102) to create a non-trading loan relationship credit (profit) on lending interest free. This would then absorb brought forward non-trading loan relationship debit (loss) which would otherwise go unrelieved.
When the loan is unwound this creates an interest expense each year which is now a current year debit (loss) and (for example) could be group relieved.
This effectively converted a brought forward loss into current year losses and worked until Finance Act 2015 put a stop to it.
Malcolm
Thank you Malcolm. We have been trying to work out why the differences above are taken to dividends/capital contributions but couldn't find anything in FRS 102 to suggest why. The technical helpline also said that the differences would go to distributions and capital contributions but could only offer an explanation of the substance of the transaction being that the difference represents a benefit that a reduced rate loan inherently gives the receiving company.
Why doesn't FRS 102 outline this specifically as these sorts of transactions are not rare in practice? Surely the standards themselves should be specific!
Interesting that the finance act 2015 stops brought forward losses arises. :-(
Whilst I agree it would be helpful if FRS 102 pushed us in the right direction with the complete double entry, I don't think we want it so prescribed. Exercising judgement is an important concept in selecting accounting policies.
As I said, I think the capital/distribution treatment is reasonable, I just know for a fact that groups have been using P&L for it which is why the tax law has been changed.
Accounting blah blah
I am concerned the cients wont understand this and wont have it in their bookkeeping records and the only time it will be picked up is if theres an audit happening...
Anyone want to throw their hat in the ring and let us all know how the tax works on this?
many thanks
Mr Sunburnt
Tax treatment
If the client is a company, debits and credits booked in the P&L or other comprehensive income (the artist formerly known as the STRGL) are deductible or taxable, respectively. Receipt or payment is irrelevant.
For unincorporated businesses, I think the same principle would apply for loans taken out for trading purposes (as we use the profit according to generally accepted accounting principles, subject to any statutory adjustments) but for loans taken out for a non-trading purpose such as the purchase of an investment, I think interest is taxed on a receipts and payments basis - this (leading to the ugly spectre of deferred tax on the accounting adjustment - so we will have a figure they won't understand based on a figure they won't understand).....
Substance over form?
Steve makes the point that a loan technically repayable on demand should be classified as a current asset/liability and not at present value - an approach supported by ICAEW guidance. ICAEW guidance goes further, stating that where no repayment terms are set out, loans are to be treated as repayable on demand and classified as creditors due within one year. It seems as though, even where both parties know that the loan will still be outstanding in 12 months' time we are told that the correct classification is "due within one year", because legally the loan is repayable on demand.
However, FRS 102, para. 2.8 firmly restates the concept of "substance over form". For many years we have happily brought leased assets onto the balance sheet knowing full well that the entity will never actually own them, because that reflected the substance of the transaction.
Now we are told that a loan must be classified as "due within one year" because that is its legal form, even though its substance is something different. This is inconsistent at best. At worst, the results are misleading or meaningless.
Wrong tree?
Nobody seems to be taking any notice of my thought that the times when we will actually have to take any notice of this where related entities lend to each other are very few and far between because the terms of such lending will hardly ever have been formalised. Am I barking up the wrong tree altogether?
It all depends John
on your client mix.
We have quite a few clients that "cross-fertilise" their finances, we also (although these are a rare breed indeed) have directors with accounts in credit - yes i know hard to believe but true!
I have had to explain to one of them why his lending the company £1m+ is now a bad idea, i must not have made myself clear about PV etc because he still cant understand how a tax liability can arise simply because the pound might be worth a bit less in a few years time.
Missing the point
We have quite a few clients that "cross-fertilise" their finances, we also (although these are a rare breed indeed) have directors with accounts in credit - yes i know hard to believe but true!
My point is not that it is very rare for companies under common ownership to lend to each other, of for company owners to lend to their companies. I agree, of course, that it happens all the time. My point is that it is, or should be, rare for those arrangements to be formalised (what would be the point of someone entering into a formal agreement with himself?).
Wrong tree, again?
John. You are right that most of these loans will not be formal arrangements, but could you be a bit more explicit about why you feel that the lack of formality means we will not have to consider this issue?
Under FRS 102, the only way a loan can be carried at anything other than present value is if it is NOT a "financing transaction" (not defined). FRS 102 para 11.13 suggests that virtually any arrangement where a loan is outstanding beyond "normal business terms" OR is provided at a below-market rate of interest, is a financing transaction.
If I understand your line of thought, you are suggesting that lack of formality means that the loan is repayable on demand and is, therefore, not a financing transaction and is simply to be measured at "cost". Presumably, such a loan would necessarily be shown as "due within one year".
Firstly, showing such a loan as due within one year may cause problems for the entity's credit rating, bank covenants, etc.
But secondly, in many cases it is nonsense. Both parties will know that the loan will remain outstanding in 12 months time. Showing all such non-formal loans as "due within one year" will render many a balance sheet meaningless.
i know its late on Friday but bear with me here
Is a creditor who isn't paid within normal terms i e the trade terms agreed at the time a "financing transaction"
It's even later on Friday
Is a creditor who isn't paid on normal terms a financing transaction? ...
Yes. See FRS 102, para 11.13
Oh my god
Is a creditor who isn't paid on normal terms a financing transaction? ...
Yes. See FRS 102, para 11.13
This is really worrying me now. Surely not.
On demand
Basically the technical advice line said exactly what Ian dandiwalton said above - these loans are financing transactions and have to be accounted for such and where no rates of interest are charged which is usually the case for these loans then we have to do the accounting treatment in FRS102 which is what the article is suggesting. The lady on the phone said that "no matter how you dress it up, it is a financing transaction and has to be accounted for as such!" (Verbatim). Whether these loans are rare or not doesn't come into it having thought about it and made enquiry after enquiry after enquiry. So we are stuck with it seemingly.
Substance over form again
As Ayesha says, we are stuck with it! But how do we apply it in practice?
Although FRS 102 mentions below-market rate loans, I cannot see any mention of the open-ended loans (whether interest-free or not) which we often find in practice. ICAEW guidance says that, where no repayment terms are formally agreed, such loans are legally repayable on demand and must be treated as "due within one year".
But FRS 102 para. 2.8 says that "transactions ... should be accounted for and presented in accordance with their substance and not merely their legal form".
So we seem to have a conflict. Either:
we apply ICAEW guidance, use strict legal form, and show such loans as "due within one year", valued at "cost"; or
we apply para 2.8, recognise that in substance the loan is really long-term and show it as "due after more than one year" valued at present value (how to determine the present value of an open-ended loan probably deserves a thread in its own right!).
All very unsatisfactory.
Very unsatisfactory
Indeed!! I think from today's stress about all this the answer is loan terms across the board. that's clearly where FRS 102 is sending us or telling us that without terms it's in as current. See you.
Grrrr.
Still don't see what I am missing. In the absence of any agreement to the contrary all loans are repayable on demand. In the case of an informal loan where there are no specific repayment terms, as nearly all loans between related parties are, there will almost always be an absence of any agreement to the contrary, so all such loans are likely to be repayable on demand. We are told that FRS 102 says that loans repayable on demand are not financing transactions. So what is the problem?
With
The greatest respect John you imply that these cases never have loan terms. This is just simply not true as is evidenced by other posters concerns to this topic whose clients clearly DO have loan terms. I appreciate that your clients may not such terms but you can't then assume they do not exist throughout the entire country because the clearly do,
So is it agreed then that when there are no formal loan terms (let's not worry about how often that is in fact the case) then none of this applies?
By the way my view that most related party loans in fact will have no formal terms associated with them is not particularly based on personal observation, but on the fact that formalising loan terms when one person is lending to himself is self-evidently pointless, and on a perhaps naive assumption that a practice that is pointless will not be widespread. I may be wrong on that of course.
All agreed?
I agree we (as accountants) may be spared the task of calculating the present value of a loan, so long as we show the loan as a current liability, but I am not sure that is the most important point. Am I the only person who finds it frustrating that we do have to show it as a current liability? Although that may be the strict legal form, many of these arrangements will persist for a number of years and showing them as long-term creditors would give a much fairer view. Clearly, calculating the present value of an open-ended loan presents some difficulties, but that simply shows up the lack of imagination on the part of standard setters. Not all financing transactions are equal and forcing us to account for them all in the same way will lead to accounts that are less meaningful.
I don't think you are looking at the bigger picture John
The "few clients" were in fact companies under common ownership/control.
The reason that there needs to be a proper agreement there (and yes we have found that proper agreements don't always exist) is because it leaves both (all) the related companies at risk.
The simple route being espoused here is just treat them all as payable on demand. That is fine if it doesn't self destruct the Balance Sheet. The reason we insist on clients having formal agreements is simply because even though all parties realise that the loan wont be repaid in the next 12 months they don't formalise that situation and it sits in current liabiltities.
The credit reference agencies (for it is their opinion that ultimately matters) view these as bad things rather than debts repayable in over 12 months as good. We have seen ridiculous transformations in credit rating simply by restating the balance sheet, we have also seen the reverse.
When you think that the accounts can be 9 months old when they hit the public domain it makes little sense (anything older than 9 months at CH is a black mark anyway).
Risk
The reason that there needs to be a proper agreement there (and yes we have found that proper agreements don't always exist) is because it leaves both (all) the related companies at risk.
How does the absence of a formal agreement, per se, put two companies under common control at risk?
But yes of course if debtors want to exclude their indebtedness from current liabilities they will have to formalise the repayment terms. There will be other occasions when formality is needed too. Lending banks may insist on formal postponement. Letters of comfort may have been given to auditors containing undertakings that need to be formalised. My guess is that these situations will be the exception rather than the rule.
As formalising loan terms from now on brings with it an obligation to comply with onerous accounting requirements, perhaps it is not idle to speculate that this will lead to even fewer loan arrangements being formalised in future.
But what about ....
What happens when a Company purchases an item of plant say on behalf of the other Company, its complicated enough (Vat, name & address on invoice, agreeing inter company loans, no terms of repayment etc), do all these little bits and bobs get treated as a loan subject to an interest charge.
Or is it a question of if its not a moneatary loan the above rules do not apply.