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Account for loan interest as paid or over the term

loan interest

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The interest on a loan is significantly more at the begingin of the term. In most cases loan is included in the accounts as per the loan statement but is there a case to recognise the interest evenly over the term of the loan. Have one case where the loan interest is ceating a loss, this is a subscription business so they are consiocous about recurring revenue/costs. Is there scope in reporting standards to recognise the interest evenly over the term of the loan?

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By paul.benny
03rd Feb 2021 08:11

No

FRS102 requires interest to be accounted for using the effective interest method. This is consistent with how most term loans operate: where instalments consist of (principal + interest), the interest element is highest at the start and decline over the term as the principal reduces.

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By Tickers
03rd Feb 2021 10:03

In terms of FRS 105, I thought the effective interest rate method is considered too
onerous to apply by micro-entities? In that case what method would they use?

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By paul.benny
03rd Feb 2021 10:22

Although FRS105 doesn't use the expression "effective interest method", para 9.14(b) uses the same concept - ie a constant rate on the balance outstanding.

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By Tickers
03rd Feb 2021 10:24

Seems to be counterintuitive. The effective interest method is to onerous but use the effective interest method?

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By paul.benny
03rd Feb 2021 12:17

There is no additional calculation needed for effect interest rate with a simple term loan where monthly instalments are a fixed amount

The calculations do become complex if, for example, there is a balloon payment at the end, or interest is capitalised. Ditto if there are material fees paid up front. These are the type of scenario where FRS105 allows preparers to deviate from using the effective interest rate.

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Giraffe
By Luke
03rd Feb 2021 10:58

I agree that it should be charged to the P&L as incurred, i.e. with the effective interest rate method. I apply this to clients reporting under FRS102 and FRS105 alike.

It would be a lot easier to go back to the days of spreading it evenly over the period for FRS105 clients but it is no longer acceptable to do so.

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