Treatment of an Interest Free Loan

How should an interest free loan from a director who is not a shareholder be treated under FRS102

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I've an issue that I've been going around in circles with for a couple of weeks now and I've exhausted all sources available to me. The main takeaway is that the nature of the transaction needs to be considered carefully.... but I can't find any guidance that relates to the circumstances below. I'd therefore be very grateful if the members of Accounting Web could shed any light. 

A new (small) limited company has purchaed a sole trade business for £300k.  For commercial reasons the individual selling his business was made a director of the new company but is not a shareholder nor a relative of any other director/shareholder. The individual has no control of the company.

The purchase of the sole trade business was financed by way of an interst free loan from the seller. This was to assist the new company to finance the purchase as bank finance would have been difficult.

The loan is repayable in equal installments over 260 weeks. Under FRS102 Section 11 this constitues a financing transaction and I've calculated the PV of the future payments discounted at a market rate.

I've two questions that I'd appreciate any assistance with:

  1. Where should the credit for the difference between the cash value of the loan and the PV of future loan payments be recorded? As the director making the loan isn't a shareholder my initial thoughts are directly to retained earnings as non-distributal reserves.
  2. Using the effective interest rate for subsequent measurement, the credit will go to the loan balance but where should the debit be recorded? If my thoughts above are correct then this would be set against the non-distributal reserves?

There are plenty of examples available where the director is also a shareholder and the initial credit is recorded as a capital contribution, but none where a non-shareholder director makes a loan.

Please help!

Replies (3)

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By paul.benny
17th Apr 2024 10:26

Firstly the disclosures. It's just a loan, although because it's from a director (ie a related party), it needs to be disclosed.

You've done the hard part by calculating the discounted amount. So the accounting -
on day 1 the loan balance is the PV of £300k - say £250k*

At the end of year 1, you've repaid £60k. The entries for this are (say)

dr loan £45k
dr P&L interest £15k
cr cash £60k

Subsequent years are similar, only the split of the payment becomes more weighted to loan.

* Notwithstanding the agreed purchase price, the actual consideration is £250k and the rest of the amount paid is interest on the amount "borrowed" from the seller by virtue of the extended payment terms.

Thanks (1)
Replying to paul.benny:
By WAcc
17th Apr 2024 14:28

Thank you Paul.

So if the breakdown of the £300k purchase price is split plant and machinery £90k, stock £40k, land and property £160k and goodwill £10k, how you you record the transaction initially?

Dr Plant and machinery £ 90k
Dr Stock £ 40k
Dr Land and property £160k
Dr Goodwill £ 10k
Cr Loan (PV) £250k
Cr ????? £ 50k

Thanks (0)
Replying to WAcc:
By paul.benny
17th Apr 2024 15:02

The credit goes pro-rata against the individual asset categories. So the actual (accounting) purchase price of the land and buildings is about £135k, etc.

I'm not a tax specialist and I've no idea whether the notional interest is an allowable expense. (my instinct is that you have to write back all the FRS102 adjustments so that the tax treatments in hands of seller and buyer mirror one another).

If tax does follow FRS102, it might be worth thinking about the allocation of the credit. There is a case for allocating none against the stock as you wouldn't expect extended terms on a current asset.

Thanks (1)