Entities preparing stand-alone financial statements must apply the full provisions of the standard to those loans that fall within its scope and this includes related company loans. In this article, we take a closer look at how this affects the accounting for related company loan receivables.
Do all related company loan receivables fall within IFRS 9?
The majority of related company loans (which includes intragroup loans as well as loans to associates or joint ventures) are debt instruments that fall within the scope of IFRS 9. This means that even though some loans may seem more akin to a capital contribution, they should typically be accounted for in accordance with IFRS 9 instead of IAS 27 (ie at cost less impairment) or IAS 28 (ie using the equity method).
Similarly, a loan to an associate or joint venture that is not equity accounted but, in substance, forms part of the net investment (ie a long-term interest) is also within the scope of IFRS 9. This means that a loan could be subject to both:
1.The IFRS 9 Expected Credit Loss (ECL) requirements, and
2.The impairment requirements of IAS 28.
Undocumented loans are typically considered to be repayable on demand from a legal perspective and also fall within the scope of IFRS 9. In some jurisdictions, it is possible that under local laws an undocumented loan is considered a capital contribution. In such cases, entities should consider seeking legal advice to support this conclusion.
Are all related company loan receivables classified at amortised cost?
Not necessarily. While many related company loans will meet the criteria to be classified at amortised cost because they are held in a ‘hold to collect’ business model and meet the ‘solely payments of principal and interest’ (SPPI) test, entities should not assume this to be the case.
For example, loans that are linked to underlying asset or borrower performance, such as a profit-linked loan, will fail the SPPI test. In addition, certain non-recourse loans, ie loans where the debtor’s claim is limited to specified assets, may also fail the SPPI test. In these cases, the loan must be classified at Fair Value through Profit Loss (FVPL) irrespective of the business model in which it is held.
Applying the new impairment model to related company loans
All related company loan receivables (including term loans and demand loans) that are not classified at FVPL are within the scope of IFRS 9’s ECL requirements and are subject to the General Approach (unless the loan is credit impaired at initial recognition). Under the General Approach, at each reporting date the lender must determine whether the loan is in Stage 1, Stage 2 or Stage 3 and recognise 12-month ECL or Lifetime ECL accordingly. Related company loans are never eligible for the Simplified Approach.
This means that a minimum of 12-month ECL must be provided for all loans, including those that are not past due and are considered to be of a high credit quality. This new forward-looking model is a major change from the previous incurred loss model and entities should not underestimate the application challenges it presents, including:
- Sourcing and incorporating forward-looking information
- Assessing for significant increases in credit risk
- Estimating a risk of default, and
- Estimating the ECL.
Where can I find more information?
BDO Global has recently published ‘Applying IFRS 9 to related company loans’, which is available now on the BDO Global IFRS webpage. The publication addresses all of the above issues in more detail and uses examples to illustrate how the requirements could be applied in practice.
In addition, earlier editions of Business Edge (see 2017 index and 2018 index) provide high-level summaries of both the IFRS 9 classification model and ECL model.
For help and advice on IFRS 9 please get in touch with your usual BDO contact or Dan Taylor.
Read more on IFRS 9:
Debt factoring of trade receivables under IFRS 9
Assessing for Significant Increases in Credit Risk under IFRS 9
Hedge Accounting Documentation under IFRS 9 Documentation
Issued financial guarantees
Hedge Accounting - policy choices available on transition
Solely Payments of Principal and Interest
The new expected credit loss model
Modifications of financial liabilities
Classification of financial assets
Hedge effectiveness thresholds
Impairment and the simplified approach
Available For Sale Financial Assets