Analysis on accounting of interest free demand loans received under Ind AS / IFRS

Accounting of Interest free demand loan given by One Company to Other Company which may or may not be related party

Entity generally advances various demand loans / Inter Corporate Deposits (ICDs) to various parties on commercial terms and sometime entities does not charge any interest or charge an interest, which is below market rate.

Ind AS 113 requires the loan liability of demand loan is the value payable on demand in itself hence no adjustment is required to make for no interest rate or below market interest rate carrying loan outstanding from the borrower’s perspective.

Whether structuring of the transactions allowed, which does not represent the true intention of the transaction and hence the same can measured at transaction price with no fair value adjustment?

Analysis:

Ind AS 109 Financial Instruments requires all transactions are required to measure at fair value. When transactions are with third parties or unrelated parties, transaction price is itself fair value.

Paragraph 47 of Ind AS 113 mentions that fair value of financial liability with a demand feature is generally not less than the amount payable on demand, after applying the discount when the amount is required to be repaid. Hence, Company cannot make immediate gain on inception of the loan arrangement (in case it is a borrower).

There is no specific guidance given specifically in any standard for accounting of below market rate loans received or given within the group. Hence, reference should made to the general concepts in the Conceptual Framework in order to reflect the substance of this part of the loan.

Ind AS is a principle based standard hence the Company while recording transactions in financial statements follows principle and intention of the parties to the contract and accordingly account the transaction in the financial statement.

An entity making a loan to a related party such as another entity within a group or outside a group should evaluate whether the loan has made on normal commercial terms. It is necessary to make a distinction between on-demand or term loans (which may be short/long term). Intention of the parties to the agreement shall reflect their intention in accounting of the transaction. Also, entity has to consider the applicability of the legal jurisdiction where it operates especially when absence of repayment of loan might considered as term loan or perpetual loan.

In case where transactions are with related parties or within the group, the transaction value does not itself become fair value unless it is justifiable. Interest free loans are often lacks the normal commercial terms. An entity making a loan to a related party such as another entity within a group should therefore evaluate whether the loan has made on normal commercial terms.

In case where intention of the parties to provide long term finance, however the repayment clause in the agreement mentions that it is having demand feature repayment, then the agreement may not considered as genuine and accordingly determine the period / tenure as the period in which it is expected to be repaid considering security, currency, amount, ratings etc.. Accordingly, it shall determine the fair value on the transaction date considering that tenure and discount rate if the Company would have advanced loan for similar tenure without having relationship.

Loan with demand feature in the agreement does not mean by itself that transaction value is the fair value. In cases where the transactions lacks commercial substance, appropriate adjustment is required to make to determine the fair value.

Sometimes loan agreements between a parent and subsidiary or related parties lacks the level of detail and documentation of commercial lending agreements. In such circumstances, the entities may need to take additional steps to clarify (and document) their rights and obligations under the agreement in order to determine the appropriate accounting.

Loans that are expected to be repaid in the near future (say less than 12 months) from the inception date should generally be recorded at the loan amount by both parties (subject to Ind AS 109’s impairment requirements). Loan amount is likely to be a sufficiently close approximation to fair value in most such cases.

Additional analysis may be needed for a longer-term loan to a related party such as a subsidiary.