In general terms one can understand that a “Commitment fees” is being charged for some approved facility which can be drawn down in future at the same terms which has been agreed initially between lender and borrower. Banks are usually charged for some fees to provide this kind of facility which is usually called commitment charges/ fees.
And “Loan processing fees” are something which once can understand that the amount of upfront charges/ payments which are being recovered by a Bank at the time of disbursing the loan (net of loan) to the borrower which usually been called as facility/ or arrangement fees etc.
Refer below some of the extracts governing accounting policies on such issues of by one of private sector bank (listed in India) which uses current accounting practices (as Ind-As will be applicable on Banks w.e.f. from 2018 as notified by MCA) as mentioned on page 137 of the report-
Rader can download/ refer the full annual report of the Bank by using link-https://www.icicibank.com/managed-assets/docs/investor/annual-reports/2016/icici-bank-annual-report-2015-16.pdf
Let’s first understand COMMITMENT FEES which are being charged on account of certain arrangement between bank and a borrower to draw down certain facility in future or whenever it is agreed based on the agreed terms and conditions agreed initially. Ind-As 109 – “Financial Instruments” para 2.3 talks about the loan commitment which are within the scope of Financial Instruments-
2.3 The following loan commitments are within the scope of this Standard:
(a) Loan commitments that the entity designates as financial liabilities at fair value through profit or loss (see paragraph 4.2.2). An entity that has a past practice of selling the assets resulting from its loan commitments shortly after origination shall apply this Standard to all its loan commitments in the same class.
(b) Loan commitments that can be settled net in cash or by delivering or issuing another financial instrument. These loan commitments are derivatives. A loan commitment is not regarded as settled net merely because the loan is paid out in installments (for example, a mortgage construction loan that is paid out in installments in line with the progress of construction).
(c) Commitments to provide a loan at a below-market interest rate (see paragraph 4.2.1(d)).
Commitment fees is therefore a fees/ charges which are being taken by a lender (a bank) to provide a choice or an option to draw down additional bank facility (whatever is agreed) at the same terms which has agreed and It gives kind of assurance to a borrower about certain environment/ charges to be incurred without affecting any change in future economic environment.
Notes on Commitment fees-
Reader would appreciate that these practices are being followed by the entities which uses IFRS around the world and materiality could be considered while formulating any such process change within any entity.
Let’s understand the PROCESSING FEES and let’s have only practical thoughts about why it is being charged and how it is being treated in current accounting system Vs. new Ind-As pronouncements –
Look at the below table which shows the offers received from two different banks –
“Effective Interest rate” as per Ind-As 109 – “Financial Instrument”- The rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset orfinancial liability to the gross carrying amount of a financial asset or to the amortized cost of a financial liability. When calculating the effective interest rate, an entity shall estimate the expected cash flows by considering all the contractual terms of the financial instrument (for example, prepayment, extension, call and similar options) but shall not consider the expected credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an Integral part of the effective interest rate (see paragraphs B5.4.1–B5.4.3), transaction costs, and all other premiums Or discounts. There is a presumption that the cash flows and the expected life of a group of similar financial instruments can be estimated reliably. However, in those rare cases when it is not possible to reliably estimate the cash flows or the expected life of a financial instrument (or group of financial instruments), the entity shall use the contractual cash flows over the full contractual term of the financial instrument (or group of financial instruments).
We can summarize the above working as below –
This is an overall and very simplified version to understand Effective Interest rate and treatment of such fees however in practice there could be more complicated situations to calculate such EIR and to apply its accounting.
A reader will appreciate about the main objective of the standard and an approach which one can follow while keeping in mind the basis of origin of such requirements. There could possibly be some specific situations or circumstances where the interpretation of any standard will be different as we should always keep in mind that IND-AS is principle based standards and lot more areas need management judgment in line with the standards relevant interpretation and best practices.
One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Readers are requested not to take this article as any kind of advice (it is not exhaustive in nature) and should evaluate all relevant factors of each individual cases separately.
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