Accounting for concessional loans (RMG 115)

Audience

This guide applies to all officials (e.g., finance teams) in Commonwealth entities that issue concessional loans.

This guide is designed to be read in conjunction with relevant Australian Accounting Standards.

Key points

This guide:

  • purpose: to provide guidance on accounting for concessional loans, including discounting using the effective interest method and the unwinding of the discount.
  • scope: Commonwealth entities who issue concessional loans. In principle, the ‘market based loan’ components of this guide can also apply to other financial instruments measured at amortised cost using the effective interest method.

Resources

Applicable accounting pronouncement

Commonwealth Entities Financial Statements Guide (incorporating the FRR)

Introduction

  1. A ‘concessional loan’ refers to a loan made by the government at a discount to the prevailing market rate to the borrower. It consists of a ‘market based loan’ and a ‘loan discount’ component.
  2. Direct transaction costs are included in the carrying amount if the loan was recognised as ‘loans and receivables’, whereas the amount recognised on initial recognition will not include any transaction costs if the loan was categorised as a financial asset at ‘fair value through profit or loss’.
  3. Entities that make concessional loans are to calculate the fair value of the market based loan by using a valuation technique (e.g., by discounting all future cash receipts at the prevailing market rate for a similar financial asset).
  4. The difference between the nominal value of the loan and the fair value of the market based loan component is recognised as the discount component, which is to be expensed immediately.
  5. Subsequent to initial recognition, a loan categorised as ‘loans and receivables’ is to be measured at ‘amortised cost’ using the ‘effective interest method’.

Part 1 – Guidance

  1. A ‘concessional loan’ as defined (see ‘Definitions used’ below) is basically the government providing a ‘market based loan’ to an entity as well as a ‘concessional’ component. The concessional component represents the opportunity cost of value forgone in providing the loan at a discounted rate and is referred to as the ‘loan discount’.

Practical guidance

As demonstrated above, the value of the concessional loan comprises of a market based loan and a loan discount component.

Dr. 2423001 Concessional loan discount (expense) (C)
Dr. Financial asset (loan receivable) (B)
Cr. Cash/Appropriation receivable (as appropriate) (A)

 See Appendix 1’s Illustrative examples and below which explain the concept in greater detail.

Initial recognition and measurement (initial accounting)

  1. On initial recognition, the components that make-up the concessional loan (A), being the market based loan (B) and the loan discount (C), are separated to reflect the economic substance of the transaction. These components are accounted for as per below.
Step 1: Initial accounting –
market based loan component (B)
Step 2: Initial accounting –
loan discount component (C)
  1. As the market based loan is a ‘financial instrument’ (see ‘Definitions used’ below) it is accounted for as per AASB 139. The market based loan is recognised as a ‘financial asset’ (loan receivable) in the Statement of Financial Position (SOFP) and measured as follows:
Practical guidance

Transaction costs are costs that are directly attributable to the acquisition or issue of the financial asset (e.g., fees and commissions, levies, transfer taxes and duties).

  • If the loan is categorised as ‘loans and receivables’, the amount recognised on initial recognition is the fair value of the loan plus transaction costs.
  • If the loan is categorised as ‘fair value through profit or loss’, the amount recognised on initial recognition will only include the fair value of the loan. Transaction costs will be expensed immediately on recognition.
  1. Concessional loans are unlikely to be categorised as available-for-sale because they are not quoted in an active market and they generally meet the definition of ‘loans and receivables’.
  2. While the ‘fair value’ (see ‘Definitions used’ below) of a financial instrument is normally its transaction price (e.g., the fair value of the consideration given), due to the concessional arrangement the fair value must be estimated through the use of a valuation technique.
  3. A commonly used valuation technique for such financial instruments is discounted cash flow (DCF) analysis1. Under DCF analysis the fair value of the market based loan is estimated as the present value of all future cash receipts discounted using the prevailing market(s) rate of interest the borrower would be subject to in the market for a similar instrument (in terms of currency, term, type of interest rate and other factors) with a similar credit rating.
Practical guidance

Cash flows are discounted by the rate a market participant (borrowing entity), not the issuer, would be subject to if the loan was instead obtained in the market. For example, a company with a ‘B’ credit rating received an AU$5 million loan with a 10-year loan term from the government at a concessional rate of 3% to construct water infrastructure. If the concessional loan was not given, the prevailing market rate would otherwise be 8% for companies with a similar credit rating to borrow in the market for a similar project, loan amount and loan term. Hence, 8% will be the discount rate for the calculation of the fair value.

Expert advice may be necessary to determine the prevailing market rate. A standard bank lending rate would need to be adjusted to take into consideration the risks associated with the borrower.

The Appendix 1 Illustrative examples use DCF analysis to measure the fair value of the market based loan.

For more information regarding the use of valuation techniques and fair value measurement see paragraphs 43A and AG76 of AASB 139 and AASB 13 Fair Value Measurement.

Step 1: Initial accounting –
market based loan component (B)
Step 2: Initial accounting –
loan discount component (C)
  1. The discount component of the concessional loan is immediately recognised as an expense in the Statement of Comprehensive Income (SOCI) when the entity becomes a party to the contractual provisions that lead to commitments to provide a loan at a below-market interest rate. The discount component is recognised as the difference between the nominal value of the loan and the fair value of the market based loan component (as per a restructure of the equation at paragraph 1 above, e.g., C = A – B).
Practical guidance

For examples, see Appendix 1’s Illustrative examples.

Subsequent accounting

Step 3: Subsequent accounting –
market based loan component (B)
Step 4: Subsequent accounting –
loan discount component (C)
  1. Subsequent accounting treatment of the market based loan component depends on the category of financial asset chosen (see paragraph 3 of this Guide). Although the facts and circumstances need to be assessed on a case-by-case basis, concessional loans are generally categorised as loans and receivables.
Practical guidance

If fair value through profit or loss is designated on initial recognition, please contact Budget Estimates and Accounting Branch at the Department of Finance for additional guidance.

  1. Loans and receivables are measured at ‘amortised cost’ using the ‘effective interest method’ (EIM) (see ‘Definitions used’ below), with changes in amortised cost recognised in the SOCI.
  2. The amortised cost of the market based loan can be calculated as follows:
(a) The carrying amount of the market based loan at initial recognition
(b) Add             Interest income accrued using the effective interest method (EIM)
(c) Less            Principal and interest repayments (Cash flows)
  Less            Reduction for impairment or uncollectibility (if any)
(d) Equals        Amortised cost
  1. Carrying amount of market based loan (amortised cost)
    1. On initial recognition the market based loan was recognised at fair value, as calculated in Step 1: Initial accounting – market based loan component. Subsequently, the carrying amount of the market based loan is calculated as per paragraph 10 of this Guide.
  2. Income (using the effective interest method (EIM))
    1. The EIM is a method of calculating the amortised cost of a financial asset or financial liability and allocating the interest income or expense over the relevant period.
    2. The effective interest rate (EIR) is the rate that exactly discounts estimated future principal and interest receipts through the expected life of the concessional loan (see ‘EIM’ in ‘Definitions used’ below for further information).
      Practical guidance

       For example, see Appendix 1 Illustrative example 1 Table 2 Column (b) which applies an EIR of 7.45% on the carrying amount of the market based loan. This rate exactly discounts estimated future cash receipts through the life of the financial instrument, resulting in an amortised cost of zero at the end of the concessional loan. This also demonstrates that the EIR will generally equal the market rate of the market based loan component.

      There are many ways to calculate the EIR, such as using the Microsoft Excel Goal Seek tool and the Internal Rate of Return (IRR) formula function. The Goal Seek tool has been used in the Appendix 1 Illustrative examples.

    3. Income calculated using the EIM can be further separated into two components: interest income and unwinding of the discount (see Step 4: Subsequent accounting – loan discount component).
  3. Cash flows – Principal and interest repayments
    1. Cash flows basically consist of principal and interest payments received.
    Practical guidance

    If a grace period is applicable, see Appendix 1 Illustrative examples 3 and 4.

    If the issued loan is interest free, see Appendix 1 Illustrative examples 2 and 4.

  4. Amortised cost
  1. Amortised cost is commonly presented in an amortisation schedule.

Practical guidance

An example of an amortisation schedule is below (extracted from Appendix 1 Illustrative example 1 Table 2):

Year

(a)

Opening amortised cost

(b) = (a) x EIR

Income (using EIM)
(EIR: 7.45%)

(c)

Cash flows

(d) = (a) + (b) – (c)

Amortised cost at year end
1 $639,216 $47,622 $199,150 $487,688
2 $487,688 $36,333 $193,113 $330,908
3 $330,908 $24,653 $187,075 $168,486
4 $168,486 $168,486 $181,038 $-

Step 3: Subsequent accounting –
market based loan component (B)

Directly attributable costs
(see paragraph 17 of AASB 116)

Step 4: Subsequent accounting –
loan discount component (C)

  1. The loan discount component which was expensed on initial recognition will subsequently be unwound (written back) over the life of the loan.
Practical guidance

For example, a 2-year concessional loan for $900 with a loan discount expense of $100. On initial recognition the market based loan component was recognised in the SOFP and the discount component was expensed:

Dr. 2423001 Concessional loan discount (expense) $100
Dr. Financial asset (loan receivable) $800
Cr. Cash $900

Over the next 2 years the expense ($100) will need to be unwound (written back) to ensure the receivable will equal $900 at the end of the loan (the amount which will be received from the borrower). Assuming the expense is unwound at the end of each year by $50 the following journal would be posted at the end of year’s 1 and 2 to recognise the unwinding of the discount:

Dr. Financial asset (loan receivable) $50
Cr. 1234001 Unwind concessional loan discount (income)* $50

*The unwinding of the concessional loan discount expense is to be recorded in account 1234001 ‘Unwind concessional loan discount’ as part of interest and dividends.

At the end of year 2 the discount is fully unwound resulting in the full receivable of $900 (the amount to be received from the borrower). When the loan is repaid the following journal is posted:

Dr. Cash $900
Cr. Financial asset (loan receivable) $900
  1. The unwinding of the discount (d) is the difference between interest income calculated under the EIM (b) and interest income calculated using the loan’s interest rate (c), as demonstrated in the table below (extracted from Appendix 1 Illustrative example 1 Table 3):
Year

(a)

Opening loan discount

(b)

Income (using EIM)

(c)

Interest income

(d) = (b) – (c)

Income from unwinding of discount

(e) = (a) – (d)

Unexpired loan discount at year end
1 $60,784 $47,622 $24,150 $23,472 $37,312
2 $37,312 $36,333 $18,113 $18,220 $19,092
3 $19,092 $24,653 $12,075 $12,578 $6,514
4 $6,514 $12,552 $6,038 $6,514 $-

 

Part 2 – Disclosure requirements

  1. Disclosure of financial instruments in general is required by AASB 7 Financial Instruments: Disclosures. Furthermore, AASB 13 requires additional fair value measurement disclosures (subject to paragraph 29 of AASB 7).

Part 3 – Budget implications

  1. The following table illustrates the impact on budget aggregates over the life of a concessional loan:

Transaction

Fiscal Balance*

Underlying Cash Balance

  1. Initial recognition - loan component

Nil impact
(no impact on net operating balance from operations or non-financial assets)

Nil impact
(loan component is treated as an investment in financial assets cash outflow not an operating outflow)

  1. Initial recognition - discount component^

Worsen
(discount expense reduces net operating balance)

Nil impact
(no cash inflow/outflow)

  1. Principal repayment

Nil impact
(no impact on net operating balance from operations or non-financial assets)

Nil impact
(principal repayment is treated as an investment in financial assets cash inflow)

  1. Cash interest received (interest income)

Improve
(interest income increases revenue)

Improve
(interest cash inflow (receipts) treated as an operating cash inflow)

  1. Unwinding of discount component

Improve
(interest income increases revenue)

Nil impact
(no cash inflow/outflow)

* The impact on fiscal balance over the entire life of the concessional loan is the actual interest earned on the concessional loan arrangement.

^ The discount component of the concessional loan is immediately recognised as an expense. It will worsen the fiscal balance but have no impact on the underlying cash balance as there is no cash inflow or outflow.

Part 4 – Definitions used

  • The amortised cost of a financial asset is the amount at which the financial asset is measured at initial recognition minus principal repayments, plus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment or uncollectibility (adapted from paragraph 9 of AASB 139).
  • A concessional loan is a loan provided on more favourable terms than the borrower could obtain in the market place. The concession provided may be in the form of lower than market interest rates, longer loan maturity or grace periods before the payment of the principal or interest.
  • The effective interest method is a method of calculating the amortised cost of a financial asset and of allocating the interest income over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset. When calculating the effective interest rate, an entity shall estimate cash flows considering all contractual terms of the financial instrument (e.g., prepayment, call and similar options) but shall not consider future 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 AASB 118 Revenue), transaction costs, and all other premiums or discounts. When it is not possible to estimate reliably the cash flows or the expected life of a financial instrument, the entity shall use the contractual cash flows over the full contractual term of the financial instrument (adapted from paragraph 9 of AASB 139).
  • Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (paragraph 9 of AASB 13).
  • A financial asset is any asset that is:
  1. cash;
  2. an equity instrument of another entity;
  3. a contractual right:
    1. to receive cash or another financial asset from another entity; or
    2. to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
  4. a contract that will or may be settled in the entity’s own equity instruments and is:
    1. a non-derivative for which the entity is or may be obliged to receive a variable number of the entity’s own equity instruments; or
    2. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments (adapted from paragraph 11 of AASB 132 Financial Instruments: Presentation).
  • A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity (paragraph 11 of AASB 132).
  • Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than:
  1. those that the entity intends to sell immediately or in the near term, which shall be classified as held for trading, and those that the entity upon initial recognition designates as at fair value through profit or loss;
  2. those that the entity upon initial recognition designates as available for sale; or
  3. those for which the holder may not recover substantially all of its initial investment, other than because of credit deterioration, which shall be classified as available for sale (adapted from paragraph 9 of AASB 139).

Appendix 1 – Illustrative examples

Illustrative example 1: Below market rate loan

Information:

On 1 July 20X0, an entity agrees to provide a $700,000 loan to a not-for-profit (NFP) organisation. The loan is provided on the following terms:

  • Principal: $700,000 to be repaid evenly over the loan term ($175,000 p.a.).
  • Loan interest rate: 3.45%.
  • Term: 4 years.

Interest is calculated on the amount outstanding at the beginning of the year. If borrowing in the market the market participant would be subject to a rate of 7.45%. Cash flows occur at year end.

Answer:

Initial accounting

In accordance with the economic substance of transaction, the entity separates the concessional loan (A) into its component parts; a market based loan (B) and the discount component (C).

The market based loan (B) is recognised at fair value using discounted cash flow (DCF) analysis. The following present value (PV) of future cash flows formula has been used in this process:

PV of future cash flows = Cash flows / (1 + discount rate) Time period

Where cash flows are the cash receipts for the period (the principal and interest repayments); the discount rate is the prevailing market rate of interest for a similar instrument, 7.45%; and the time period is the period in the life of the loan the PV calculation is being performed for.

The PV of future cash flows at the market rate for (B) and at the concessional rate of 3.45% for (A) are illustrated in the following table:

Table 1: Discounted cash flow analysis

 

Year

 

Principal repayment

 

Interest payment at loan rate (3.45%)

 

Total cash flows

(A)

PV at loan rate (3.45%)

(B)

PV at market rate (7.45%)

1

$175,000

$24,150
(700,000 x 0.0345)

$199,150

$192,508
(199,150 / (1.0345)1)

$185,342
(199,150 / (1.0745)1)

2

$175,000

$18,113
(525,000 x 0.0345)

$193,113

$180,447
(193,113 / (1.0345)2)

$167,263
(193,113 / (1.0745)2)

3

$175,000

$12,075
(350,000 x 0.0345)

$187,075

$168,976
(187,075 / (1.0345)3)

$150,798
(187,075 / (1.0745)3)

4

$175,000

$6,038
(175,000 x 0.0345)

$181,038

$158,069
(181,038 / (1.0345)4)

$135,814
(181,038 / (1.0745)4)

Total

$700,000

$60,376

$760,376

$700,000

$639,216

 

The difference between the loan’s nominal value at the concessional rate (A) and fair value at the market rate (B) represents the discount implicit in the loan (C):

Loan discount (C) = (A)’s total – (B)’s total = $700,000 – $639,216 = $60,784

At 1 July 20X0, the entity posts the following journal to recognise the fair value of the market based loan component and to expense the associated loan discount component:

Dr. 2423001 Concessional loan discount (expense) $60,784
Dr. Financial asset (loan receivable)   $639,216
Cr/ Cash $700,000

Subsequent accounting

Subsequent to initial recognition, the entity classifies the market based loan as a loan and receivable and measures the financial asset at amortised cost using the EIM. The entity has calculated an EIR at 7.45% with the use of Excel’s Goal Seek tool.

The following amortisation schedule outlines the amortisation of the market based loan, and illustrates how the EIM effectively discounts estimated future principal and interest receipts through the expected life of the loan:

Table 2: Amortisation schedule – market based loan

 

Year

(a)

Opening amortised cost

(b) = (a) x EIR

Income (using EIM)
(EIR: 7.45%)

(c)

Cash flows*

(d) = (a) + (b) – (c)

Amortised cost at year end

1

$639,216^

$47,622

$199,150

$487,688

2

$487,688

$36,333

$193,113

$330,908

3

$330,908

$24,653

$187,075

$168,486

4

$168,486

$12,552

$181,038

$-

*See Table 1 column ‘total cash flows’ above.
^See Table 1 column ‘(B)’ above.

The following table illustrates the unwinding of the loan discount, which is calculated as the difference between the loan discount on initial recognition and any subsequent unwinding (writing back) of the discount component:

Table 3: Calculation of unwinding of discount and unexpired discount

 

Year

(a)

Opening loan discount

(b)

Income (using EIM)*

(c)

Interest income^

(d) = (b) – (c)

Income from unwinding of discount

(e) = (a) – (d)

Unexpired loan discount at year end

1

$60,784

$47,622

$24,150

$23,472

$37,312

2

$37,312

$36,333

$18,113

$18,220

$19,092

3

$19,092

$24,653

$12,075

$12,578

$6,514

4

$6,514

$12,552

$6,038

$6,514

$-

Total

 

 

$60,376

$60,784

 

*See Table 2 column ‘(b)’ above.
^See Table 1 column ‘interest payment’ above.
See the ‘loan discount’ formula above.

 

The following journals are posted at the end of each financial year:

 

30/06/X1

$

30/06/X2

$

30/06/X3

$

30/06/X4

$

Dr. Cash

175,000

175,000

175,000

175,000

Cr. Financial asset (loan receivable)

175,000

175,000

175,000

175,000

To recognise the principal repayments ($175,000 p.a.)

 

 

 

 

Dr. Cash

24,150

18,113

12,075

6,038

Cr. Interest income

24,150

18,113

12,075

6,038

To recognise interest income (Table 3 column ‘(c)’)

 

 

 

 

Dr. Financial asset (loan receivable)

23,472

18,220

12,578

6,514

Cr. 1234001 Unwind concessional loan discount (income)

23,472

18,220

12,578

6,514

To recognise the unwinding of the discount
(Table 3 column ‘(d)’)

 

 

 

 

Illustrative example 2: Interest free loan

Information:

On 1 July 20X0, an entity agrees to provide a $700,000 loan to a NFP organisation. The loan is provided on the following terms:

  • Principal: $700,000 to be repaid evenly over the loan term ($175,000 p.a.).
  • Loan interest rate: Interest free.
  • Term: 4 years.

Interest is calculated on the amount outstanding at the beginning of the year. If borrowing in the market the market participant would be subject to a rate of 7.45%. Cash flows occur at year end.

Answer:

Initial accounting

As per Illustrative example 1, the loan (A) is separated into a market based loan (B) and the loan discount (C). The market based loan (B) is recognised at fair value using DCF analysis.

However, in this case, the cash receipts for the period only consist of the principal repayments as the concessional loan is interest free. The discount rate for (B) is still 7.45%.

The PV of the future cash flows at the market rate for (B) and at the concessional rate of 0% for (A) are illustrated in the following table:

Table 1: Discounted cash flow analysis

 

Year

 

Principal repayment

 

Interest payment at loan rate (0%)

 

Total cash flows

(A)

PV at loan rate
(0%)

(B)

PV at market rate (7.45%)

1

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)1)

$162,866
(175,000 / (1.0745)1)

2

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)2)

$151,574
(175,000 / (1.0745)2)

3

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)3)

$141,065
(175,000 / (1.0745)3)

4

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)4)

$131,284
(175,000 / (1.0745)4)

Total

$700,000

$-

$700,000

$700,000

$586,789

 

The difference between the interest free loan (A) and the market based loan (B) is:

Loan discount (C) = $700,000 – $586,789 = $113,211

 

At 1 July 20X0, the entity posts the following journal to recognise the fair value of the market based loan component and to expense the associated loan discount component:

Dr. 2423001 Concessional loan discount (expense) $113,211
Dr. Financial asset (loan receivable)  $586,789
Cr. Cash    $700,000

Subsequent accounting

As per Illustrative example 1, the entity classifies the market based loan as a loan and receivable financial asset measured at amortised cost using the EIM (the EIR is 7.45% using Excel’s Goal Seek tool).

The following amortisation schedule outlines the amortisation of the market based loan:

Table 2: Amortisation schedule – market based loan

 

Year

(a)

Opening amortised cost

(b) = (a) x EIR

Income (using EIM)
(EIR: 7.45%)

(c)

Cash flows*

(d) = (a) + (b) – (c)

Amortised cost at year end

1

$586,789^

$43,716

$175,000

$455,505

2

$455,505

$33,935

$175,000

$314,440

3

$314,440

$23,426

$175,000

$162,866

4

$162,866

$12,134

$175,000

$-

*See Table 1 column ‘total cash flows’ above.
^See Table 1 column ‘(B)’ above.

The following table illustrates the unwinding of the loan discount:

Table 3: Calculation of unwinding of discount and unexpired discount

 

Year

(a)

Opening loan discount

(b)

Income (using EIM)*

(c)

Interest income^

(d) = (b) – (c)

Income from unwinding of discount

(e) = (a) – (d)

Unexpired loan discount at year end

1

$113,211

$43,716

$-

$43,716

$69,495

2

$69,495

$33,935

$-

$33,935

$35,560

3

$35,560

$23,426

$-

$23,426

$12,134

4

$12,134

$12,134

$-

$12,134

$-

Total

 

 

$-

$113,211

 

*See Table 2 column ‘(b)’ above.
^See Table 1 column ‘interest payment’ above.
See the ‘loan discount’ formula above.

The following journals will be posted at the end of each financial year (note no interest income):

 

30/06/X1

$

30/06/X2

$

30/06/X3

$

30/06/X4

$

Dr. Cash

175,000

175,000

175,000

175,000

Cr. Financial asset (loan receivable)

175,000

175,000

175,000

175,000

To recognise the principal repayments ($175,000 p.a.)

 

 

 

 

Dr. Financial asset (loan receivable)

43,716

33,935

23,426

12,134

Cr. 1234001 Unwind concessional loan discount (income)

43,716

33,935

23,426

12,134

To recognise the unwinding of the discount
(Table 3 column ‘(d)’)

 

 

 

 

Illustrative example 3: Below market rate loan with grace period

Information:

On 1 July 20X0, an entity agrees to provide a $700,000 loan to a NFP organisation. The loan is provided on the following terms:

  • Principal: $700,000 to be repaid in four equal instalments ($175,000 p.a.) from Year 3 to Year 6.
  • Loan interest rate: 3.45%.
  • Term: 6 years, with a grace period of no principal repayments for Years 1-2.

Interest is calculated on the amount outstanding at the beginning of the year. If borrowing in the market the market participant would be subject to a rate of 7.45%. Cash flows occur at year end.

Answer:

Initial accounting

As per Illustrative example 1, the loan (A) is separated into a market based loan (B) and the loan discount (C). The market based loan (B) is recognised at fair value using DCF analysis.

However, in this case, whilst the cash receipts consist of both the principal and interest repayments, the principal repayments do not apply during the grace period but interest still applies. The discount rate for (B) is still 7.45%.

The PV of the future cash flows at the market rate for (B) and at the concessional rate of 3.45% for (A) are illustrated in the following table:

Table 1: Discounted cash flow analysis

 

Year

 

Principal repayment

 

Interest payment at loan rate (3.45%)

 

Total cash flows

(A)

PV at loan rate
(3.45%)

(B)

PV at market rate (7.45%)

1

$-

$24,150
(700,000 x 0.0345)

$24,150

$23,345
(24,150 / (1.0345)1)

$22,476
(24,150 / (1.0745)1)

2

$-

$24,150
(700,000 x 0.0345)

$24,150

$22,566
(24,150 / (1.0345)2)

$20,917
(24,150 / (1.0745)2)

3

$175,000

$24,150
(700,000 x 0.0345)

$199,150

$179,882
(199,150 / (1.0345)3)

$160,532
(199,150 / (1.0745)3)

4

$175,000

$18,113
(525,000 x 0.0345)

$193,113

$168,612
(193,113 / (1.0345)4)

$144,872
(193,113 / (1.0745)4)

5

$175,000

$12,075
(350,000 x 0.0345)

$187,075

$157,893
(187,075 / (1.0345)5)

$130,612
(187,075 / (1.0745)5)

6

$175,000

$6,038
(175,000 x 0.0345)

$181,038

$147,702
(181,038 / (1.0345)6)

$117,633
(181,038 / (1.0745)6)

Total

$700,000

$108,676

$808,676

$700,000

$597,042

 

The difference between the concessional loan (A) and the market based loan (B) is:

Loan discount (C) = $700,000 – $597,042 = $102,958

At 1 July 20X0, the entity posts the following journal to recognise the fair value of the market based loan component and to expense the associated loan discount component:

Dr. 2423001 Concessional loan discount (expense) $102,958
Dr. Financial asset (loan receivable) $597,042
Cr. Cash $700,000

                                                             

Subsequent accounting

As per Illustrative example 1, the entity classifies the market based loan as a loan and receivable financial asset measured at amortised cost using the EIM (the EIR is 7.45% using Excel’s Goal Seek tool).

The following amortisation schedule outlines the amortisation of the market based loan:

Table 2: Amortisation schedule – market based loan

 

Year

(a)

Opening amortised cost

(b) = (a) x EIR

Income (using EIM)
(EIR: 7.45%)

(c)

Cash flows*

(d) = (a) + (b) – (c)

Amortised cost at year end

1

$597,042^

$44,480

$24,150

$617,372

2

$617,372

$45,994

$24,150

$639,216

3

$639,216

$47,622

$199,150

$487,688

4

$487,688

$36,333

$193,113

$330,908

5

$330,908

$24,653

$187,075

$168,486

6

$168,486

$12,552

$181,038

$-

*See Table 1 column ‘total cash flows’ above.
^See Table 1 column ‘(B)’ above.

 

The following table illustrates the unwinding of the loan discount:

Table 3: Calculation of unwinding of discount and unexpired discount

 

Year

(a)

Opening loan discount

(b)

Income (using EIM)*

(c)

Interest income^

(d) = (b) – (c)

Income from unwinding of discount

(e) = (a) – (d)

Unexpired loan discount at year end

1

$102,958

$44,480

$24,150

$20,330

$82,628

2

$82,628

$45,994

$24,150

$21,844

$60,784

3

$60,784

$47,622

$24,150

$23,472

$37,312

4

$37,312

$36,333

$18,113

$18,220

$19,092

5

$19,092

$24,653

$12,075

$12,578

$6,514

6

$6,514

$12,552

$6,038

$6,514

$-

Total

 

 

$108,676

$102,958

 

*See Table 2 column ‘(b)’ above.
^See Table 1 column ‘interest payment’ above.
See the ‘loan discount’ formula above.

 

The following journals will be posted at the end of each financial year (note grace period):

 

30/06/X1

$

30/06/X2

$

30/06/X3

$

30/06/X4

$

30/06/X5

$

30/06/X6

$

Dr. Cash

-

-

175,000

175,000

175,000

175,000

Cr. Financial asset (loan receivable)

-

-

175,000

175,000

175,000

175,000

To recognise the principal repayments ($175,000 p.a. excluding the grace period)

 

 

 

 

 

 

Dr. Cash

24,150

24,150

24,150

18,113

12,075

6,038

Cr. Interest income

24,150

24,150

24,150

18,113

12,075

6,038

To recognise interest income
(Table 3 column ‘(c)’)

 

 

 

 

 

 

Dr. Financial asset (loan receivable)

20,330

21,844

23,472

18,220

12,578

6,514

Cr. 1234001 Unwind concessional loan discount (income)

20,330

21,844

23,472

18,220

12,578

6,514

To recognise the unwinding of the discount (Table 3 column ‘(d)’)

 

 

 

 

 

 

Illustrative example 4: Interest free loan with grace period

Information:

On 1 July 20X0, an entity agrees to provide a $700,000 loan to a NFP organisation. The loan is provided on the following terms:

  • Principal: $700,000 to be repaid evenly over the loan term ($175,000 p.a.).
  • Loan interest rate: Interest free. (per Illustrative example 2)
  • Term: 6 years, with a grace period of no principal repayments for Years 1-2. (per Illustrative example 3).

Interest is calculated on the amount outstanding at the beginning of the year. If borrowing in the market the market participant would be subject to a rate of 7.45%. Cash flows occur at year end.

Answer:

Initial accounting

As per the other Illustrative examples, the loan (A) is separated into a market based loan (B) and the loan discount (C). The market based loan (B) is recognised at fair value using DCF analysis.

However, while the cash receipts only consist of the principal repayments as interest free (as in Illustrative example 2), the repayments do not apply during the grace period (as in Illustrative example 3). The discount rate for (B) is still 7.45%.

The PV of the future cash flows at the market rate for (B) and at the concessional rate of 0% for (A) are illustrated in the following table:

Table 1: Discounted cash flow analysis

 

Year

 

Principal repayment

 

Interest payment at loan rate (0%)

 

Total cash flows

(A)

PV at loan rate
(0%)

(B)

PV at market rate (7.45%)

1

$-

$-

$-

$-

$-

2

$-

$-

$-

$-

$-

3

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)3)

$141,065
(175,000 / (1.0745)3)

4

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)4)

$131,284
(175,000 / (1.0745)4)

5

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)5)

$122,182
(175,000 / (1.0745)5)

6

$175,000

$-

$175,000

$175,000
(175,000 / (1.0000)6)

$113,710
(175,000 / (1.0745)6)

Total

$700,000

$-

$700,000

$700,000

$508,241

 

The difference between the interest free loan (A) and the market based loan (B) is:

Loan discount (C) = $700,000 – $508,241 = $191,759

At 1 July 20X0, the entity posts the following journal to recognise the fair value of the market based loan component and to expense the associated loan discount component:

Dr.   2423001 Concessional loan discount (expense) $191,759
Dr. Financial asset (loan receivable)  $508,241
Cr. Cash $700,000

 

Subsequent accounting

As per Illustrative example 1, the entity classifies the market based loan as a loan and receivable financial asset measured at amortised cost using the EIM (the EIR is 7.45% using Excel’s Goal Seek tool).

The following amortisation schedule outlines the amortisation of the market based loan:

Table 2: Amortisation schedule – market based loan

 

Year

(a)

Opening amortised cost

(b) = (a) x EIR

Income (using EIM)
(EIR: 7.45%)

(c)

Cash flows*

(d) = (a) + (b) – (c)

Amortised cost at year end

1

$508,241^

$37,864

$-

$546,105

2

$546,105

$40,685

$-

$586,790

3

$586,790

$43,715

$175,000

$455,505

4

$455,505

$33,935

$175,000

$314,440

5

$314,440

$23,426

$175,000

$162,866

6

$162,866

$12,134

$175,000

$-

*See Table 1 column ‘total cash flows’ above.
^See Table 1 column ‘(B)’ above.

The following table illustrates the unwinding of the loan discount:

Table 3: Calculation of unwinding of discount and unexpired discount

 

Year

(a)

Opening loan discount

(b)

Income (using EIM)*

(c)

Interest income^

(d) = (b) – (c)

Income from unwinding of discount

(e) = (a) – (d)

Unexpired loan discount at year end

1

$191,759

$37,864

$-

$37,864

$153,895

2

$153,895

$40,685

$-

$40,685

$113,210

3

$113,210

$43,715

$-

$43,715

$69,495

4

$69,495

$33,935

$-

$33,935

$35,560

5

$35,560

$23,426

$-

$23,426

$12,134

6

$12,134

$12,134

$-

$12,134

$-

Total

 

 

$-

$191,759

 

*See Table 2 column ‘(b)’ above.
^See Table 1 column ‘interest payment’ above.
See the ‘loan discount’ formula above.

The following journals will be posted at the end of each financial year (note grace period and no interest income):

 

30/06/X1

$

30/06/X2

$

30/06/X3

$

30/06/X4

$

30/06/X5

$

30/06/X6

$

Dr. Cash

-

-

175,000

175,000

175,000

175,000

Cr. Financial asset (loan receivable)

-

-

175,000

175,000

175,000

175,000

To recognise the principal repayments ($175,000 p.a. excluding the grace period)

 

 

 

 

 

 

Dr. Financial asset (loan receivable)

37,864

40,685

43,715

33,935

23,426

12,134

Cr. 1234001 Unwind concessional loan discount (income)

37,864

40,685

43,715

33,935

23,426

12,134

To recognise the unwinding of the discount (Table 3 column ‘(d)’)

 

 

 

 

 

 


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