Resource Management Guide No Accounting for concessional loans

Transcription

1 Resource Management Guide No. 115 Accounting for concessional loans NOVEMBER 2014

2 Commonwealth of Australia 2014 ISBN: (Online) With the exception of the Commonwealth Coat of Arms and where otherwise noted, all material presented in this document is provided under a Creative Commons Attribution 3.0 Australia ( licence. The details of the relevant licence conditions are available on the Creative Commons website (accessible using the links provided) as is the full legal code for the CC BY 3 AU licence. Use of the Coat of Arms The terms under which the Coat of Arms can be used are detailed on the following website: Contact us Questions or comments about this guide should be directed to: Public Management Reform Agenda Department of Finance John Gorton Building King Edward Terrace Parkes ACT pmra@finance.gov.au Internet: This guide contains material that has been prepared to assist Commonwealth entities and companies to apply the principles and requirements of the Public Governance, Performance and Accountability Act 2013 and associated rules, and any applicable policies. In this guide the: mandatory principles or requirements are set out as things entities and officials must do; and actions, or practices, that entities and officials are expected to take into account to give effect to those and principles and/or requirements are set out as things entities and officials should consider doing.

3 Audience This Guide applies to: CFOs and CFO Units in all Commonwealth entities that issue concessional loans. This guide is designed to be read in conjunction with the relevant Australian Accounting Standards. Key points Purpose: To provide guidance on accounting for concessional loans, including ing using the effective interest method and the unwinding of the. 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. Aim: To provide non-mandatory explanation and examples relating to the interpretation and application of Australian Accounting Standards and the PGPA Financial Reporting Rule (FRR) to the above entities. Reference previous guidance: This guide replaces Accounting Guidance Note No. 2010/2. Resources This guide is available on the Department of Finance website at Applicable accounting pronouncements AASB 139 Financial Instruments: Recognition and Measurement Commonwealth Entities Financial Statements Guide (incorporating the FRR) Chapter 34 Financial Instruments Contact information For further information or clarification, please Budget Estimates and Accounting (BEA) at 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 ed rate and is referred to as the loan. (A) Concessional loan (B) Market based loan (C) Loan Practical guidance As demonstrated above, the value of the concessional loan comprises of a market based loan and a loan component. Resource Management Guide 115 Accounting for concessional loans 1

4 Dr Concessional loan (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) 2. On initial recognition, the components that make-up the concessional loan (A), being the market based loan (B) and the loan (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 component (C) 3. 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: 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. 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 (see AASB 139.AG13 for more information). 4. It is unlikely that the default category of available-for-sale will be applicable for concessional loans as they generally meet the definition of loans and receivables. 5. 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. 6. A commonly used valuation technique for such financial instruments is ed cash flow (DCF) analysis 1. Under DCF analysis the fair value of the market based loan is estimated as the present value of all future cash receipts ed using the prevailing market(s) rate of interest the market participant 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 ed 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, if an entity provides a concessional loan to a foreign country the cash flows would be ed by the rate the foreign country would be required to pay if it borrowed in the market if the concessional loan was not provided. 1 This technique falls under the income approach for AASB 13 Fair Value Measurement. Resource Management Guide 115 Accounting for concessional loans 2

5 Expert advice may be necessary to determine the 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 AASB 139 paragraph 43A and AASB 13. Step 1: Initial accounting market based loan component (B) Step 2: Initial accounting loan component (C) 7. The component of the concessional loan is immediately recognised as an expense in the Statement of Comprehensive Income (SOCI). The 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 component (C) 8. Subsequent accounting treatment of the market based loan component depends on the category of financial asset chosen (see paragraph 3 above). 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 (see contact information underneath Resources above) for additional guidance. 9. 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. 10. The amortised cost of the market based loan can be calculated as follows: The carrying amount of the market based loan at initial recognition (b) Add Interest income accrued using the effective interest method (EIM) Less Principal and interest repayments (Cash flows) Less (d) Equals Amortised cost Reduction for impairment or uncollectibility (if any) Resource Management Guide 115 Accounting for concessional loans 3

6 Carrying amount of market based loan (amortised cost) 11. 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 above. (b) Income (using the effective interest method (EIM)) 12. 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. 13. The effective interest rate (EIR) is the rate that exactly s 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 s 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. 14. Income calculated using the EIM can be further separated into two components: interest income and unwinding of the (see Step 4: Subsequent accounting loan component). Cash flows Principal and interest repayments 15. Cash flows basically consist of principal and interest payments received. Practical guidance If a grace period applies, see Appendix 1 Illustrative examples 3 and 4. (d) Amortised cost If the issued loan is interest free, see Appendix 1 Illustrative examples 2 and 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): Opening amortised cost (b) = x EIR Income (using EIM) (EIR: 7.45%) Cash flows (d) = + (b) Amortised cost at year end 1 639,216 47, , , ,688 36, , , ,908 24, , , ,486 12, ,038 - Resource Management Guide 115 Accounting for concessional loans 4

7 Step 3: Subsequent accounting market based loan component (B) Step 4: Subsequent accounting loan component (C) 17. The loan 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 expense of 100. On initial recognition the market based loan component was recognised in the SOFP and the component was expensed: Dr Concessional loan (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 : Dr. Financial asset (loan receivable) 50 Cr Unwind concessional loan (income)* 50 *The unwinding of the concessional loan expense is to be recorded in account Unwind concessional loan as part of interest and dividends. At the end of year 2 the 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) The unwinding of the (d) is the difference between interest income calculated under the EIM (b) and interest income calculated using the loan s interest rate, as demonstrated in the table below (extracted from Appendix 1 Illustrative example 1 Table 3): Opening loan (b) Income (using EIM) Interest income (d) = (b) Income from unwinding of (e) = (d) Unexpired loan at year end 1 60,784 47,622 24,150 23,472 37, ,312 36,333 18,113 18,220 19, ,092 24,653 12,075 12,578 6, ,514 12,552 6,038 6,514 - Resource Management Guide 115 Accounting for concessional loans 5

8 Disclosure requirements 19. Disclosure of financial instruments in general is required by AASB 7 Financial Instruments: Disclosures and PRIMA Forms. Furthermore, AASB 13 requires additional fair value measurement disclosures as laid out in PRIMA Forms (subject to AASB 7 paragraph 29 etc). Budget implications 20. 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 2. Initial recognition - component Nil impact (no impact on net operating balance from operations or nonfinancial assets) Worsen ( expense reduces net operating balance) Nil impact (loan component is treated as an investment in financial assets cash outflow not an operating outflow) Nil impact (no cash inflow/outflow) 3. Principal repayment Nil impact (no impact on net operating balance from operations or nonfinancial assets) Nil impact (principal repayment is treated as an investment in financial assets cash inflow) 4. Cash interest received (interest income) Improve (interest income increases revenue) Improve (interest cash inflow (receipts) treated as an operating cash inflow) 5. Unwinding of 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. Resource Management Guide 115 Accounting for concessional loans 6

9 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 AASB 139.9). 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 s 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 s. 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 AASB 139.9). 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 (AASB 13.A). A financial asset is any asset that is: cash; (b) an equity instrument of another entity; a contractual right: (i) to receive cash or another financial asset from another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or (d) a contract that will or may be settled in the entity s own equity instruments and is: (i) 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 (ii) 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 AASB ). 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 (AASB ). Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than: 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; (b) those that the entity upon initial recognition designates as available for sale; or 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 AASB 139.9). Resource Management Guide 115 Accounting for concessional loans 7

10 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 pa). 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 component (C). The market based loan (B) is recognised at fair value using ed 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 + rate) Time period Where cash flows is the cash receipts for the period (the principal and interest repayments); the 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 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 ) 2 175,000 18,113 (525,000 x ) 3 175,000 12,075 (350,000 x ) 4 175,000 6,038 (175,000 x ) 199, ,508 (199,150 / (1.0345) 1 ) 193, ,447 (193,113 / (1.0345) 2 ) 187, ,976 (187,075 / (1.0345) 3 ) 181, ,069 (181,038 / (1.0345) 4 ) 185,342 (199,150 / (1.0745) 1 ) 167,263 (193,113 / (1.0745) 2 ) 150,798 (187,075 / (1.0745) 3 ) 135,814 (181,038 / (1.0745) 4 ) Total 700,000 60, , , ,216 Resource Management Guide 115 Accounting for concessional loans 8

11 The difference between the loan s nominal value at the concessional rate (A) and fair value at the market rate (B) represents the implicit in the loan (C): Loan (C) = (A) s total (B) s total = 700, ,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 component: Dr Concessional loan (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 s estimated future principal and interest receipts through the expected life of the loan: Table 2: Amortisation schedule market based loan Opening amortised cost (b) = x EIR Income (using EIM) (EIR: 7.45%) Cash flows* (d) = + (b) Amortised cost at year end 1 639,216^ 47, , , ,688 36, , , ,908 24, , , ,486 12, ,038 - *See Table 1 column total cash flows above. ^See Table 1 column (B) above. The following table illustrates the unwinding of the loan, which is calculated as the difference between the loan on initial recognition and any subsequent unwinding (writing back) of the component: Table 3: Calculation of unwinding of and unexpired Opening loan (b) Income (using EIM)* Interest income^ (d) = (b) Income from unwinding of (e) = (d) Unexpired loan at year end 1 60,784 47,622 24,150 23,472 37, ,312 36,333 18,113 18,220 19, ,092 24,653 12,075 12,578 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 formula above. Resource Management Guide 115 Accounting for concessional loans 9

12 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 Cr. Financial asset (loan receivable) 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 ) Dr. Financial asset (loan receivable) 23,472 18,220 12,578 6,514 Cr Unwind concessional loan (income) 23,472 18,220 12,578 6,514 To recognise the unwinding of the (Table 3 column (d) ) Resource Management Guide 115 Accounting for concessional loans 10

13 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 pa). 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 (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 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 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 / (1.0000) 1 ) 2 175, , ,000 (175,000 / (1.0000) 2 ) 3 175, , ,000 (175,000 / (1.0000) 3 ) 4 175, , ,000 (175,000 / (1.0000) 4 ) 162,866 (175,000 / (1.0745) 1 ) 151,574 (175,000 / (1.0745) 2 ) 141,065 (175,000 / (1.0745) 3 ) 131,284 (175,000 / (1.0745) 4 ) Total 700, , , ,789 The difference between the interest free loan (A) and the market based loan (B) is: Loan (C) = 700, ,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 component: Dr Concessional loan (expense) 113,211 Dr. Financial asset (loan receivable) 586,789 Cr. Cash 700,000 Resource Management Guide 115 Accounting for concessional loans 11

14 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 Opening amortised cost (b) = x EIR Income (using EIM) (EIR: 7.45%) Cash flows* (d) = + (b) Amortised cost at year end 1 586,789^ 43, , , ,505 33, , , ,440 23, , , ,866 12, ,000 - *See Table 1 column total cash flows above. ^See Table 1 column (B) above. The following table illustrates the unwinding of the loan : Table 3: Calculation of unwinding of and unexpired Opening loan (b) Income (using EIM)* Interest income^ (d) = (b) Income from unwinding of (e) = (d) Unexpired loan at year end 1 113,211 43,716-43,716 69, ,495 33,935-33,935 35, ,560 23,426-23,426 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 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 Cr. Financial asset (loan receivable) 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 Unwind concessional loan (income) 43,716 33,935 23,426 12,134 To recognise the unwinding of the (Table 3 column (d) ) Resource Management Guide 115 Accounting for concessional loans 12

15 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 evenly over the loan term (175,000 pa). Loan interest rate: 3.45%. Term: 6 years, with a grace period of no principal repayments for s 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 (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 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 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 ) 2-24,150 (700,000 x ) 3 175,000 24,150 (700,000 x ) 4 175,000 18,113 (525,000 x ) 5 175,000 12,075 (350,000 x ) 6 175,000 6,038 (175,000 x ) 24,150 23,345 (24,150 / (1.0345) 1 ) 24,150 22,566 (24,150 / (1.0345) 2 ) 199, ,882 (199,150 / (1.0345) 3 ) 193, ,612 (193,113 / (1.0345) 4 ) 187, ,893 (187,075 / (1.0345) 5 ) 181, ,702 (181,038 / (1.0345) 6 ) 22,476 (24,150 / (1.0745) 1 ) 20,917 (24,150 / (1.0745) 2 ) 160,532 (199,150 / (1.0745) 3 ) 144,872 (193,113 / (1.0745) 4 ) 130,612 (187,075 / (1.0745) 5 ) 117,633 (181,038 / (1.0745) 6 ) Total 700, , , , ,042 The difference between the concessional loan (A) and the market based loan (B) is: Loan (C) = 700, ,042 = 102,958 Resource Management Guide 115 Accounting for concessional loans 13

16 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 component: Dr Concessional loan (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 Opening amortised cost (b) = x EIR Income (using EIM) (EIR: 7.45%) Cash flows* (d) = + (b) Amortised cost at year end 1 597,042^ 44,480 24, , ,372 45,994 24, , ,216 47, , , ,688 36, , , ,908 24, , , ,486 12, ,038 - *See Table 1 column total cash flows above. ^See Table 1 column (B) above. The following table illustrates the unwinding of the loan : Table 3: Calculation of unwinding of and unexpired Opening loan (b) Income (using EIM)* Interest income^ (d) = (b) Income from unwinding of (e) = (d) Unexpired loan at year end 1 102,958 44,480 24,150 20,330 82, ,628 45,994 24,150 21,844 60, ,784 47,622 24,150 23,472 37, ,312 36,333 18,113 18,220 19, ,092 24,653 12,075 12,578 6, ,514 12,552 6,038 6,514 - Total 108, ,958 *See Table 2 column (b) above. ^See Table 1 column interest payment above. See the loan formula above. Resource Management Guide 115 Accounting for concessional loans 14

17 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 , , , ,000 Cr. Financial asset (loan receivable) , , , ,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 ) Dr. Financial asset (loan receivable) 20,330 21,844 23,472 18,220 12,578 6,514 Cr Unwind concessional loan (income) 20,330 21,844 23,472 18,220 12,578 6,514 To recognise the unwinding of the (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 pa). Loan interest rate: Interest free. (per Illustrative example 2) Term: 6 years, with a grace period of no principal repayments for s 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 (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 rate for (B) is still 7.45%. Resource Management Guide 115 Accounting for concessional loans 15

18 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 (A) (B) Principal repayment Interest payment at loan rate (0%) Total cash flows PV at loan rate (0%) PV at market rate (7.45%) , , ,000 (175,000 / (1.0000) 3 ) 4 175, , ,000 (175,000 / (1.0000) 4 ) 5 175, , ,000 (175,000 / (1.0000) 5 ) 6 175, , ,000 (175,000 / (1.0000) 6 ) 141,065 (175,000 / (1.0745) 3 ) 131,284 (175,000 / (1.0745) 4 ) 122,182 (175,000 / (1.0745) 5 ) 113,710 (175,000 / (1.0745) 6 ) Total 700, , , ,241 The difference between the interest free loan (A) and the market based loan (B) is: Loan (C) = 700, ,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 component: Dr Concessional loan (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 Opening amortised cost (b) = x EIR Income (using EIM) (EIR: 7.45%) Cash flows* (d) = + (b) Amortised cost at year end 1 508,241^ 37, , ,105 40, , ,790 43, , , ,505 33, , , ,440 23, , , ,866 12, ,000 - *See Table 1 column total cash flows above. ^See Table 1 column (B) above. Resource Management Guide 115 Accounting for concessional loans 16

19 The following table illustrates the unwinding of the loan : Table 3: Calculation of unwinding of and unexpired Opening loan (b) Income (using EIM)* Interest income^ (d) = (b) Income from unwinding of (e) = (d) Unexpired loan at year end 1 191,759 37,864-37, , ,895 40,685-40, , ,210 43,715-43,715 69, ,495 33,935-33, ,426-23,426 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 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 , , , ,000 Cr. Financial asset (loan receivable) , , , ,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 Unwind concessional loan (income) 37,864 40,685 43,715 33,935 23,426 12,134 To recognise the unwinding of the (Table 3 column (d) ) Resource Management Guide 115 Accounting for concessional loans 17