Below market rate loans

Below market rate loans Parent lending to subsidiary Subsdiary lending to parent Loans between subsidiaries Example 1a Example 1b Example 2a Example 2b Example 3a Example 3b Fixed term loan with no demand Repayable on demand at the Fixed term loan with no demand Repayable on demand at the Fixed term loan with no demand Repayable on demand at the features, or subsidiary has early repayment option option of the parent features, or parent has early repayment option option of the subsidiary features, or borrower has early repayment option option of the lender Lender Parent recognises loan at fair difference recognised as an investment in subsidiary. Parent recognises loan at fair difference recognised as an investment in subsidiary. Subsidiary recognises loan at fair difference recognised as a distribution to parent. Subsidiary recognises loan at fair difference recognised as a distribution to parent. Lender recognises loan at fair difference recognised as interest expense or distribution if done under instruction of parent. Lender recognises loan at fair difference recognised as interest expense or possibly a distribution. Borrower Subsidiary recognises loan at fair Subsidiary recognises loan at amount payable (discounted difference recognised as a capital from the demand date, if contribution. material). Parent recognises loan at fair difference recognised as income from subsidiary. Parent recognises loan at amount payable (discounted from the demand date, if material) Borrower recognises loan at fair Borrower recognises loan at amount payable (discounted difference recognised as interest from the demand date, if income or capital contribution if material) done under instruction of parent. Comments Treatment reflects that the parent contributed to the subsidiary by lending the subsidiary funds at a below market rate. Treatment reflects that the subsidiary has made a distribution to the parent by lending the parent funds at an below market rate. Notes See Note 1. See Note 2. and 3. See Note 1. See Note 2 and 3. See Note 1. See Note 2 and 3. Note 1 - If the term loan is below market rate, and the borrower has the option to repay the loan early, then we consider the accounting would normally be the same for a fixed rate loan without the option. This is because the below market nature of the loan would be such that on an arms length basis, the option would not be expected to be exercised. Note 2 - Based on arm's length behaviour, a lender would immediately give notice for repayment as the loan is below market rate. However, a consideration is that the lender might not be able to get the funds back immediately if the proceeds have already been invested in a project. This situation could, therefore, have measurement implications for the lender as the fair value of the loan would not necessarily be the same as the loan amount. Note 3 - From the borrower perspective, the loan is repayable immediately on demand. FRS 102.12.11 means that the fair value of a loan that is due on demand is not less than the amount repayable discounted from the demand date. In this case the lender and borrower accounting would not be a mirror image.

Above market rate loans Parent lending to subsidiary Example 4a Fixed term loan with no demand features, or parent has early repayment option Example 4b Repayable on demand at the option of the subsidiary Lender Parent recognises loan at fair difference recognised as income from subsidiary. Parent recognises loan at amount repayable. (discounted from the demand date, if material). Borrower Subsidiary recognises loan at fair difference recognised as a distribution to parent. Subsidiary recognises loan at amount repayable. (discounted from the demand date, if material). Comments This treatment also reflects that the subsidiary has made a distribution to the parent by borrowing funds at an above market rate. Notes See Note 4 and 5. Note 6. Note 4 - If the parent (lender) has the right to immediately demand, the borrower should not record the loan at less than the amount repayable. FRS 102.12.11. However, as the loan is above market rate the fair value of the loan is greater than the nominal amount payable. Hence, despite the lender's demand feature the borrower should also recognise the loan at fair value, which is higher than nominal amount. Note 5 - A term loan where the lender has the option to early repay, would in the case of an above market rate loan, likely be accounted for in the same way as a term loan without the early repayment feature. This is because the above market nature of the loan would be such that on an arms length basis, the option would not be expected to be exercised Note 6 - Assuming arm's length behaviour, the lender could expect that the borrower would exercise their right to repay immediately and borrow the funds from the market at the lower market rate. Therefore, the fair value should assume immediate exercise, resulting in the loan being recognised at the immediately repayable amount. In some cases there may be a challenge that the fair value is different to the amount repayable if there was practical restriction on the ability of the subsidiary to exercise its option (eg lack of availability of funds or alternative sources).

Example 1a - Parent lending to subsidiary - Fixed term loan with no demand features, or subsidiary has early repayment option, Below market rate Repayment date 31-Dec-15 2015 105,000 0.8264 86,777 Current UK GAAP: FRS 102: 31-Dec-14 100,000 5,000 5,000 100,000 31-Dec-14 91,322 9,132 5,000 95,455 31-Dec-15 100,000 5,000 105,000-31-Dec-15 95,455 9,545 105,000 - Dr. Loan receivable 100,000 Dr. Loan receivable - Balance sheet 91,322 Cr. Bank 100,000 Dr. Investment in subsidiary - Balance sheet 8,678 Dr. Bank 5,000 Cr. Interest income 5,000 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,132 Cr. Interest income - Profit and loss 9,132 Dr. Bank 105,000 Cr. Interest income 5,000 Cr. Loan receivable 100,000 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,545 Cr. Interest income - Profit and loss 9,545 Dr. Bank 100,000 Cr. Loan payable 100,000 Cr. Bank 5,000 Cr. Loan payable - Balance sheet 91,322 Cr. Capital contribution - Equity 8,678 Dr. Loan payable 100,000 Cr. Bank 105,000 Dr. Interest expense - Profit and loss 9,132 Cr. Bank - Balance sheet 5,000 Cr. Loan payable - Balance sheet 4,132 Dr. Interest expense - Profit and loss 9,545 Cr. Bank - Balance sheet 5,000 Cr. Loan payable - Balance sheet 4,545

Example 1b - Parent lending to subsidiary - Repayable on demand at the option of the parent, Below market rate Repayment date On demand (Only expected to be able to repay after 2 years) 2015 105,000 0.8264 86,777 Note - Based on arm's length behaviour, a lender would immediately give notice for repayment as the loan is below market rate. However, a consideration is that the lender might not be able to get the funds back immediately if the proceeds have already been invested in a project. In this case the lender only expects the borrower to be able to repay the loan in 2 years time. FRS 102: Current UK GAAP: 31-Dec-14 91,322 9,132 5,000 95,455 31-Dec-15 95,455 9,545 105,000-31-Dec-14 100,000 5,000 5,000 100,000 31-Dec-15 100,000 5,000 105,000 - Dr. Loan receivable - Balance sheet 91,322 Dr. Investment in subsidiary - Balance sheet 8,678 Dr. Loan receivable 100,000 Cr. Bank 100,000 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,132 Dr. Bank 5,000 Cr. Interest income - Profit and loss 9,132 Cr. Interest income 5,000 Dr. Bank - Balance sheet 5,000 Dr. Bank 105,000 Dr. Loan receivable - Balance sheet 4,545 Cr. Interest income 5,000 Cr. Interest income - Profit and loss 9,545 Cr. Loan receivable 100,000 Dr. Bank 100,000 Cr. Loan payable 100,000 Cr. Loan payable - Balance sheet 100,000 Cr. Bank 5,000 Dr. Interest expense - Profit and loss 5,000 Cr. Bank - Balance sheet 5,000 Dr. Loan payable 100,000 Cr. Bank 105,000 Dr. Interest expense - Profit and loss 5,000 Cr. Bank - Balance sheet 5,000

Example 2a - Subsidiary lending to parent - Fixed term loan with no demand features, or parent has early repayment option, Below market rate Repayment date 31-Dec-15 2015 105,000 0.8264 86,777 Current UK GAAP: FRS 102: 31-Dec-14 100,000 5,000 5,000 100,000 31-Dec-14 91,322 9,132 5,000 95,455 31-Dec-15 100,000 5,000 105,000-31-Dec-15 95,455 9,545 105,000 - Dr. Bank 100,000 Cr. Loan payable 100,000 Cr. Loan payable - Balance sheet 91,322 Cr. Income from subsidiary - Profit and loss 8,678 Cr. Bank 5,000 Dr. Interest expense - Profit and loss 9,132 Cr. Bank - Balance sheet 5,000 Cr. Loan payable - Balance sheet 4,132 Dr. Loan payable 100,000 Cr. Bank 105,000 Dr. Interest expense - Profit and loss 9,545 Cr. Bank - Balance sheet 5,000 Cr. Loan payable - Balance sheet 4,545 Dr. Loan receivable 100,000 Cr. Bank 100,000 Dr. Bank 5,000 Cr. Interest income 5,000 Dr. Loan receivable - Balance sheet 91,322 Dr. Distribution to parent - Equity 8,678 Dr. Bank 105,000 Cr. Interest income 5,000 Cr. Loan receivable 100,000 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,132 Cr. Interest income - Profit and loss 9,132 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,545 Cr. Interest income - Profit and loss 9,545

Example 2b - Subsidiary lending to parent - Repayable on demand at the option of the subsidiary, Below market rate Repayment date On demand (Only expected to be able to repay after 2 years) 2015 105,000 0.8264 86,777 Note - Based on arm's length behaviour, a lender would immediately give notice for repayment as the loan is below market rate. However, a consideration is that the lender might not be able to get the funds back immediately if the proceeds have already been invested in a project. In this case the lender only expects the borrower to be able to repay the loan in 2 years time. FRS 102: 31-Dec-14 91,322 9,132 5,000 95,455 31-Dec-15 95,455 9,545 105,000 - Current UK GAAP: 31-Dec-14 100,000 5,000 5,000 100,000 31-Dec-15 100,000 5,000 105,000 - Cr. Loan payable - Balance sheet 100,000 Dr. Interest expense - Profit and loss 5,000 Dr. Bank 100,000 Cr. Bank - Balance sheet 5,000 Cr. Loan payable 100,000 Dr. Interest expense - Profit and loss 5,000 Cr. Bank - Balance sheet 5,000 Cr. Bank 5,000 Dr. Loan payable 100,000 Cr. Bank 105,000 Dr. Loan receivable - Balance sheet 91,322 Dr. Distribution to parent - Equity 8,678 Dr. Loan receivable 100,000 Cr. Bank 100,000 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,132 Dr. Bank 5,000 Cr. Interest income - Profit and loss 9,132 Cr. Interest income 5,000 Dr. Bank - Balance sheet 5,000 Dr. Bank 105,000 Dr. Loan receivable - Balance sheet 4,545 Cr. Interest income 5,000 Cr. Interest income - Profit and loss 9,545 Cr. Loan receivable 100,000

Example 3a - Loan between subsidiaries - Fixed term loan with no demand features, or borrower has early repayment option, Below market rate Repayment date 31-Dec-15 2015 105,000 0.8264 86,777 Current UK GAAP: FRS 102: 31-Dec-14 100,000 5,000 5,000 100,000 31-Dec-14 91,322 9,132 5,000 95,455 31-Dec-15 100,000 5,000 105,000-31-Dec-15 95,455 9,545 105,000 - Subsidiary (borrower) accounts Subsidiary (borrower) accounts Dr. Bank 100,000 Cr. Loan payable 100,000 Cr. Loan payable - Balance sheet 91,322 Cr. Interest income(profit and loss) / Capital contribution(equity) 8,678 Cr. Bank 5,000 Dr. Interest expense - Profit and loss 9,132 Cr. Bank - Balance sheet 5,000 Cr. Loan payable - Balance sheet 4,132 Dr. Loan payable 100,000 Cr. Bank 105,000 Dr. Interest expense - Profit and loss 9,545 Cr. Bank - Balance sheet 5,000 Cr. Loan payable - Balance sheet 4,545 Subsidiary (lender) accounts Dr. Loan receivable 100,000 Cr. Bank 100,000 Subsidiary (lender) accounts Dr. Bank 5,000 Cr. Interest income 5,000 Dr. Loan receivable - Balance sheet 91,322 Dr. Interest expense(profit and loss) / Distribution(Equity) 8,678 Dr. Bank 105,000 Cr. Interest income 5,000 Cr. Loan receivable 100,000 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,132 Cr. Interest income - Profit and loss 9,132 Dr. Bank - Balance sheet 5,000 Dr. Loan receivable - Balance sheet 4,545 Cr. Interest income - Profit and loss 9,545

Example 3b - Loan between subsidiaries - Repayable on demand at the option of the lender, Below market rate Repayment date On demand (Only expected to be able to repay after 2 years) 2015 105,000 0.8264 86,777 Note - Based on arm's length behaviour, a lender would immediately give notice for repayment as the loan is below market rate. However, a consideration is that the lender might not be able to get the funds back immediately if the proceeds have already been invested in a project. In this case the lender only expects the borrower to be able to repay the loan in 2 years time. FRS 102: Current UK GAAP: 31-Dec-14 91,322 9,132 5,000 95,455 31-Dec-15 95,455 9,545 105,000-31-Dec-14 100,000 5,000 5,000 100,000 Subsidiary (borrower) accounts 31-Dec-15 100,000 5,000 105,000 - Subsidiary (borrower) accounts Cr. Loan payable - Balance sheet 100,000 Dr. Bank 100,000 Cr. Loan payable 100,000 Dr. Interest expense - Profit and loss 5,000 Cr. Bank - Balance sheet 5,000 Cr. Bank 5,000 Dr. Interest expense - Profit and loss 5,000 Cr. Bank - Balance sheet 5,000 Dr. Loan payable 100,000 Cr. Bank 105,000 Subsidiary (lender) accounts Subsidiary (lender) accounts Dr. Loan receivable - Balance sheet 91,322 Dr. Loan receivable 100,000 Dr. Interest expense(profit and loss) / Distribution(Equity) 8,678 Cr. Bank 100,000 Dr. Bank 5,000 Dr. Bank - Balance sheet 5,000 Cr. Interest income 5,000 Dr. Loan receivable - Balance sheet 4,132 Cr. Interest income - Profit and loss 9,132 Dr. Bank 105,000 Cr. Interest income 5,000 Dr. Bank - Balance sheet 5,000 Cr. Loan receivable 100,000 Dr. Loan receivable - Balance sheet 4,545 Cr. Interest income - Profit and loss 9,545

Example 4a - Parent lending to subsidiary - Fixed term loan with no demand features, or parent has early repayment option, Above market rate Interest rate 15% Cash flows Discount factor Present value Loan date 01-Jan-14 2014 15,000 0.9091 13,636 Repayment date 31-Dec-15 2015 115,000 0.8264 95,041 Market rate 10% 108,678 Current UK GAAP: FRS 102: 31-Dec-14 100,000 15,000 15,000 100,000 31-Dec-14 108,678 10,868 15,000 104,545 31-Dec-15 100,000 15,000 115,000-31-Dec-15 104,545 10,455 115,000 - Dr. Loan receivable 100,000 Dr. Loan receivable - Balance sheet 108,678 Cr. Bank 100,000 Cr. Income from subsidiary - Profit and loss 8,678 Dr. Bank 15,000 Cr. Interest income 15,000 Dr. Bank - Balance sheet 15,000 Cr. Loan receivable - Balance sheet 4,132 Cr. Interest income - Profit and loss 10,868 Dr. Bank 115,000 Cr. Interest income 15,000 Cr. Loan receivable 100,000 Dr. Bank - Balance sheet 15,000 Cr. Loan receivable - Balance sheet 4,545 Cr. Interest income - Profit and loss 10,455 Dr. Bank 100,000 Cr. Loan payable 100,000 Dr. Interest expense 15,000 Cr. Bank 15,000 Dr. Distribution to parent - Equity 8,678 Cr. Loan payable - Balance sheet 108,678 Dr. Loan payable 100,000 Dr. Interest expense 15,000 Cr. Bank 115,000 Dr. Interest expense - Profit and loss 10,868 Dr. Loan payable - Balance sheet 4,132 Cr. Bank - Balance sheet 15,000 Dr. Interest expense - Profit and loss 10,455 Dr. Loan payable - Balance sheet 4,545 Cr. Bank - Balance sheet 15,000

Example 4b - Parent lending to subsidiary - Repayable on demand at the option of the subsidiary, Above market rate Interest rate 15% Loan date 01-Jan-14 Repayment date On demand Market rate 10% Note - Assuming arm's length behaviour, the lender could expect that the borrower would exercise their right to repay immediately and borrow the funds from the market at the lower market rate. Therefore, the fair value should assume immediate exercise, resulting in the loan being recognised at the immediately repayable amount. In some cases there may be a challenge that the fair value is different to the amount repayable if there was practical restriction on the ability of the subsidiary to exercise its option (eg lack of availability of funds or alternative sources). Current UK GAAP: FRS 102: 31-Dec-14 100,000 15,000 15,000 100,000 31-Dec-14 100,000 15,000 15,000 100,000 31-Dec-15 100,000 15,000 115,000-31-Dec-15 100,000 15,000 115,000 - Dr. Loan receivable 100,000 Dr. Loan receivable - Balance sheet 100,000 Cr. Bank 100,000 Dr. Bank 15,000 Dr. Bank - Balance sheet 15,000 Cr. Interest income 15,000 Cr. Interest income - Profit and loss 15,000 Dr. Bank 115,000 Dr. Bank - Balance sheet 15,000 Cr. Interest income 15,000 Cr. Interest income - Profit and loss 15,000 Cr. Loan receivable 100,000 Dr. Bank 100,000 Cr. Loan payable 100,000 Cr. Loan payable - Balance sheet 100,000 Dr. Interest expense 15,000 Cr. Bank 15,000 Dr. Interest expense - Profit and loss 15,000 Cr. Bank - Balance sheet 15,000 Dr. Loan payable 100,000 Dr. Interest expense 15,000 Cr. Bank 115,000 Dr. Interest expense - Profit and loss 15,000 Cr. Bank - Balance sheet 15,000