IFRS 9 and intercompany loans
It is important not to underestimate the challenges of applying the new IFRS 9 model to intercompany loans.
The majority of related company loans (including intragroup loans as well as loans to associates or joint ventures) are debt instruments that fall within the scope of IFRS 9. This means that even though some loans may seem similar to a capital contribution, they should typically be accounted for in accordance with IFRS 9 instead of IAS 27 (i.e. at cost less impairment) or IAS 28 (i.e. using the equity method).
Similarly, a loan to an associate or joint venture that is not equity accounted but, in substance, forms part of the net investment (i.e. a long-term interest) is also within the scope of IFRS 9.
This means that a loan could be subject to both the IFRS 9 Expected Credit Loss (ECL) requirements, and the impairment requirements of IAS 28.
Undocumented loans are typically considered to be repayable on demand from a legal perspective and also fall within the scope of IFRS 9. In some jurisdictions, it is possible that under local laws an undocumented loan is considered a capital contribution. In such cases, entities should consider seeking legal advice to support this conclusion.
While many related company loans will meet the criteria to be classified at amortised cost because they are held in a ‘hold to collect’ business model and meet the ‘solely payments of principal and interest’ (SPPI) test, this cannot always be assumed to be the case.
For example, loans that are linked to underlying asset or borrower performance, such as a profit-linked loan, will fail the SPPI test. In addition, certain non-recourse loans, i.e. loans where the debtor’s claim is limited to specified assets, may also fail the SPPI test. In these cases, the loan must be classified at Fair Value through Profit Loss (FVPL) irrespective of the business model in which it is held.
All related company loan receivables (including term loans and demand loans) that are not classified at FVPL are within the scope of IFRS 9’s ECL requirements and are subject to the General Approach (unless the loan is credit impaired at initial recognition).
Under the General Approach, at each reporting date the lender must determine whether the loan is in Stage 1, Stage 2 or Stage 3 and recognise 12-month ECL or Lifetime ECL accordingly. Related company loans are never eligible for the Simplified Approach.
This means that a minimum of 12-month ECL must be provided for all loans, including those that are not past due and are considered to be of a high credit quality.
This new forward-looking model is a major change from the previous incurred loss model and entities should not underestimate the application challenges it presents. This includes:
- Sourcing and incorporating forward-looking information.
- Assessing for significant increases in credit risk.
- Estimating a risk of default.
- Estimating the ECL.