CFM22100 - Accounting for corporate finance: Old UK GAAP excluding FRS 26 lenders: accrual accounting: variable rate loans

The following guidance covers Old UK GAAP (applied before 2015) where FRS 26 was not applied.

Accounting for variable rate loans

A variable rate loan pays interest at an amount linked to a base rate, e.g. a 5 year loan paying interest at LIBOR plus 2%. The amount above LIBOR is negotiated between the lender and the borrower but is dependent primarily on the credit risk of the borrower and the nature of the security granted to the lender. Typically the lender will acquire (give money to the borrower) such a loan at face value. The return to the lender is the interest receivable on the loan.

Under the accruals basis, finance income is recognised in the period to which it relates. Thus any changes in finance income brought about, for example, because of changes in the LIBOR, will be reflected in the period in which the interest rate changes.

Example

On 31 March 2005, Company A lends £1.2M to Company H. The loan has a five year term with a variable rate of LIBOR plus 3%. As at 31 March 2005 LIBOR amounted to 6% but on 30 September 2005 it fell by 1% to 5%. Interest is payable by Company H annually on 31 March each year. Company A has a 31 December year-end.

This means that the interest rate on the loan is 9% from 31 March 2005 to 30 September 2005 (6 months) and 8% from 1 October 2005 to 31 December 2005 (3 months).

The book-keeping would be:

-	Debit	Credit
On 31 March 2005
Loan to Company H	£1,200,000	-
Cash at bank	-	£1,200,000
On 31 December 2005	-	-
Prepayments - finance income receivable	£78,000	-
Finance Income (in P&L)	-	£78,000

The finance income prepayment to 31 December 2005 consists of 6 months at 9% (i.e. £54,000 and 3 months at 8% (i.e. £24,000).