CFM33100 - Loan relationships: Core rules: GAAP: fair value and amortised cost accounting

CTA09/S313

Although the general rule is that the computation of loan relationship credits and debits should follow the amounts shown in accounts drawn up in accordance with GAAP, in places the rules require either the amortised cost basis of accounting or fair value accounting to be used.

For example, amounts from connected party loan relationships must be brought into account on an amortised cost basis (see CFM35030).

‘Amortised cost basis’ of accounting and ‘fair value accounting’ are defined at CTA09/S313.

Amortised cost basis

This means a basis of accounting in which the loan asset or liability is:

  • shown in the balance sheet at amortised cost using the effective interest rate method,
  • adjusted as necessary where the loan is the hedged item under a designated fair value hedge.

Both 'amortised cost' and 'effective interest rate method' take the meaning they have for accounting purposes (see CFM23045 and CFM21170).

In particular, the carrying value will reflect:

  • amortisation of any discount or premium using the effective interest rate method, which takes into account fees for entering into the loan, and
  • any impairment (CFM33220), repayment or release.

'Designated fair value hedge' and 'hedged item' also take their accounting meaning (see CFM27120).

Pre-2016 periods and instruments

A slightly different definition of amortised cost basis of accounting applied for accounting periods commencing before 1 January 2016.

This previous definition continues to apply for the connected company debt rules at CTA09/349 in cases where the loan was entered into in an AP that commenced before 1 January 2016 [see F(No.2)A/Sch7/Para 106(6)].

There are two key differences in the pre-2016 definition:

  • It required the loan to be measured at 'cost' on initial recognition, whereas typically the accounting standards require loans to be measured at their present value or fair value on inception. This will usually be the same as its 'cost'. However, there can be a difference where the loan is entered into on non-market terms.
  • It did not permit the adjustment of amortised basis of accounting for designated fair value hedges.

Fair value accounting

Fair value accounting is defined as a basis of accounting under which:

  • assets or liabilities are shown in the company’s balance sheet at their fair value, and
  • Changes in the fair value of assets and liabilities are recognised as items of profit or loss.

This is often referred to in accounting as 'fair value through profit or loss' (FVTPL).

‘Fair value’ takes its accounting meaning (see CFM21160).

Pre-2016 periods

A different definition of fair value accounting applied for accounting periods that commenced before 1 January 2016.

The previous definition simply required the loan to be shown in the accounts at its fair value.

Under this old definition, a company would have been using fair value accounting if

  • it accounts for the loan at fair value through profit and loss (see CFM21530)
  • it accounts for debt assets as available-for-sale assets under IAS39 (CFM21590)

it accounted for debt assets as fair value through other comprehensive income (FVTOCI) under IFRS 9 (CFM21830)

Micro-entities

If a company that is a micro-entity adopts FRS105, all financial instruments will normally be accounted for on an amortised cost basis. See CFM23030 for more about current UK accounting standards.