CFM22110 - Accounting for corporate finance: Old UK GAAP excluding FRS 26: lenders: accrual accounting: discounted securities

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

Accounting for discounted securities

A discounted security is one acquired at a discount to its face value. The same accounting applies to a security issued at face value and redeemable at a premium (or any combination of discount/premium on acquisition and discount/premium on redemption). The return to the lender comprises the interest received on the bond plus the difference between the purchase price and the redemption price.

Example

On 1 January 2008 Company A lends £800,000 in return for a £1M bond in Company J. The bond pays interest at 2%. The bond is redeemable in 5 years (31 December 2012) for £1M.

This means that the total return to Company A as lender is the £200,000 increase in the value of the bond together with five year’s interest of £20,000 per annum. This is the equivalent of a fixed rate loan of £800,000 with an interest rate of 6.9%. (This is based on the assumption that all but £20,000 of the interest each year is rolled up into the balance outstanding).

The accounting is set out below:

In the year ended 31 December 2008, the bookkeeping would be:

-	Debit	Credit
On 1 January 2008	-	-
Loan to Company J	£800,000	-
Cash at Bank	-	£800,000
On 31 December 2008	-	-
Loan to Company J	£55,200	-
Finance Income (in P&L)	-	£55,200
Cash at Bank	£20,000	-
Loan to Company J	-	£20,000

The finance income of £55,200 amounts to 6.9% of the opening balance on the bond of £800,000.

As at 31 December 2008, the balance on the loan due from Company J will have increased to £835,200 (being the £800,000 balance at the beginning of the year plus finance income receivable of £55,200 less finance income received of £20,000).

In the following accounting period (31 December 2009) Company A will record finance income of £57,600. This represents 6.9% of the opening carrying value of the loan of £835,200.

The bookkeeping in this accounting period would be:

-	Debit	Credit
On 31 December 2009
Loan to Company J	£57,600	-
Finance Income (in P&L)	-	£57,600
Cash at Bank	£20,000	-
Loan to Company J	-	£20,000

As at 31 December 2009, the balance on the loan to Company J will amount to £872,800 (being opening balance £835,200 loan plus finance income receivable of £55,600 less finance income received of £20,000).

In the subsequent accounting periods, the balance on the loan to Company J will increase, so that as at 31 December 2012 immediately before the loan is repaid and interest for 2012 is paid, the balance will be £1,020,000, being £1M due from Company J plus the 2% interest due in 2012:

Year	Opening	Finance Income	Finance Income	Loan	Closing
-	Balance	At 6.9%	Received	Repayment	Balance
-	£	£	£	£	£
2008	800,000	55,200	(20,000)	-	835,200
2009	835,200	57,600	(20,000)	-	872,800
2010	872,800	60,200	(20,000)	-	913,000
2011	913,000	63,000	(20,000)	-	956,000
2012	956,000	64,000	(20,000)	1,000,000	-