Loan relationships: computational rules: GAAP: fair value and amortised cost accounting
Fair value accounting and amortised cost accounting
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, CTA09/S349 says that debits and credits from connected party loan relationships must be brought into account on an amortised cost basis.
‘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 cost, adjusted for
- amortisation of any discount or premium using the effective interest rate method, which takes into account fees incurred for borrowing (or received for lending) and similar amounts, and
- any impairment (CFM33220), repayment or release.
It is broadly equivalent to the authorised accruals basis that applied in periods of account beginning before 1 January 2005. If a company does not adopt IAS 39 or FRS 26 - for example, where a small company continues to use the FRSSE - and the company previously accounted for loan relationships on an authorised accruals basis, the FA 2004 changes to the loan relationships legislation should not bring about any change in the basis on which its debt assets and liabilities are taxed.
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. ‘Fair value’, in relation to a loan relationship, is the amount that an independent third party would pay for a debt asset, or the amount the company would have to pay an independent person for release of a debt liability.
A company will be using fair value accounting if
- it accounts for loan relationship assets (or, exceptionally, liabilities) at fair value through profit and loss (see CFM21530)
- it accounts for debt assets as available-for-sale assets (CFM21590)
- it has not adopted IAS 39 or FRS 26, but accounts for loan relationships on a basis that would, in a period beginning before 1 January 2005, have been an authorised mark to market basis.
A company that designates a loan relationship as the hedged item in a fair value hedge may also be taken as using fair value accounting for that loan relationship.