Effective interest rate, fees and costs

Learning objectives

• Determine the effective interest rate from the estimated cash flows and the fees and costs included, and calculate the interest for the period on the carrying amount.L2, L3
• Record the journal entries for the effective interest rate, fees and transaction costs and measure their effect on the financial position, profit or loss and other comprehensive income.L2, L3
• Prepare a workpaper documenting the effective interest rate, fees and transaction costs.L2, L3

Normative references

• IFRS 9 §5.4.1Interest revenue: effective interest method applied to the gross carrying amount, except (a) for purchased or originated credit-impaired financial assets, to which the credit-adjusted effective interest rate is applied to the amortised cost from initial recognition, and (b) for assets that subsequently became credit-impaired, to which the effective interest rate is applied to the amortised cost (net of the loss allowance) in subsequent reporting periods. The return to the gross basis is governed by para. 5.4.2.
• IFRS 9 §B5.4.1The entity identifies the fees that are an integral part of the instrument's effective interest rate; the name given to a fee does not necessarily reflect its nature. Such fees are treated as an adjustment to the effective interest rate, unless the instrument is measured at fair value through profit or loss, in which case they are recognised as revenue or expense on initial recognition. Examples of fees that are an integral part of the rate are given in para. B5.4.2; examples of fees that are not, accounted for under IFRS 15, in para. B5.4.3.
• IFRS 9 §B5.4.4Fees, points paid or received, transaction costs and other premiums or discounts included in the calculation of the effective interest rate are generally amortised over the expected life of the instrument; a shorter period is used when they relate to a shorter period, for example to the next repricing date to market rates of a variable rate instrument. The composition of transaction costs is set out in para. B5.4.8.
• IFRS 9 §B5.4.8Transaction costs include fees and commissions paid to agents (including employees acting as selling agents), advisers, brokers and dealers, levies by regulatory agencies and securities exchanges, and transfer taxes and duties; they do not include debt premiums or discounts, financing costs or internal administrative or holding costs.
• IFRS 9Appendix A (amortised cost terms): the gross carrying amount is the amortised cost of a financial asset before adjusting for any loss allowance; the effective interest rate exactly discounts estimated future cash flows through the expected life of the instrument, considering all its contractual terms (prepayment, options); the credit-adjusted effective interest rate of purchased or originated credit-impaired (POCI) assets also takes expected credit losses into account; the modification gain or loss is the amount arising from adjusting the gross carrying amount to reflect the renegotiated or modified cash flows; the reclassification date is the first day of the first reporting period following the change in business model.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

3 questions

• A bank grants a loan measured at amortised cost. Which of these fees is an integral part of the effective interest rate?L2
• Nova SA grants a loan measured at amortised cost, whose fair value at origination is {fair_value}. It receives from the borrower origination fees of {integral_fees_received}, which are an integral part of the effective interest rate, and incurs direct transaction costs of {transaction_costs}. Calculate the net initial amount used to compute the effective interest rate.L2
• Zéta SA acquires a zero-coupon security repayable in two years for {redemption_amount}, with no other cash flow. The annual effective interest rate, given by the case, is {effective_rate}, and the security is measured at amortised cost. Calculate the initial amount of the security (present value of the cash flows at the effective rate), then the interest income for the first year.L3