CFM23050 - Accounting for corporate finance: UK GAAP before 1 January 2005: borrowers: accrual accounting: variable rate loans

Accounting for variable rate loans

A variable rate loan pays interest at an amount linked to the 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, amongst other things, on the credit risk of the borrower and the nature of the security granted to the lender. A variable rate loan will normally be issued at par, i.e. its nominal value

For example, Snapper plc borrows £100m at LIBOR plus 2% for 5 years. In Year 1 LIBOR is constant at 5%. At the start of Year 2 LIBOR increases to 6% and remains at this level for the remainder of the 5 years.

At inception Snapper plc receives £100m (ignoring expenses) from the bank.

Accruals accounting will record the loan at £100m for the entire five years. Interest will be accrued at a rate of £7m per annum for the first year and £8m per annum for the next four years. Interest is payable annually. A balance sheet for Snapper plc prepared between interest dates will show accrued interest payable based on the time that has passed since the last interest date.

At all times the loan is recorded as £100m within creditors. In the above example the position after 12 months shows that the interest has been paid before the year end.