IFRS is generally replete with provisions for present values taking into account the

time value of money and the imputed interest where long-term transactions are
carried at low or no interest. This has taken the concept of ‘Substance over Form’ to
a new level. In IFRS, as per IAS 39, the correct valuation basis for non-current
liabilities is the present value of future payments using the market rate of interest,
either that stated or implied in the transaction, at the date the debt was incurred. An
exception to the use of the market rate of interest stated or implied in the transaction
in valuing long-term liabilities occurs when it is necessary to use an imputed interest
rate, if the debt is either non-interest-bearing or bears a clearly non-market rate of
interest.
EFFECTIVE INTEREST METHOD
The effective interest method is a method of calculating the amortised cost of a
financial asset or a financial liability and of allocating the interest income or interest
expense over the relevant period. The effective interest rate used in the allocation
process is the rate that exactly discounts estimated future cash flows (receipts or
payments) to the net carrying amount of the financial instrument through the
expected life of this instrument (or, a shorter period, when appropriate). Also,
interestingly, IAS 37 (Provisions, Contingent Liabilities and Contingent Assets),
paragraph 45 states that “where the effect of the time value of money is material, the
amount of a provision shall be the present value expenditures expected to be required
to settle the obligation.” On the other hand, AS 29 (Provisions, Contingent Liabilities
and Contingent Assets), paragraph 35 states that the amount recognised as a
provision should be the best estimate of the expenditure required to settle the present
obligation on the balance-sheet date. The amount of a provision should not be
discounted to its present value. While this is the position with loans and provisions,
what of government assistance in the form of interest-free loans? We, in India, are
familiar with interest-free sales tax loans which are linked to sales tax and are
repayable after the lapse of a certain number of years. These loans are usually
granted by the development agencies of the government as a part of incentive
provisions to encourage economic development in backward areas. In these cases,
the real benefit to an entity is the use of money without having to pay the time-value
of money and the benefit derived from such loan.
IFRS NORM
IFRS expects the assistance received from the government in the form of interest-
free loans to be treated for what they are. IAS 20 (Accounting for Government
Grants and Disclosures of Government Assistance), paragraph 10A states: “The
benefit of a government loan at a below-market rate of interest is treated as a
government grant. The loan shall be recognised and measured in accordance with
IAS 39 — Financial Instruments: Recognition and Measurement. The benefit of the
below-market rate of interest shall be measured as the difference between the initial
carrying value of the loan determined in accordance with IAS 39 and the proceeds
received…” This is an amendment to the standard and comes into effect from
January 1, 2009, for all loans received after that date. In practical terms, when the
loan is received, if no terms are prescribed as to how the loan is to be utilised, then
the following entry will be passed: Bank A/c — (Dr) Rs 1,00,000; Interest-free sales
tax loan (discounted to the present value) — (Cr) Rs 90,000; Grant from the
government (taken to equity) — (Cr) Rs 10,000 Subsequently, every year the
imputed interest cost will be provided in the profit and loss (P&L) account for the
year as an expense with the corresponding credit, over the years finally winding back
the loan amount to what would be the repayable amount (the amount that was
received originally). Simultaneously, an appropriate amount will be transferred from
equity to the P&L account which will have the effect of negating the interest cost in
the P&L account. –