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Interest-Free Loan to Subsidiary — IFRS 9 Worked Example | CALC SERIES #14

Zero-interest loans must be recognised at fair value under IFRS 9 — not face value. Here's the full PV calculation, day-one journal entry, equity contribution treatment, and three-year EIR accretion table for a €200k interest-free intra-group loan.

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Interest-Free Loan to Subsidiary — IFRS 9 Worked Example | CALC SERIES #14

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In this video

  1. 0:00 Introduction — why a zero-percent loan isn't recognised at face value
  2. 0:22 The scenario — €200k loan, 0%, 3 years, market rate 8%
  3. 0:55 IFRS 9 para 5.1.1 — initial recognition at fair value
  4. 1:20 PV calculation: €200k ÷ 1.08³ = €158,766
  5. 1:50 Day-one adjustment: €41,234 = equity contribution to subsidiary
  6. 2:15 Journal entry at inception — Dr Loan receivable + Dr Investment in sub / Cr Cash
  7. 2:50 EIR accretion Y1: 8% × €158,766 = €12,701 interest income
  8. 3:20 3-year accretion table — loan walks from €158,766 to €200,000
  9. 3:50 Common mistake — recording at face value €200,000
  10. 4:20 Recap — PV at market rate, equity contribution, EIR accretion

Key terms in plain English

Day-one adjustment
The difference between the transaction price and the fair value of a financial instrument at initial recognition. Under IFRS 9 B5.1.1, if the instrument is not at market terms, the difference is accounted for according to the substance of the transaction.
Capital contribution
For a below-market or interest-free intra-group loan from parent to subsidiary, the day-one adjustment is treated as an additional equity contribution — it represents economic value transferred to the subsidiary without any obligation to repay.
Effective interest rate (EIR)
The rate that exactly discounts the estimated future cash flows to the gross carrying amount. For the interest-free loan, the EIR is the market rate (8%) used to determine fair value on day one.
Amortised cost
The amount at which a financial asset or liability is initially measured, minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between the initial and maturity amounts.

Full explanation

Why IFRS 9 requires fair value, not face value

IFRS 9 paragraph 5.1.1 requires all financial assets to be initially measured at fair value. For a standard market-rate loan, fair value equals the amount lent — because the terms are at market. For a below-market or zero-interest loan, the fair value is lower than the face amount, because a lender would normally demand interest. The fair value is found by discounting the future cash flows at the market rate for an equivalent instrument.

IFRS 9 Appendix B paragraph B5.1.1 goes further: where a financial instrument is issued at below-market terms, the difference between fair value and the transaction amount is accounted for according to the substance of the arrangement. For a parent-to-subsidiary loan, the substance is a capital contribution — the parent is effectively injecting equity into the subsidiary without receiving a market return.

The scenario: €200,000 zero-interest loan, three years, market rate 8%

Fair value at inception: €200,000 / 1.08³ = €200,000 / 1.259712 = €158,766. Day-one adjustment: €200,000 − €158,766 = €41,234. This €41,234 is not a loss — it is an additional investment in the subsidiary, recognised as an increase in the investment account in the parent's separate financial statements.

Journal entry at inception

Dr Loan receivable (financial asset at amortised cost) €158,766
Dr Investment in subsidiary €41,234
Cr Cash €200,000

EIR accretion — three years to face value

The loan is subsequently measured at amortised cost using the EIR of 8%.

Year 1: Opening €158,766 × 8% = €12,701 interest income. Closing: €171,467. Dr Loan receivable €12,701 / Cr Interest income €12,701.

Year 2: Opening €171,467 × 8% = €13,717. Closing: €185,184.

Year 3: Opening €185,184 × 8% = €14,815. Closing: €200,000 (repaid). Total interest income over three years: €41,233 — approximately equal to the day-one adjustment (rounding).

Common mistake: recording at face value

If the parent records Dr Loan receivable €200,000 / Cr Cash €200,000, three errors follow: the loan asset is overstated by €41,234; no equity contribution is recognised in the investment account; and interest income over three years is zero instead of €41,233. The parent's reported income from the subsidiary is understated and the investment account misrepresents the true economic cost of the lending arrangement.