20 November 2020
The Coronavirus Business Interruption Loan Scheme (CBIL Scheme) provides financial support to UK based SME businesses with turnover up to £45m that were trading successfully before coronavirus that are now losing revenue, and seeing their cashflow disrupted, as a result of the coronavirus pandemic.
The Bounce Back Loan Scheme (BBL Scheme) provides financial support via loans of between £2,000 and £50,000 (restricted to 25 per cent of a business’ turnover) to small and medium sized business who have been negatively affected by the coronavirus pandemic.
The Future Fund Scheme (FF Scheme) is for companies that are higher risk than would qualify for CBIL Scheme and provides matched convertible loans of between £125,000 and £5m for innovative UK companies with good potential that typically rely on equity investment and are currently affected by coronavirus.
The CBIL Scheme was launched on 23 March 2020 and is applicable where the lender considers the borrowing proposal viable were it not for coronavirus. As such accounting for these loans has not yet developed, and as access is via existing lenders using existing protocols it is unlikely many entities will have accessed the funding at 31 March 2020, so should not affect reporting as at 31 March 2020.
Nevertheless, this article sets out RSM’s early interpretation of the likely accounting consequences for the borrower. Given that the loans are provided by high street banks, we have assumed that the financial instrument will meet the definition of a basic financial instrument.
Overview – CBIL Scheme
The key issue is accounting for the government assistance which:
- will make a Business Interruption Payment to the lender to cover the first 12 months of interest payments and any lender-levied fees. (This means smaller businesses will benefit from no upfront costs and lower initial repayments); and
- will provide lenders with a guarantee of 80 per cent on each loan (subject to pre-lender cap on claims) to give lenders further confidence in continuing to provide finance to small and medium-sized businesses.
We believe that the Business Interruption Payment covering the first 12 months’ interest will be made directly to the banking institution, so the borrower will, in effect, have an ‘interest-free’ loan for the first 12 months.
Both elements above meet the FRS 102 definition of Government Grants and should be accounted for as such (Section 24).
Overview – BBL Scheme
The BBL Scheme was launched on 27 April 2020 with applications accepted from 4 May 2020 and is very similar to the Coronavirus Business Interruption Loan Scheme (CBIL Scheme), the principal consistent element being the government will cover the first 12 months of interest payments and any lender fees, there are however some differences:
- The scheme is 100% government backed rather than 80 per cent.
- A 12-month capital repayment holiday is automatically applied at inception whereas for CBILS this could vary depending on the lender.
- The interest rate is fixed at 2.5 per cent APR for all BBL’s instead of varying under CBILS.
- The loan term is 6 years, and early repayment is possible without additional charges.
- Those who have applied for a CBIL of £50,000 or less will be able to apply to convert their CBIL to a BBL.
Whilst the terms of the BBL Scheme are different, the underlying accounting treatment will be the same as for CBILS and therefore the guidance in the rest of the article will apply equally to both schemes.
All grants should be measured at the fair value of the asset received or receivable.
- In the case of the 12 months of interest paid by HM Government, assessment of fair value is simple – it will be the value of the cash interest payments made by the Government on behalf of the entity.
- In respect of the guarantee provided by the Government, it is important to note that this is primarily to reduce the risk to the lender in order to encourage lending at a time of high economic uncertainty. In the event of default, the usual methods of debt recovery are pursued first. On that basis, the only benefit receivable by the entity itself are that the loan may bear a lower interest rate than it otherwise might, on the basis of the guarantee provided.
Given the difficulties of obtaining market value for a similar loan without such conditions, no value is likely to be attached to this, but disclosure will be required under FRS 102:
1. Accounting for the 12-month interest free element of the loan
Whilst management have an accounting policy choice to make on a class-by-class basis between using the performance or accrual models, in reality there is unlikely to be any material difference between these models due to the grant income being received at the same time as the interest is charged by the bank, and hence under the performance model, the interest paid by the government is receivable over time, and under the accruals model, a systematic basis of charging would be to credit the grant income over the period of benefit, ie the first 12 months in each case.
Therefore, in both models, the first-year interest free element will be booked as an interest expense and an equal but opposite government grant income.
2. Disclosing the 80 per cent guarantee
As discussed above, where the loan is offered at a materially lower interest rate than market rate then the loan ought to be classed as a financing transaction on the basis that it is an arrangement financed at a rate of interest which does not reflect market rates. However, given the current market conditions, it is unlikely the bank will offer a lower rate, and even if it does, it will be somewhat challenging to obtain a reliable estimate of that loan rate.
It is too early to say whether rates are discounted, however anecdotally we are not seeing banks offering discounted rates, and in fact rates appear quite high (press coverage has indicated up to 30 per cent), with the usual commercial due process and securities being required to ensure the banks cover their risk and the government guarantee is genuinely a last resort.
Therefore, the possible impact of the 80 per cent guarantee is unlikely to be accounted for in the entity’s accounts, rather it will be disclosed as required by FRS 102.24.6d:
24.6 An entity shall disclose the following:
(d) an indication of other forms of government assistance from which the entity has directly benefited.
…. government assistance is action by government designed to provide an economic benefit specific to an entity or range of entities qualifying under specified criteria. Examples include … the provision of guarantees.
Example of the accounting for the overall CBIL instrument: By way of a worked example, consider a £1m loan at 10 per cent interest rate with bullet repayment at the end of year three, the journals will be:
|Dr Interest (P&L)||100|
|Cr Grant funding (P&L)||100|
Where the loan is repaid in instalments over the three years this ought not to be any different in principle, albeit a calculation will be needed of the interest charged in the first year, which will equate to the government grant income.
Whilst entities won’t pay any interest or fees in the first 12 months, the interest that is paid by the government will still be charged to profit or loss, ie we should expect an interest expense to be debited to profit or loss each year of the loan.
Given the accepted challenges of ascertaining a market rate it will usually be appropriate to recognise the loan at the net proceeds received, along with suitable disclosure of the loan terms, hence providing the users’ an adequate understanding of the transactions.
Overview – FF Scheme
The Future Fund Scheme is a particularly complex arrangement for companies that are higher risk than would qualify for CBIL funding. Introduced in April 2020 and currently due to expire on 31 January, the government will invest in convertible loans of innovative UK companies with good potential that typically rely on equity investment and are currently affected by coronavirus.
In summary, the government will invest via a convertible loan of between £125,000 and £5m which must be matched by at least the same investment from private investors. The loans accrue interest of at least 8 per cent per annum (non-compounding) and the loan plus interest will convert into a variable number of shares under certain circumstances including an exit or the company’s next qualifying funding round. If that doesn’t happen then at the end of the loan term (expected to be 3 years), the holders have the option to choose for it to be repaid by the company with a significant redemption premium, or to convert into equity at the discount rate to the price set by the most recent funding round.
The interest charged and the strict criteria including matched funding suggest the loans are issued on an arms’ length basis, and so there is no government grant to be recognised by the entity. The transaction price will be considered to be the fair value of the lending at initial recognition, and then the entity must consider the requirements of section 12: Other financial instruments issues of FRS 102 for ongoing measurement. Careful analysis will be required to determine whether the entity already has an accounting policy for convertible debt under section 12 (ie does it apply the provisions of section 11 and 12 in full, the recognition and measurement provisions of IAS 39 or IFRS 9 and IAS 39 (as amended by IFRS 9), with the disclosures required by section 11 and 12. The entity must then consider whether the Companies Act permits the financial liability to be fair valued.
- Understand all the terms and conditions of the financing, and therefore account for the interest and the government grant through profit and loss account in the first year.
- Appropriate disclosure in this area will be key to ensure that the users of the financial statements fully understand the underlying transactions. Disclosure is required to discuss “other forms of government assistance from which the entity has benefited. … Examples include … the provision of guarantees.”