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IFRS Question 018: How to account for loan transaction fees?

I work for a banking industry and my bank is charging a fee of 3% for each loan issued to customers on some of loan categories. However such fee is divided into two categories:

  • Loan Origination Fee of 1 % is amortized over the loan period. Currently we are using straight-line as an alternative for effective interest method, and
  • Loan application fee is 2%. This is fully recognised as income in profit or loss because management states that it is directly linked to freely transacting via Bank’s agent network across the country along with administrative fees limited to cost of stationeries, credit checks, security and business appraisal.

Is this treatment OK under IFRS?

IFRS Answer 018

Nice question.

First of all, the treatment of all these transaction costs depends on how you classify the financial instrument.

Here, I’m going to focus on financial assets, because the question relates to the bank providing a loan, thus generating financial assets:

  • If you classify the financial asset at fair value through profit or loss, then you must recognize the transaction costs in profit or loss when they arise.
  • If you classify the financial asset at fair value through other comprehensive income or at amortized cost, then the transaction costs enter into the initial measurement of the financial asset.

IFRS 9 Initial Measurement

I guess most of the retail loans provided by banks to the customers is indeed measured at amortized cost, because they usually meet the two criteria for amortized cost measurement.

Well, you can learn more about the classification of loans in the podcast episode n. 4.

So, it is clear that if the loans are at amortized cost category, then the transaction costs enter into the initial measurement.

Subsequently, you should amortize these fees or costs over the expected life of the loan.

In most cases, they are included in the effective interest rate calculation, but yes, you can use alternative method of amortization.

Now, we need to distinguish what the transaction fees are received for.

Here, focus on what the customer gets for these costs or what service is delivered to the customer.

Do NOT look at what own expenses the bank wants to recover by charging those fees – like security cost, cost of running the branch, etc. – it is not relevant here.

The standard IFRS 9 gives us some guidance on which fees associated with the loan are transaction fees and which are not the transaction fees.

What is the purpose of these fees? Why did the bank charge them?

The most common types of the transaction fees are:

    • Origination fees on creation of the loan.
      The bank usually charges these fees to cover its costs for evaluating the borrower’s financial condition, for assessment of guarantees or collateral, negotiating the terms of the loan, preparing the loan contract and other similar activities.In other words, origination fees cover the activities that result in creating the loan.

Another type is

  • Fees charged for loan servicing.
    These fees are charged usually throughout the life of the loan for the administrative aspects for the loan, like fees for sending monthly payment statements, collecting the payments, maintaining the records and other items.

It seems that the bank from today’s question charged loan application fees to partially cover its expenses related to loan generation and loan servicing, too.

The loan servicing fees are NOT the part of the loan’s initial measurement, but these are accounted fr in line with the standard IFRS 15 Revenue from contracts with customers.

What does it mean in this case?

It can happen that the loan servicing fees are charged up front in one sum at the time of generating the loan.

But, you still cannot recognize them straight in profit or loss at the time of charging them.

The reason is that under IFRS 15, you have to recognize them as revenue when you meet the performance obligation – in this case, when you service the loan, over the life of the loan.

Thus, the right accounting treatment would be to recognize the loan servicing fees received up front as a contract liability under IFRS 15 and subsequently, derecognize the contract liability over the life of the loan.

Illustration – loan transaction fees

Let’s say that the bank provides a loan of CU 1 000 for 3 years and charges the fee of CU 100, thereof

  • CU 50 for the assessment of borrower’s situation and collaterals, and
  • CU 50 for loan servicing over the life of the loan.

The loan is at amortized cost.

The accounting treatment of the loan is as follows:

  • Initial recognition of the loan:
    • Debit Financial Assets – Loans: CU 1 000
    • Credit Cash: CU 1 000
  • Transaction cost – loan origination fee:
    • Debit Cash: CU 50
    • Credit Financial Assets – Loans: CU 50<l/i>
  • Transaction cost – loan servicing fee received upfront:
    • Debit Cash: CU 50
    • Credit Contract liability: CU 50

When loan servicing fees are charged monthly instead of one up-front fee , then they can be recognized straight in profit or loss, because the receipts would be roughly aligned with the pattern of providing the service to the customer – which is OK under IFRS 15.

Any questions or comments? Please let me know below. Thank you!