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Understanding the difference between Staff loans and Staff advance
Many companies use these two words interchangeably and they wonder why auditors keep asking them for details on what constitutes their staff loan or staff advance, or whichever name they have chosen to call them.
The reason for this curious questioning is not far-fetched. This is because each of these is expected to be treated differently regardless of what name the Company may have called it.
Before we kick off into the accounting bit of it. Let's take a look at the meaning of each and why it is significant to get it right.
Staff loan is a loan or salary advance given to an employee for the purpose of the employee’s personal use with an agreement to pay back the loan to the company at an interest.
Okay, don't get it twisted, not all staff loans are given at an interest. In fact, some companies are generous that they give their employees loans at zero interest or sometimes at an interest rate below the market rate. But this creates an accounting issue which we will see how to account for it very soon.
Now let's talk about the staff advance.
Staff advance is an employee advance or expense advance given to an employee for the purpose of meeting business needs to prevent employees from paying out of their own pocket.
Did you notice the difference between both definitions above? Simply, the difference between staff loans and staff advances is that staff loans are for the employees' personal use while staff advances are to be spent by the employee for the purpose of the business.
Now that we understand the difference, let's look at the accounting implication. How to account for staff loans under IFRS and how to account for staff advances.
Financial assets or non-financial assets?
Staff loans are financial assets
IFRS 9 paragraph 11 defines a financial asset as any asset that is cash, an equity instrument of another entity, a contractual right to receive cash or another financial asset from another entity.
Simply put, the end result of a financial asset is that you are expecting cash as a result of holding it.
When the company gives out staff loans, even if it is at zero interest, the company expects that the staff should pay back the loan in cash. This implies that staff loans will be measured in accordance with the requirements of IFRS 9 Financial Instruments.
Note that because many companies use different names for these two items and sometimes even use them interchangeably, it is important that you understand them beyond the name so as to address them appropriately.
When a company gives a staff loan to its employee with the expectation of receiving cash over a given period of time, such staff loan is measured at amortized cost.
According to IFRS 9 paragraph 5.1.1, the company will measure the staff loan at its fair value. This simply means that the company will discount to present value, all the expected cash flows that relate to the loan using a market interest rate on similar loans (as though the company does not have a relationship with the staff at all, just the way a bank will give out a loan and charge interest). Note that it does not matter whether the company gave out the loan to the staff at an interest rate or not. It is the market interest rate that will be used to discount.
Let's try our hands on the scenario below.
At the beginning of the year 2022, Company A gave out $5,000 staff loan at 2% interest rate. The frequency of payment by the staff for both principal and interest is on an annual basis over 5 years, with the principal paid evenly across the 5 years starting from the end of year 2022. The market rate for a similar loan would have been 5%. The company's year-end is 31 December.
Let's list out the fact of the arrangement to help us determine our computation and how the Company A (the holder of the financial asset) will treat this in its books.
- Loan origination date - 1 January
- Year end of the Company - 31 December
- Maturity date - 5 years' time
- Loan amount - $5,000
- Contractual rate - 2%
- Market rate - 5%
- Frequency of principal repayment - Annually
- Frequency of interest repayment - Annually
Now let's go back to what IFRS 9 told us to do. It says that we are to determine the fair value of the loan using the market rate of a similar loan. This rate has been established as 5%. We are to discount the $5,000 principal and the expected interest to be received from the staff over 5 years.
The below schedule shows the discounting process.
In accordance with IFRS 9 paragraph 5.5.1, because the staff loan is a financial asset measured at amortized cost, it should be subjected to an impairment assessment for determining its expected credit loss to cater for a situation where the staff is unable to pay back (may default on the staff loan).
At initial recognition, Company A will raise the below journal entries:
When the cash is released to the staff
DR Staff loan $5,000
CR Bank $5,000
To recognize the transaction cost borne by the company
DR Prepayment $402
CR Staff loan $402
Download the excel file (showing the computation, journal entries, and reconciliation movement) for the above by clicking on the link in the description box of the YouTube video below.
To gain a classroom understanding of the difference between Staff loans and Staff advances and how to raise accounting journal entries and disclosures required on staff loans, watch the YouTube video below.
Alright, so let's wrap up our discussion.
Yes! You made it to the end.
I will be happy to receive any questions you may have that are not addressed in the article/video.
What name does your company use for its staff loan or staff advance? Share in the comment section for others to learn and identify.
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For: IFRS IS EASY
Wow!!! This is insightful.ReplyDelete
Thanks for the insight! I would want you to touch more on impairment of staff loans: considerations, drivers and computation.ReplyDelete
Hi, thanks!! This will help for my afternoon interviews.ReplyDelete
Thanks, so simplifiedReplyDelete
You simplified it completely. Thank youReplyDelete
Please how do you impair staff cash advances and why should one impair staff cash advances.ReplyDelete