Mastering GRAP 104: Investments and loan receivables unpacked

The complexities of financial reporting in the public sector can be daunting, especially when it comes to investments and loans receivable. GRAP 104, revised in 2019, provides a detailed framework for accounting for investments and loans receivable, which must meet the definition of a financial asset to fall within its scope. This article outlines essential principles and considerations to guide public sector entities in applying GRAP 104 (revised).

What are investments and loan receivables?

Investments and loan receivables are contractual rights for an entity to receive cash or another financial instrument that arises from a loan receivable or an investment made by an entity (such as the purchase of bonds, notice deposits, treasury bills, etc.).

When should entities recognise investments and loan receivables?

Investments and loan receivables are recognised when an entity becomes a party to the contractual provisions of the instrument. If the investment is a regular way purchase transaction, trade date accounting should be applied.

How should entities classify and measure these instruments?

Financial instruments are initially measured at fair value and subsequently at amortised cost or fair value through surplus or deficit, based on the entity’s management model and the contractual cash flow characteristics.

If the management model is not to realise the cash flows by holding the instrument, and/or the cash flows are not solely payments of principal and interest (SPPI), it is classified as fair value through surplus or deficit. This includes a management model where an entity holds financial assets to collect contractual cash flows and for sale. If the management model indicates that the entity holds the loan or investment to collect the contractual cash flows, and the cash flows of the loan or investment are SPPI, it is classified as amortised cost.

💡 For example, if a municipality lends funds to a local business, the loan is recognised once the contract is signed. The loan is initially measured at fair value, which is usually the transaction price. If the municipality plans to hold the loan to collect contractual cash flows which are solely payments of the principal amount of the loan and the interest, it would be measured at amortised cost.

Special considerations for classification

Entities must consider whether features of the financial instrument affect its classification. Features such as leveraged rates or repayments linked to specific activities or thresholds should be evaluated. Interest-free loans do not automatically fail the SPPI requirements.

Impairment and loss allowance

A critical aspect of GRAP 104 is the recognition of expected credit losses. Entities must assess credit risk and recognise expected losses for investments and loan receivables measured at amortised cost, ensuring that financial statements realistically reflect expected credit losses. Entities should use lifetime expected credit losses if there has been a significant increase in credit risk since initial recognition. Otherwise, entities should use 12-month expected credit losses.

💡Continuing from the example above, if the local business has a history of late payments and the current economic environment is expected to continue as adverse, the municipality would need to estimate and recognise expected credit losses on the loan accordingly.

For investments and loan receivables measured at fair value through surplus or deficit, the concept of impairment does not apply in the same way. This is because these instruments are measured at fair value at each reporting date, with changes in fair value recognised in surplus or deficit. This approach inherently takes into account any changes in the instrument’s value due to impairment. Therefore, a separate impairment test is not necessary.

Interest revenue

Interest revenue is recognised using the effective interest method, which calculates the amortised cost of a financial asset and allocates interest income over the relevant period. The interest revenue of a loan receivable or investment measured at fair value through surplus or deficit is not separately identified or presented as interest revenue in the financial statements. Instead, it is included in the total return on the instrument, which is presented as a net gain or loss in surplus or deficit.

How should entities derecognise these instruments?

A financial asset is derecognised when the contractual rights to cash flows expire or when substantially all the risks and rewards are transferred.

What are entities required to disclosure?

GRAP 104 requires detailed disclosures about the significance of investments and loan receivables, their impact on the entity’s financial position and performance, and the associated risks. This ensures stakeholders have a clear understanding of an entity’s financial health.

💡 For instance, the municipality would need to disclose the carrying amount of the loan, its credit risk, and any collateral held.

In conclusion, GRAP 104 provides a comprehensive framework for recognising, measuring, presenting and disclosing financial instruments, including specific guidelines for investments and loan receivables. The Standard emphasizes the importance of understanding the management model, cash flow characteristics and unique features of each financial instrument to ensure accurate classification and measurement. It also encourages transparency through detailed disclosures. By adhering to these principles, entities can enhance the reliability and comparability of their financial statements, fostering greater confidence among users, such as tax and rate payers.

Let us continue to drive excellence in financial reporting by embracing this revised Standard! For additional guidance on investments and loan receivables, refer to this fact sheet.

Disclaimer

The article has been prepared by the Secretariat of the ASB for information purposes only. It has not been reviewed, approved, or otherwise acted on by the Board.