Loan arrangement fees: why interest expense exceeds the cash coupon
A lender advances a £10,000 two-year loan and charges a £200 origination fee. The borrower receives £9,800 net and pays £500 cash interest each year. Treating £500 as the whole annual financing cost would leave out the fee. For this hypothetical ordinary loan measured at amortised cost under UK-adopted IFRS 9, the initial carrying amount is £9,800 and the effective annual rate is about 6.0923%. Total interest expense over the loan's life is £1,200, although the cash coupons total £1,000.
Assess the fee before building the schedule
IFRS 9 paragraph 5.1.1 adjusts initial fair value for directly attributable transaction costs when the instrument is not measured at fair value through profit or loss. The effective interest definitions in Appendix A include integral fees, transaction costs and other premiums or discounts when calculating the rate that discounts estimated contractual payments to the liability's amortised cost.
Paragraphs B5.4.1 and B5.4.2 explain why the label on a bill is insufficient. Origination fees paid when issuing an amortised-cost financial liability are integral to its effective interest rate. A charge for something else needs its own assessment. Transaction costs are incremental costs that would not have arisen without issuing the instrument; internal administration is excluded.
This article concerns a borrower's ordinary amortised-cost liability. Fair-value-through-profit-or-loss instruments have different treatment. Modifications, early repayment, floating rates, hedges and costs capitalised into qualifying assets are outside this example. These are financial reporting calculations, not a market rate or tax deduction.
Sources and context, checked :
- UK Endorsement Board: IFRS 9, financial liability measurement, paragraph 4.2.1
- UK Endorsement Board: IFRS 9, UK-adopted 2026 text
- UK Endorsement Board: IFRS 9, UK-adopted 2026 text
- UK Endorsement Board: IFRS 9, UK-adopted 2026 text
- UK Endorsement Board: IFRS 9, UK-adopted 2026 text
- UK Endorsement Board: IFRS 9, UK-adopted 2026 text
- UK Endorsement Board: IFRS 9, origination fees, paragraph B5.4.2(c)
Solve the rate using every contractual payment
Assume the loan's fair value before the fee equals its £10,000 face amount. The £200 is a qualifying integral origination fee paid to the lender. Cash interest of £500 is due at each year end, with the whole £10,000 principal repaid at the second year end. There are no other flows or tax effects, and interest is expensed.
The effective rate solves £9,800 = £500 / (1 + r) + £10,500 / (1 + r)². The annual rate is 6.092284739871038%. Carry the calculation at full precision and round displayed amounts to pence. Dividing the £200 equally between the two years would not reproduce the effective-interest calculation.
The combined inception entry is Dr bank £9,800; Cr loan carrying amount £9,800. The schedule should still show £10,000 face principal and the £200 fee adjustment separately. Combining them in the accounting carrying amount does not change the contractual principal owed to the lender.
| Year | Opening carrying amount | Effective interest expense | Cash paid | Closing carrying amount |
|---|---|---|---|---|
| 1 | £9,800.00 | £597.04 | £500.00 | £9,897.04 |
| 2 | £9,897.04 | £602.96 | £10,500.00 | £0.00 |
Sources and context, checked :
Why the balance rises in year one
The first year's interest is the £9,800 opening carrying amount multiplied by the effective rate, or £597.04 after rounding. Cash paid is only £500. The £97.04 difference increases the liability to £9,897.04 as part of the fee adjustment is unwound.
The entry is Dr interest expense £597.04; Cr bank £500; Cr loan £97.04. The lender's face principal remains £10,000. Forcing the accounting balance to that principal would erase the unamortised fee.
In year two, interest expense is £602.96. The £10,500 payment clears both that expense and the £9,897.04 opening liability. Record Dr interest expense £602.96; Dr loan £9,897.04; Cr bank £10,500. Total expense is £597.04 + £602.96 = £1,200, exactly the £1,000 coupons plus the £200 fee.
Separate origination from ongoing services
IFRS 9 identifies loan servicing and certain commitment fees as examples that are not integral to effective interest. That discussion includes fee recipients applying IFRS 15; it is not an instruction for a borrower to account for an expense as customer revenue. Read what the borrower actually received and which requirements apply.
Integral adjustments generally amortise over the expected life, although a shorter relevant repricing period can apply in the circumstances set out in paragraph B5.4.4. Keep the agreement and fee invoice with a schedule showing principal, remaining fee adjustment, carrying amount, effective interest and cash. Before approving it, prove that every contractual flow is included and the final balance clears.