Accounting for Negative Interest Income

At its August meeting, the Monetary Policy Committee shied away from setting a negative base rate, but it devoted four pages of the accompanying report to explaining why it may be a suitable tool for the future. Even without a negative policy rate, UK money market rates are already trending towards zero, while the Debt Management Office has recently issued gilts and treasury bills with negative yields. Together, these have brought net returns from sterling money market funds close to zero even after managers have lowered their fees.

Given the psychological barrier to accepting a negative return, treasury managers will hope to avoid these for some time yet. But corporate finance managers should be thinking now about the accounting implications, ready for when the time comes.

Under IFRS 9, basic amortised cost accounting is only permitted for financial assets where the cash flows are solely payments of principal and interest. The application guidance is explicit that a negative effective interest rate can still be classed as a payment of interest. Amortised cost accounting therefore remains permitted if all the other conditions including the business model test are also met.

The other main question is around presentation. Negative interest on financial assets should be classed as an interest expense, not a reduction in interest income. This is because the IFRS Conceptual Framework defines income as arising from a growth in assets or reduction in liabilities, whereas negative investment interest is a reduction in assets.

At current interest rates, the total value of negative interest is likely to be very small, and local authorities can show this within interest payable and similar charges. Should the sums involved ever become material, such as they will with banks, then a separate line within finance and investment income and expenditure would be appropriate. New general ledger codes may be required to handle this, with automated coding systems updated.

Negative returns on money market funds will cause an additional complication for local authorities in England and Wales. Since funds cannot pay negative dividends, they will manage negative rates by reducing the net asset value below £1.00, causing their fair value to fall. IFRS requires fair value changes to be taken to finance and investment income and expenditure, but capital finance regulations require the impact of this on the revenue account to be reversed to an account established, charged and used solely for the purpose of recognising fair value gains and losses on pooled investment funds.

To discuss IFRS accounting for financial instruments and the interaction with local authority capital financing regulations, please contact the Arlingclose technical team at treasury@arlingclose.com.

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