Amortised cost and the effective interest rate: getting loan processing fees right under IFRS 9

A practical guide for borrowers on computing the EIR and recording interest expense on loans with upfront charges

Why this topic keeps coming up

Ask a finance team how it accounts for the 1% processing fee its bank deducted when the term loan was drawn, and you will hear a range of answers. Some expense it immediately because "the bank charged it and it is gone". Some park it as a prepayment and release it evenly. Others net it against the loan but never revisit the rate. Each approach has a practical logic, and each can produce a different finance cost line from the one IFRS 9 requires.

In the UAE the question has become more pressing for three reasons. Corporate tax now takes accounting profit as its starting point, so the timing of finance costs feeds straight into taxable income and into the general interest limitation calculation. Lenders are increasingly layering fees into facilities (processing, arrangement, participation, commitment and agency fees are all common in syndicated deals). And auditors are paying closer attention to how debt is measured, particularly where covenants are tested on reported finance costs or net debt.

This article walks through the principles, shows how the EIR is computed, and then works through a practical scenario involving a term loan with processing charges. We also look at what happens when a loan is prepaid, repriced or renegotiated, because that is usually where the mistakes start.

The building blocks: amortised cost and the EIR

Most bank borrowings are financial liabilities measured at amortised cost under IFRS 9. At initial recognition, the standard requires the liability to be measured at fair value minus transaction costs that are directly attributable to its issue. For an arm's length bank loan, fair value is normally the principal drawn, so in practical terms the opening carrying amount typically equals the proceeds received adjusted for transaction costs and fees that form part of the effective interest calculation.

From there, the liability is carried at amortised cost. IFRS 9 defines this as the amount measured at initial recognition, minus principal repayments, plus or minus the cumulative amortisation, using the effective interest method, of any difference between that initial amount and the maturity amount. In plain language, the discount created by netting the fees is unwound over the life of the loan so that, by maturity, the carrying amount equals the amount repayable.

The effective interest rate is the rate that exactly discounts the estimated future cash payments through the expected life of the liability to its amortised cost at initial recognition. The calculation considers all contractual terms, including prepayment, extension and call options, and it includes all fees and points paid or received between the parties that are an integral part of the EIR, together with transaction costs and any premiums or discounts. Two consequences follow. First, the EIR on a loan with upfront fees will typically be higher than its coupon. Second, the unwinding is not linear: it follows the outstanding balance, so more of the fee is released in periods when more of the loan is outstanding.

IFRS 9 also adds a point that can be easy to miss. Fees, transaction costs and discounts or premiums which are included in the EIR are amortised over the expected life of the instrument. A shorter period applies only where the item relates to a variable that resets to market rates before maturity. For e.g., a discount on a floating-rate loan that reflects market rate movements since the last reset is amortised to the next reset date. An upfront processing fee, or any amount that reflects the credit spread over the benchmark, is still amortised over the expected life of the loan.

Which fees belong in the EIR?

Not every amount paid to a bank is part of the cost of the borrowing. IFRS 9 draws the line using two concepts: fees that are integral to the effective interest rate, and transaction costs, which the standard describes as incremental costs directly attributable to the issue of the liability. The application guidance confirms that transaction costs include fees and commissions paid to agents, advisers, brokers and dealers, levies by regulatory agencies and transfer taxes and duties. They do not include financing costs, internal administrative costs or holding costs.

The table below summarises how we typically see the common UAE facility charges treated.

Table 1: Common loan charges and their treatment under IFRS 9

A useful test in practice is simple: would we have paid this if we had not taken the loan? If not, it is a candidate for the EIR, but then ask what it pays for. A one-off fee for arranging or issuing the loan, or an external cost incurred to put the loan in place, goes into the EIR. A fee that pays for a service over time (monitoring, agency, account maintenance), and internal costs, go to profit or loss.

Computing the EIR, step by step

The EIR is an internal rate of return. There is no closed formula for most loans, so it is solved iteratively, which in practice means the RATE or IRR function in Excel, or XIRR where cash flows fall on irregular dates. The steps are the same whatever tool is used.

1. Establish the net proceeds. Take the amount drawn and deduct the qualifying fees and transaction costs. This is the opening amortised cost.
2. Map the expected cash flows. List every expected payment of interest and principal, on the dates they are expected to be paid, taking into account contractual repayment schedules and any prepayment you expect to make.
3. Solve for the rate. Find the single rate that makes the present value of those cash flows equal to the net proceeds. Use a periodic rate that matches the payment frequency and annualise it if needed.
4. Build the amortisation table. Each period, interest expense equals the opening carrying amount multiplied by the EIR. The cash coupon reduces the balance, and the difference between the two is the release of the fees.
5. Check the closing position. At maturity the carrying amount must equal the final repayment exactly. If it does not, the rate or the cash flows are wrong.

Practical example: Dubai Co and its term loan from Gulf Bank

On 1 January 2025, Dubai Co draws down a five-year term loan of AED 50 million from Gulf Bank to fund an expansion of its logistics warehouse. The key terms are set out below.

Table 2: Key terms of the facility

(Note: This example is considering a situation where it is for working capital purpose and not for construction/acquisition of an asset. In case of acquisition/construction of an asset, IAS 23.8 requires capitalisation of the