Section 11 of FRS 102 covers the everyday financial instruments most companies hold: cash, bank loans, trade debtors and creditors, ordinary loans and most investments in ordinary shares. Debt instruments that meet the conditions in paragraph 11.9 are measured at amortised cost using the effective interest method, so arrangement fees and other costs are spread over the life of the loan rather than written off at once.

What is a basic financial instrument?

Paragraph 11.3 defines a financial instrument as a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. Paragraph 11.8 lists the instruments accounted for as basic:

  • cash;
  • a debt instrument, such as an account, note or loan receivable or payable, that meets the conditions in paragraph 11.9 and is not a derivative;
  • a debt instrument that fails those conditions but is consistent with the principle in paragraph 11.9A;
  • commitments to receive or make a loan that cannot be settled net in cash and would produce a basic loan; and
  • an investment in a non derivative instrument that is equity of the issuer, such as most ordinary shares and certain preference shares.

Paragraph 11.10 gives everyday examples that normally qualify: trade accounts and notes receivable and payable, loans from banks or other third parties, payables in a foreign currency, and loans to or from subsidiaries or associates that are due on demand. Anything else falls into Section 12, covered on the page on FRS 102 Section 12. Paragraph 11.1 says even entities with only basic instruments must consider the scope of Section 12 to make sure it does not apply.

Paragraph 11.2 also gives a policy choice: apply Sections 11 and 12 in full, or apply the recognition and measurement rules of IAS 39 or IFRS 9 with the disclosures of Sections 11 and 12. Almost all small and owner managed companies use Sections 11 and 12.

Which loans pass the paragraph 11.9 conditions?

The conditions look at the contractual terms, assessed at initial recognition. Paragraph 11.6A says the classification is only revisited if the terms are later modified in a way relevant to the assessment. In outline, a debt instrument is basic if:

  • the return to the lender is a fixed amount, a positive fixed or variable rate, or a positive variable rate combined with a positive or negative fixed rate (SONIA plus 200 basis points qualifies; 500 basis points less SONIA does not);
  • any link to inflation uses a single general price index of the loan’s currency and is not leveraged;
  • no contractual term could make the lender lose principal or interest already due (being subordinated does not count as such a term);
  • early repayment or put options are not contingent on future events, other than protecting the lender against credit deterioration or a change of control, or either party against changes in tax or law; and
  • any extension of the term keeps the return within the same conditions.

Paragraph 11.9A adds a principle: a loan that misses these conditions can still be basic if its cash flows are repayments of principal plus reasonable compensation for the time value of money, credit risk and other basic lending risks and costs. The examples after paragraph 11.9 show where the line falls. A loan at a bank’s standard variable rate plus 1% is basic. A loan at twice the standard variable rate is leveraged and is not. Interest equal to a percentage of the borrower’s profits, or a mortgage linked to a house price index, fails both tests and goes to Section 12.

How is a basic instrument measured at first?

Paragraph 11.12 says an instrument is recognised only when the entity becomes a party to its contractual provisions. Paragraph 11.13 then measures it at the transaction price, adjusted for transaction costs, unless it is in effect a financing transaction. For goods sold on short term credit, the receivable is simply the invoice price. A bank loan at a market rate is recognised at the cash received less separately incurred transaction costs.

An arrangement is a financing transaction if payment is deferred beyond normal business terms or the rate of interest is not a market rate. In that case the instrument is measured at the present value of the future payments discounted at a market rate for a similar debt instrument. That rule, and the exceptions in paragraph 11.13A, are explained on loans at below market interest rates and directors’ loans under FRS 102.

What does amortised cost mean?

Paragraph 11.14(a) requires debt instruments within paragraph 11.8(b) or (bA) to be measured at each reporting date at amortised cost using the effective interest method. Paragraph 11.15 defines amortised cost as the amount at initial recognition, less principal repaid, plus or minus the cumulative amortisation of any difference between the initial amount and the maturity amount, less any impairment for financial assets.

There is a practical shortcut. Under paragraph 11.14(a)(ii), a non interest bearing debt payable or receivable within one year on normal business terms is measured at the undiscounted amount expected to be paid or received, net of impairment. Ordinary trade debtors and creditors therefore need no discounting.

How does the effective interest method work?

Paragraph 11.16 describes the effective interest rate as the rate that exactly discounts the estimated future cash flows through the expected life of the instrument to its carrying amount at initial recognition. Each period’s interest is the opening carrying amount multiplied by that rate. Paragraph 11.18 requires related fees, transaction costs, premiums and discounts to be amortised over the expected life, or over a shorter period if they relate to a period that ends at an earlier repricing date. Paragraph 11.17 says future credit losses not yet incurred are not built into the rate.

Illustration only. A company borrows £200,000 from a bank for five years at a fixed 7% (£14,000 a year), repayable in full at the end, and pays an arrangement fee of £6,000. The loan is recognised at £194,000. The effective interest rate that discounts the payments back to £194,000 is about 7.75%.

Year Opening balance Interest charge Cash paid Closing balance
1 £194,000 £15,028 £14,000 £195,028
2 £195,028 £15,108 £14,000 £196,135
3 £196,135 £15,193 £14,000 £197,329
4 £197,329 £15,286 £14,000 £198,615
5 £198,615 £15,385 £214,000 Nil

The £6,000 fee is spread through the interest charge rather than expensed in year one. Paragraph 11.20 says that if the expected cash flows change, for example because the company plans to repay early, the carrying amount is recalculated at the original effective rate and the difference goes to profit or loss. Paragraph 11.19 explains that for a variable rate loan recognised at its principal amount, reestimating future interest payments normally has no significant effect on the carrying amount.

How are share investments and loan commitments measured?

Under paragraph 11.14(d), an investment in ordinary or similar shares outside the group is measured at fair value through profit or loss if the shares are publicly traded or their fair value can otherwise be measured reliably, and at cost less impairment if not. For investments in other group entities within Section 11, the company chooses, for each class, between cost less impairment, fair value through other comprehensive income, or fair value through profit or loss. Paragraph 11.14(c) measures qualifying loan commitments at cost, which is sometimes nil, less impairment. Paragraph 11.14(b) also allows a debt instrument to be designated at fair value through profit or loss on initial recognition, but only where this removes an accounting mismatch or reflects a portfolio managed on a fair value basis.

When must a financial asset be impaired?

Paragraph 11.21 requires an assessment at each reporting date of whether there is objective evidence of impairment of financial assets held at cost or amortised cost. Paragraph 11.22 lists loss events including significant financial difficulty of the debtor, a default or delinquency, a concession granted because of the debtor’s difficulty, and probable bankruptcy. Equity instruments, and other assets that are individually significant, must be assessed individually (paragraph 11.24).

For an asset at amortised cost, paragraph 11.25 measures the loss as the difference between the carrying amount and the present value of expected cash flows at the original effective rate. Paragraph 11.26 requires a reversal if the loss later decreases because of an objectively related event, capped at what the carrying amount would have been without the impairment. For how this sits with tax relief on trade debts, see bad debts: accounting and tax.

What are the common mistakes?

  • Expensing a loan arrangement fee immediately instead of including it in the effective interest rate.
  • Treating a loan as basic without reading its terms, when profit linked interest, a leveraged rate or an unusual prepayment trigger moves it into Section 12.
  • Discounting ordinary trade debtors and creditors that are due within a year on normal terms.
  • Recording an interest free loan with a fixed repayment date at face value without checking whether it is a financing transaction or falls within an exception.
  • Forgetting that Section 1A changes disclosures, not measurement: a small company measures these instruments in exactly the same way (see FRS 102 Section 1A).

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.