Under FRS 102 an arrangement fee paid to take out a loan is a transaction cost, so it is deducted from the loan when it is first recognised and then charged to profit or loss over the life of the loan as part of the interest expense, using the effective interest method. It is not written off when paid. Micro entities using FRS 105 spread a material fee on a straight line basis instead, and may expense an immaterial one.

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Why can the fee not simply be expensed when it is paid?

Paragraph 11.13 of FRS 102 requires a financial liability to be measured initially at the transaction price adjusted for transaction costs, unless it is later measured at fair value through profit or loss. The standard’s own example says that a bank loan at a market rate is recognised at “the amount of the cash received from the bank less separately incurred transaction costs”. A basic loan is then measured at amortised cost using the effective interest method under paragraph 11.14(a), and paragraph 11.18 requires related fees, transaction costs and other premiums or discounts to be amortised over the expected life of the instrument when calculating the effective interest rate.

The effect is that the true cost of borrowing, interest plus fees, is spread evenly against the carrying amount of the loan. Expensing the fee upfront would overstate costs in the first year and understate them for the rest of the term. For the general rules on basic financial instruments, see FRS 102 Section 11.

Which costs count as transaction costs?

The FRS 102 glossary defines transaction costs for financial instruments as incremental costs directly attributable to the acquisition, issue or disposal of a financial asset or liability, meaning costs that would not have been incurred had the instrument not been issued. In practice that usually includes:

  • arrangement or facility fees charged by the lender;
  • broker or introducer fees for finding the loan;
  • legal fees for the loan agreement and security documents;
  • valuation fees required by the lender.

Costs that would have been incurred anyway are not transaction costs. Internal staff time, general management costs and ongoing monitoring or agency fees charged each year are expensed as incurred.

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How does the effective interest method spread the fee?

Paragraph 11.16 defines the effective interest rate as the rate that exactly discounts estimated future cash payments through the expected life of the instrument to its carrying amount at initial recognition. Once the fee is deducted, the opening carrying amount is lower than the amount that must be repaid, so the effective rate is higher than the contractual rate. Each period’s interest expense is the opening carrying amount multiplied by the effective rate. The difference between that expense and the cash interest paid increases the carrying amount until it reaches the full repayment amount at maturity.

Paragraph 11.17 requires the calculation to take account of all contractual terms, including prepayment options. For a variable rate loan, paragraph 11.18 uses a shorter amortisation period where a fee relates to a rate that reprices to market before maturity, and paragraph 11.19 allows cash flows to be re estimated as market rates change.

What does this look like in numbers?

Illustration only. A company borrows 500,000 pounds for three years at 6% fixed, paying interest annually in arrears and repaying the principal at the end. It pays an arrangement fee of 10,000 pounds. The loan is recognised at 490,000 pounds and the effective interest rate works out at about 6.76%.

Year Opening carrying amount Interest expense at 6.76% Cash paid Closing carrying amount
1 490,000 33,118 30,000 493,118
2 493,118 33,329 30,000 496,447
3 496,447 33,553 530,000 nil

Total interest expense is 100,000 pounds: 90,000 pounds of contractual interest plus the 10,000 pounds fee. ICAEW’s guidance on renegotiating loans under FRS 102 uses the same approach for a 5 million pound loan with a 100,000 pound fee, recognising it initially at 4.9 million pounds and charging interest of 1.7 million pounds over four years. The postings are covered in recording business loans and interest.

Is straight line amortisation acceptable?

For an FRS 102 entity, the requirement is the effective interest method. Where the fee is small relative to the loan and the term is short, straight line spreading will often give a result that is not materially different, and paragraph 10.3 of FRS 102 says an entity need not follow a requirement if the effect of doing so would not be material. The test is whether the difference is material, not convenience.

Micro entities applying FRS 105 have an explicit simplification. Paragraph 9.7 of FRS 105 deducts transaction costs from the cost of a financial liability unless they are not material, in which case they are expensed immediately. Paragraph 9.15 then recognises the deferred costs in profit or loss on a straight line basis over the term of the contract. The FRS 105 example shows a 1,000 currency unit loan with 50 of fees spread at 25 a year over two years.

How is the loan presented in the balance sheet?

The loan is shown net of the unamortised fee, not gross with a separate prepayment. The split between amounts due within one year and after more than one year is based on when the lender can demand repayment, explained further in breached loan covenant: current or non current. The notes should explain that borrowings are measured at amortised cost.

What happens if the loan is repaid early or refinanced?

When a loan is repaid early, the liability is extinguished. Paragraph 11.38 recognises in profit or loss the difference between the carrying amount and the amount paid, so any unamortised fee is charged at that point. In the illustration, repaying at the end of year 2 would give a charge of 3,553 pounds, being 500,000 pounds paid less the carrying amount of 496,447 pounds, plus any early repayment penalty.

A refinancing with the same lender needs more thought. Paragraph 11.37 treats a substantial modification of terms as an extinguishment of the old loan and recognition of a new one. ICAEW’s guidance shows that in that case the old unamortised fee is written off and any new fee is deducted from the new loan; if the modification is not substantial, the old loan continues and, on the approach illustrated, a fee paid for the modification is expensed.

How is the fee treated for tax?

For a company, borrowing is a loan relationship. HMRC’s Corporate Finance Manual at CFM33060 confirms that expenses of bringing a loan relationship into existence, such as bank arrangement fees and loan guarantee fees, are allowable under section 306A of the Corporation Tax Act 2009. Under the general rule in section 307, summarised at CFM30170, the debits brought into account are those recognised under generally accepted accounting practice. The fee is therefore normally deducted for tax as it is amortised in the accounts, with no separate computation. The wider rules are in loan relationships basics.

For sole traders and partnerships, HMRC’s Business Income Manual at BIM45815 lists allowable incidental costs of obtaining loan finance, including fees, commissions, legal and valuation fees, and the costs of rolling over or varying a loan.

What mistakes come up?

  • Expensing the whole fee in year one. Unless immaterial, the fee belongs in the loan’s carrying amount.
  • Showing the fee as a prepayment. It is deducted from the liability.
  • Forgetting the balance on early repayment. Any unamortised fee is charged when the loan is extinguished.
  • Including costs that are not incremental. Internal time and recurring agency fees are expensed.
  • Amortising over the wrong period. Use the expected life, or the repricing period for a variable rate fee.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.