Effective Interest rate method
As per IAS 39- Loans and borrowings are measured at amortised cost using Effective Interest Rate (EIR) method. Amortised cost is calculated by taking into account any discount or premium paid on acquisition and fees or costs that are an integral part of the effective interest rate.
Further, EIR is nothing but the IRR rate i.e rate at which future payments (including interest payments, loan repayments) equals to the current receipt (loan receipt less transaction costs). The term for EIR calculation is nothing but the loan tenure over which we need to calculate the IRR.
EIR is easy to calculate in case of fixed interest rate loan instrument. However, practically in the current scenario you can find the case of floating interest rate loan instruments (eg. 1 month USD LIBOR +2%).
Now the question is:
1. How we can calculate the effective interest rate in case of floating interest rate loan instrument?
2. Do we need to revisit this present value calculation at each reporting date as there will be revision in estimates relating to the projected variable interest rate like LIBOR?
3. Is it really practical to use EIR in case of floating rate instruments OR can we get rid of this method as there is lot uncertainty involved in estimation of the LIBOR rate for future year and revisiting them at each reporting date?
Many thanks and regards for those who can understand and reply to my querry.
CAclubindia
