CC member loan

[aktorsyl]

We have a CC with 2 members. The one member paid some of the CC's invoices in the previous financial year (to the total amount of about R18,000), and also lent the CC an amount of R30,000 in cash. Thus the CC owes this member a total of about R48,000.
My question is, how do we record this in our new accounting software (Quickbooks) in the new financial year? Do we add this as an equity account, or can we add it as a long-term liability account and treat it as a normal loan?

[aktorsyl]

Just an update: We have decided to re-do the last financial year in Quickbooks as well (the company only started in January 2012, so it's just one month's worth of financial data to re-do). But this makes the question above even more important - how do we allocate these "loans"?

[Dave A]

Technically any subordinated loan would go to an equity account, and indefnite period loan to a long term liability account, and any loan amount payable within the next 12 months to a current liability account.

For the purposes of internal management accounting, it does not matter much whether you use a long term liability account or an equity account. It would just need to be reallocated correctly according to the above when the financial statements are drawn up.

My tip is to also have a member transaction account set up as a bank account - it's the easiest way to process expenditure incurred on behalf of the company, keep track of drawn funds that has gone to the member etc. Then from time to time you'd just put through a clearing entry between this transaction account and the member's loan account.

[aktorsyl]

Thanks Dave. Can both categories be put up as a loan, though? (The cash that the company borrowed from him, as well as the invoices he paid on behalf of the company)? Just being careful, don't want SARS to think we're trying to evade tax by creatively inventing liabilities.

[DavidvN]

If the nature of the transaction was to loan the CC money, then the amount can be treated as a loan payable to the member. Normal rules regarding liabilities would apply.

Raising a member loan in the business is not something that will affect tax, but rather it is the expenses that affect tax - so instead of worrying about the treatment of the loan, if you are certain that the expenses paid by the member are for the business.

Regarding a loan with no fixed terms of repayment, these should actually be disclosed as current, as the loans can be recalled at any time (also within the next 12 months). It is quite common that loans with no fixed terms of repayment are disclosed as long-term, but if you want to be correct in terms of accounting standards, it should be current. If you want the loan to be long-term, then simply stipulate in a loan agreement that by nature the loan is long-term, or indicate that the loan will not be recalled within the following 12 months subsequent to year end.

[DavidvN]

Can't edit posts - This sentence:

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should read:

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[aktorsyl]

Thanks David. Am I correct in assuming that, for this new financial year, the equity brought forward would be in the negative then (since it includes the liability of that loan)?
Also, how would we handle equity accounts in the future? For instance, if a member borrows money from the CC, it would go into his equity account, correct? And when he repays it, it goes from his equity account back to the cheque account?

THe only thing that bothers me is the fact that we now differentiate between liabilities (for instance the R48,000 loan from the one member) and equity accounts. We use both for essentially the same thing... is this normal? (Shout if you don't know what I mean, I realise this last sentence may not have been very clear)

[aktorsyl]

To clarify my last post a bit - what I mean by differentiating between equity accounts and liabilities:

1) We classify the member's loan of R48,000 of last year as a liability account (loan).
2) Another member now borrows R500 from the CC, but that goes into his equity account.
3) He then repays that R500, which is also recorded in his equity account.
4) And now the CC borrows R1000 from that second member as well. So this goes into his equity account as well, I assume.

So the company owes member A the amount of R48,000, which is classified as a liability/loan.
And it owes member B the amount of R1,000, but THIS is classified as an equity account and not a liability.

See why I'm getting so confused?

[DavidvN]

I would recommend staying away from designating these accounts as equity.

Equity would denote an investment made in the CC i.e. "Here is my money I give to the business and I don't expect any of it back unless I sell my membership in the CC. The only form of income I expect from my investment will be from the CC declaring dividends." However, I'm sure the member expects the CC to repay him these funds at some point in future.

Equity in a CC represents the member contributions to the CC, as well as any retained earnings made by the CC, and other reserves. This is very different from a loan, and as such it would be clearer on the balance to separate these two different types of balances (the one indicating ownership in the form of membership contribution, and the other being money the CC owes to someone in the form of a loan). If the member's intention was just to loan the money to the CC, then it is just a loan. You can almost pretend that money came from a bank if that helps clarify the nature of the loan versus the nature of equity. All the transactions you've mentioned above should just be treated as "Member loans" on the balance sheet and in the accounting records.

Regarding your points in the second post:

1) Correct.
2) Incorrect - this will be a debit loan account. Members can have both credit and debit loans. Again, as mentioned above, see the R500 as an amount that the CC has loaned out to a third party.
3) Per point two above, your treatment is correct, but it will be to a loan and not to equity. Again, be mindful of the difference between a "loan" and "equity".
4) Per point two above, your treatment is correct, but this will also go to his loan account.

The transactions and balance of the loan account would be:

Opening balances:

1) Member 1 Loan Account: R48,000 (CR) opening balance.
2) Member 2 Loan Account: NIL opening balance.

Per your above scenario, the transactions with Member 2 would be:

1) Member 2 Loan Account: Debit R500. Loan Balance R500(dr)
2) Member 2 Loan Account: Credit R500. Loan Balance RNIL
3) Member 2 Loan Account: Credit R1000. Loan Balance R1000(cr)

The other side of the transaction will be posted to bank.

Always remember two things regarding the above:

1) A loan and equity are two very different things.
2) You can only determine which of the two things the above is when you know the intention of the members i.e. are they investing the money in the CC (member contribution)? Or do they expect the money to be repaid (just a normal loan)?

From the above, it seems like they're just a simple loan. Let me know if you need any more help explaining the above, glad to help.

[aktorsyl]

David, that was tremendously helpful, thank you!
These member loan accounts, are they classified as fixed liabilities? (according to Quickbooks you can choose between a fixed liability and a long-term liability).

[DavidvN]

I'd say go with Long-term. I have no idea what Quickbooks is referring to when they term it "fixed".

[aktorsyl]

Ok, so long-term with zero interest? Also, I assume it is standard practice to have money that the member loans FROM the company also reflect in his loan account?

[CLIVE-TRIANGLE]

Hi aktorsyl. Quickbooks will only give you two options when creating the liability, 'Other current liability' and 'Long term liability'. You should select Long term, unless you reasonably foresee that the loan will be repaid in 12 months.

The CC's Accounting Officer will determine the correct classification when he prepares the Financial Statements. To explain more fully:
- The part of the loan that is not expected to be repaid within the 12 months after date of year end, is treated as long term. This may be the entire loan.
- The part of the loan that IS expected to be repaid within the next 12 months, is treated as current. This may be the entire loan.

The presence of a loan agreement simplifies this.
The absence of a loan agreement is not necessarily an issue, because the classification in the notes to the AFS may simply say that "no repayments within the next 12 months are expected."

[DavidvN]

Interest would depend on the loan agreement, or if there is none, then the agreement between the members as to whether the loan attracts interest.

Credit loan balances (money loaned to the CC) don't have to have interest charged, unless it is part of the loan agreement.

Debit member loan balances (money loaned by the CC) can become particularly complicated when you consider SARS's view on debit member loan balances. Generally, you will want to charge interest on a member's debit loan balance, if there is still an amount payable to the CC at the end of a financial year. The reason for this is two-fold:

1) SARS may deem the interest that would have been charged on the loan (at the SARS recommended rate) to be a fringe benefit taxable in the member's hands.
2) SARS may deem the loan to actually be a dividend, and demand dividends tax (from 1 April 2012) be paid on the debit loan.

Simplest solution, in most cases, is just to ensure a loan to a member is conducted at arms length, in that interest is charged thereon at the SARS recommended interest rate (currently 6.5%).

Regarding your query about the debits and credits - yes, you'll treat all money in and money out between a member and a CC as part of one account (his member loan account). There's no need to show debits and credits in separate accounts in this case.

[aktorsyl]

Thanks guys, appreciate the help so far.
Few more questions:

1) The member who paid the invoices in the previous financial year, on behalf of the CC, needs to somehow be reimbursed. However, since he didn't lend the money directly to the CC, it'd be tricky to classify that as a liability/loan. We have the original invoices that he paid. Will it work if I capture those invoices on Quickbooks, then "pay" them by transferring the money into his bank account? In other words, we pay the invoices according to the system, and he gets his money back. Does this make any sense?

2) We have a rent-to-own / lease agreement with a 3rd-party company for equipment, where we pay X amount per month until the full sum has been paid off, after which we take possession of the equipment. There is no interest on this agreement. Can we add this as a long-term liability, or is SARS going to frown on that? It's quite a large amount. If we do add it as a long-term liability, the liability account will gradually decrease as we make payments, and once it reaches zero, the fixed assets accounts will suddenly increase by the full value of the equipment, am I correct?

3) If we do add the rent-to-own / lease agreement as a long-term liability, do we add an entry to the liability account with the date matching the date on which the agreement was signed? With an entry amount equal to the total value of the equipment?

4) What is the best way to remunerate the members? It'll be a profit share: in other words, on the 1st of each month, a pre-defined portion of the previous month's profit will be divided between the members as per their member's interest. What's the best way to do these payments in a simple manner? Do you classify it as dividends? Do you have to subtract tax from the dividend before paying it over to the member? Or can the members just invoice the CC every month for "consulting", the invoice amount being the amount they're supposed to get as per the profit share for that given month? Would this be legal/acceptable?