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Accounting For Loan Impairments [Case Example]

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Accounting for Loan ImpairmentLoan impairment arises when it is probable that the creditor may not be able to collect all of the principal and interest due on a loan. What is accounting treatment for loan impairment? What entries should be made? This post provides the answers. Enjoy!

 

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Loan Impairment Case Example

Let’s assume that on December 31, 2006, the Lie Dharma Company issued a $1,000,000, five-year, non-interest-bearing note to the Putra Security Bank, yielding 10% per year. At the date of the issuance the Lie Dharma Company paid $620,920 = (1,000,000 x 0.62092). The following entries were made:

1. By the creditor, the Putra Security Bank:

[Debit]. Notes Receivable = $1,000,000
[Credit]. Discount on Notes Receivable = $379,080
[Credit]. Cash = $620,920

2. By the debtor, the Lie Dharma Company

[Debit]. Cash = $620,920
[Debit]. Discount on Notes Payable = $379,080
[Credit]. Notes Payable = $1,000,000

 

The following table shows the note discount amortization using the effective interest method:

First Loan Amortization Schedule

 

Now, let’s assume that because of bad economic conditions for the Lie Dharma Company, the Putra Security Bank estimates on December 31, 2008, that only $800,000 is collectable at the end of the five years. Therefore, it estimates its loss due to impairment as follows:

  • Carrying amount of the loan, 12/31/208 = $751,312.20
  • Present value of $800,000 due in 3 years at 10% compounded annually (800,000 x 0.75132) = $601,056.00
  • Loss due to impairment (751,312.20 – 601,056) = $150,256.20

 

Therefore, the Putra Security Bank made the following entry:

[Debit]. Bad Debt Expense = $150,256.20
[Credit]. Allowance for Doubtful Accounts = $150,256.20

 

The Lie Dharma Company does not make an entry. The Putra Security Bank prepares a new schedule of discount amortization based on the new carrying amount of $601,056. It is shown in the next table:

Second Loan Amortization Schedule

 

The following entries are made on Dec. 31, 2009:

1. By the Putra Security Bank

[Debit]. Discount on Notes Receivable = $75,131.32
[Credit]. Interest Revenue = $60,105.60
[Credit]. Allowance for Doubtful Accounts = $15,025.72

2. By the Lie Dharma Company

[Debit]. Interest Expense = $75,131.32
[Credit]. Discount on Notes Payable = $75,131.32

 

At the maturity date, on January 1, 2000, the Lie Dharma Company pays $800,000 and the following entries are made:

1. By the Putra Security Bank

[Debit]. Cash = $800,000
[Debit]. Allowance for Doubtful Accounts = $200,000
[Credit]. Notes Receivable = $1,000,000

2. By the Lie Dharma Company

[Debit]. Notes Payable = $1,000,000
[Credit]. Cash = $800,000
[Credit]. Gain on Extinguishment = $200,000

2 Comments

2 Comments

  1. Ritchie

    Jun 30, 2015 at 12:38 pm

    Make the example more comprehensive. Look at the years in the solution. It didn’t coincide at the problem. THanks.

  2. AJoy

    Aug 7, 2015 at 12:30 am

    please help me in my financial accounting part 1

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