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# Accounting For Loan Impairments [Case Example]

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Loan 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!

### 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:

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:

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

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