Professional Documents
Culture Documents
APPENDIX 7B
IMPAIRMENTS OF RECEIVABLES
11. Describe the accounting for a loan impairment. Companies continually evaluate their receivables to determine their ultimate collectibility. As discussed in the chapter, the FASB considers the collectibility of receivables a loss contingency. Thus, the allowance method is appropriate in situations where it is probable that an asset has been impaired and the amount of the loss can be reasonably estimated. Generally, companies start with historical loss rates and modify these rates for changes in economic conditions that could affect a borrower's ability to repay the loan. The discussion in the chapter assumed use of this approach to determine the amount of bad debts to be recorded for a period. However, for long-term receivables such as loans that are identified as impaired, companies perform an additional impairment evaluation. 18A loan is defined as a contractual right to receive money on demand or on fixed and determinable dates that is recognized as an asset in the creditor's statement of financial position. For example, accounts receivable with terms exceeding one year are considered loans. [11] GAAP has specific rules for measurement and reporting of these impairments. These rules relate to determining the value of these loans and how much loss to recognize if the holder of the loans plans to keep them in hope that the market will recover. More complex rules arise when these loans are sold as part of the securitization process, especially when the original terms of the notes are modified. 19Note that the impairment test shown in this Appendix only applies to specific loans. However, if the loans are bundled into a security (e.g., the mortgage-backed securities), the impairment test is different. Impairments of securities are measured based on fair value. We discuss this accounting in Chapter 17.
edugen.wileyplus.com/edugen/courses/crs7181/kieso9781118147290/c07/a2llc285NzgxMTE4MTQ3MjkwYzA3LWFwcC0wMDAyLnhmb3Jt.enc?course=crs718
1/3
12/10/13
As indicated, this loan is impaired. The expected cash flows of $115,000 are less than the contractual cash flows, including principal and interest, of $130,000. The amount of the impairment to be recorded equals the difference between the recorded investment of $100,000 and the present value of the expected cash flows, as shown in Illustration 7B-2.
The loss due to the impairment is $12,434. Why isn't it ? Because Ogden Bank must measure the loss at a present-value amount, not at an undiscounted amount, when it records the loss.
LOST IN TRANSLATION
Floyd Norris, noted financial writer for the New York Times, recently wrote in his blog that he attended a conference to discuss the financial crisis in subprime lending. He highlighted, and provided translations of, some of the statements he heard at that conference:
edugen.wileyplus.com/edugen/courses/crs7181/kieso9781118147290/c07/a2llc285NzgxMTE4MTQ3MjkwYzA3LWFwcC0wMDAyLnhmb3Jt.enc?course=crs718 2/3
12/10/13
There is a problem of misaligned incentives. Translation: Many parties in the lending process were complicit in not performing due diligence on loans because there were lots of fees to be had if the loans were made, good loans or bad. It is pretty clear that there was a failure in some key assumptions that were supporting our analytics and our models. Translation: The rating agencies that evaluated the risk level of these securities made many miscalculations. Some structured finance products that were given superior ratings are no longer worth much. The plumbing of the U.S. economy has been deeply damaged. It is a long window of vulnerability. Translation: The U.S. has caused a financial crisis as a result of poor lending practices, and many financial institutions are fighting to survive. I'm glad that this time we did not cause it. Translation: Other countries realized they had caused financial crises in the past but were not to blame for the current U.S. financial situation. What you see is what you get. If you don't see it, it will get you. Translation: A large number of financial institutions have to take losses on assets that are not reported on their balance sheets. Their continuing interest in some of the loans that they supposedly sold is now coming back to them and they will have to report losses.
Source: Floyd Norris blog, http://www.norris.blogs.nytimes.com/ (acce sse d June 2008).
Copyright 2012 John Wiley & Sons, Inc. All rights reserved.
edugen.wileyplus.com/edugen/courses/crs7181/kieso9781118147290/c07/a2llc285NzgxMTE4MTQ3MjkwYzA3LWFwcC0wMDAyLnhmb3Jt.enc?course=crs718
3/3