If your bank immediately recognizes loan origination fees and costs directly to your income statement, you are not alone. This is a common practice among many community banks. However, this practice is not in accordance with Generally Accepted Accounting Principles (GAAP).
According to Accounting Standards Codification (ASC) 310-20-25-2, loan origination fees and direct costs are to be deferred and amortized over the life of the loan to which they relate.
What constitutes loan origination fees and costs?
The fees and costs include but are not limited to:
- Prepaid interest
- Fees to reimburse the lender for origination activities
- Other fees charged to the borrower directly related to the loan origination
- Costs directly related to evaluating the financial performance of the potential borrower
- Preparing and processing loan documentation
- Employees compensation directly related to the loan
Can I consider my loan origination fees and costs as immaterial?
ASC 310-20 does not directly dictate a minimum amount of fees and costs to be deferred, but does indicate direct loan costs are to be offset against fees received and only the net amount is to be deferred. It is a common practice for community bankers to consider these net amounts as “immaterial”. Each institution is different and should evaluate their costs to determine if they could be considered immaterial.
In order to evaluate the costs, the following should be performed by management:
- Outline the minimum loan fee for which immediate recognition will be practiced.
- Outline the documentation requirements associated with determining the direct loan costs for loan origination fees in excess of the minimum amount, including whether a standard costing system will be used.
- Establish the timing for which the guidelines and costing method will be reviewed and modified.
- Outline the recognition practice associated with loans in the process of closing at year end.
- Address the accounting practices associated with renewing, refinancing, restructuring and modifying loans with deferred fees and costs.
A bank could consider these fees as immaterial if their policies and practices support that determination. An exercise of calculating the net deferred loan fee and cost should be performed. Best practices indicate this exercise could be done by calculating the cost for a sample of loans of the same type, and using that information to calculate the average cost, which could be netted against the loan-specific loan origination fees.