The practice of many banks is to immediately recognize loan origination fees and costs directly to income and expense at the time of loan origination. This practice runs counter to Generally Accepted Accounting Principles (GAAP) and puts banks at risk of being out of regulatory compliance on call reports.
Accounting Standards Codification (ASC) 310-20-25-2 states that loan origination fees and direct loan costs are to be deferred and amortized over the life of the loan to which the fees and costs directly relate.
For more information like this, read Loan Origination Fees: To Recognize Immediately or Amortize
Loan origination fees include but are not limited to fees charged to the borrow as prepaid interest, fees to reimburse the lender for origination activities, and other fees charged to the borrower directly relating to the origination of the loan. Direct loan origination costs include but are not limited to costs directly related to evaluating the financial performance of the prospective borrower, preparing and processing loan documentation and employees’ compensation directly related to the loan.
ASC 310-20 does not dictate the minimum amount of fees and costs that must be deferred but does indicate direct loan costs are to be offset against fees received and only the net amount is to be deferred.
Banks should not assume that the difference between immediate and deferred fees and costs is immaterial. Banks that fail to comply with GAAP could be asked so support their accounting treatment of those fees and costs.
Accordingly, management should establish guidelines to assist in complying with ASC 310-20 which:
- 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.
The practice of immediate recognition would be appropriate only if an assessment regarding the accounting policy supports it. In other words, the bank could consider calculating the cost for a sample of loans of the same type and use that information to calculate the average cost which can be netted against the loan-specific loan origination fee for calculating the net deferred loan fee and cost.