Follow-up on Restoring Nonaccrual Loans to Accrual Status

1/19/2012

By Robert L. Hamby, CPA

Since writing the original article on this topic back in March 2011, I have received several emails regarding the accounting guidance for which the article was based. I have also heard from several financial institutions on issues for the accounting treatment related to their current software provider. Therefore I am writing a follow up article to address some of these issues.

The accounting guidance is more of a regulatory accounting issue. Deferring the immediate interest income recognition to more of an effective yield to maturity method is in accordance with the Call Report instructions included in the glossary section. Financial institutions should set up the appropriate accounting treatment for these types of loans when filing their quarterly call reports. Furthermore, the OCC Bank Accounting Advisory Series also discusses the topic in the non-accrual loan section. The OCC authors go on to discuss that when doubt exists as to the collectability of the loan, interest payments applied to the principal balance should not be reversed as they were based on circumstances that the principal balance of the loan may not be recoverable.

The biggest accounting issue I have heard in regard to the financial institution software providers is that the systems will not account for restoring nonaccrual loans to accrual status appropriately. The software does not recognize the “lost” income for these loans until the loan matures. Therefore the interest income that was applied to the principal balance during the nonaccrual stage is not recognized until the end of the loan. In order to properly account for the transaction, financial institutions may need to manually set up a new general ledger account for the discount that gets recorded and monthly accretion entries. When manually setting up accounts to properly account for the interest income, financial institutions should consider any prior charge-off amounts and the reversal of the income the software system will book when the loan matures.