Banks, credit unions can use flexible approach for recording interest income on loan modifications

FASB staff members were asked to clarify how interest income should be recognized on a loan payment holiday, a transaction that allows borrowers to temporarily stop payments for a period of time. Interest would not accrue while the loan payment holiday is in effect.

Companies would apply FASB ASC 310-20 (Non-refundable Fees and Other Costs) and account for the modification as the continuation of the original lending arrangement, FASB’s Acting Technical Director Shayne Kuhaneck said during April 8 board discussions. It would not be accounted for as a new lending arrangement and therefore the modification would not be accounted for as an extinguishment of the original loan and the recognition of a new loan.

Kuhaneck said it would be appropriate for an institution to continue to recognize interest income during the deferment period or the loan payment holiday.

The topic lands banks in uncharted waters. It is especially critical to the sector because the majority of what they earn for revenue is interest income on their loans.

Under the Coronavirus Aid, Relief and Economic Security (CARES) Act, banks are encouraged to work with borrowers to defer payments over a reasonable period of time.

Under normal circumstances, financial institutions would have had to consider whether the deferral is a troubled debt restructuring and apply ASC 310-40, Troubled Debt Restructuring by Creditors. Those rules have certain accounting and financial reporting implications. Companies, for example, would need to continue to recognize interest income.

Though the issue FASB addressed is specific to a scenario where interest will not accrue during the payment deferral period, financial institutions can apply the same logic when interest will continue to accrue.

This difference may be significant enough for an institution to consider revising the effective interest rate used for the loan on a prospective basis, said Skaggs. “Based on the expected volume of modifications related to COVID-19, it will be important for the finance and lending functions to have a good process in place to assess whether this difference is significant based on the terms of the modified loans,” he said.

If you have questions about how these changes could affect you, reach out to a KraftCPAs professional. We’ll be happy to answer your questions.

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