Understanding Loan Receivables: A Borrower's Perspective

A loan receivable is a term used in banking to refer to the amount of money owed by a debtor to a creditor. It is recorded as an asset in the creditor's books, specifically in the creditor's general ledger, which details all unpaid amounts from borrowers. The loan receivable is considered a current asset if it is to be repaid within a year, otherwise, it is listed as a non-current asset. The accounting process for loan receivables involves a double-entry system, which requires a detailed bookkeeping process and provides better accuracy and fraud prevention.

Double-entry accounting

A loan receivable is the amount of money owed from a debtor to a creditor, typically a bank or credit union. It is recorded as a "loan receivable" in the creditor's books. Banks and financial institutions use a double-entry system of accounting for all their transactions, including loan receivables. This system requires a detailed bookkeeping process, where every entry has a corresponding entry in a different account. For every "debit", there must be a matching "credit", and vice versa. The totals for each must balance, otherwise, a mistake has been made. This system provides better accuracy by quickly detecting errors and is effective in preventing fraud or mismanagement of funds.

For example, let's say a small business owner wants a $15,000 loan to start a bike company. The bank approves the loan, with a repayment schedule of monthly instalments based on an interest rate. The bank deposits the amount directly into the owner's account. Here, the bank is the creditor, and it records this transaction with a debit and credit entry. The bank's accountant debits the amount in the customer's loan account, reducing the bank's cash when they credit the loan to the customer's account. The bank then credits the loan amount as a loan receivable, which is listed under the liability side of the bank's balance sheet.

In this case, the double-entry system would look like this:

Debit: Bank (asset account)

Credit: Loan Receivable (asset account)

The double-entry system is also used when the loan is repaid. For example, if the small business owner repays the loan in monthly instalments, each repayment would be recorded as a debit in the loan receivable account and a credit in the bank account. This ensures that the accounting books remain accurate and balanced.

Additionally, loans receivable can be classified as either held for sale (HFS) or held for investment (HFI) based on management's intentions. HFS loans are measured at the lower of cost or fair value, while HFI loans are measured at amortized cost, which includes adjustments for interest, fees, cash collection, write-offs, and fair value hedge accounting. This classification helps in determining the value and risk associated with the loans receivable.

Current assets vs non-current assets

A loan receivable is a banking term for an asset account that shows amounts owed by borrowers. Financial institutions record the amounts paid out and owed to them in the asset and debit accounts of their general ledger. This is a double-entry system of accounting, which requires a detailed bookkeeping process where every entry has a corresponding entry in a different account.

Now, onto the differences between current and non-current assets. Current assets are short-term assets that a company expects to liquidate and spend within a year or less. They are important because they can be used to fund day-to-day business operations and pay for ongoing expenses. Examples of current assets include cash, cash equivalents, and accounts receivable, stock inventory, and marketable securities.

On the other hand, non-current assets are long-term investments that are not easily converted into cash or that a business does not expect to turn into cash within a year. They are important for a company's long-term strategic growth and future financial development. Examples of non-current assets include long-term investments, intangible assets, fixed assets, property, machinery, and intellectual property.

The value of non-current assets is calculated by subtracting depreciation from the original purchase price. While non-current assets are rolled together on a balance sheet, it is important to list non-depreciating assets separately. For example, a company may list property, plants, and equipment together and then subtract depreciation, but also list assets like intellectual property or brand recognition separately.

Held for sale vs held for investment

A loan receivable is a term used in banking to describe an asset account that details the amounts owed by borrowers. The lender's ledger will list the exact amounts of money that are due from borrowers, excluding any money already paid. This is usually recorded using a double-entry system, where every 'debit' has a matching 'credit' and vice-versa, ensuring accurate financial statements.

Loan receivables are classified as either held for sale (HFS) or held for investment (HFI) based on management's intentions. If a loan is held for sale, it means that the entity that created or bought the loan intends to sell it to another entity, such as a government-sponsored enterprise. This classification is made once the decision to sell the loan has been made, and management must confirm their ability and intent to sell. Loans held for sale are measured at the lower of cost or fair value.

On the other hand, a loan is held for investment if the entity that created or bought the loan intends to hold it for the foreseeable future or until maturity or payoff. Loans held for investment are shown on the balance sheet at their amortized cost basis, which includes adjustments for interest, fees, cash collection, write-offs, and fair value hedge accounting. This amortized cost basis is the amount at which the loan was originated or acquired, adjusted for applicable accrued interest, accretion, or amortization of premium, discount, and net deferred fees or costs. Loans held for investment are measured at amortized cost when the intention is to collect contractual cash flows on specified dates, and those cash flows are solely payments of principal and interest.

Amortized cost

A loan receivable is a term used in banking to refer to an asset account that shows amounts owed by borrowers. The lender's ledger details all unpaid amounts from borrowers. Loans receivable are handled transparently and logically, like other accounting processes. The balance sheet shows loan receivables as current assets if they are repaid within a year. Otherwise, they are non-current assets and are listed lower.

Loan receivables are classified as either held for sale (HFS) or held for investment (HFI) based on management's intent. If a loan receivable is held for sale, it is measured at the lower of cost or fair value. If it is held for investment, it is measured at amortized cost. According to IFRS 9, if a financial asset is held with the intention of collecting contractual cash flows on specified dates, and those cash flows are solely payments of principal and interest, then the asset should be measured at amortized cost.

The formula for calculating the amortization of monthly payments is:

Principal Payment = TMP − (OLB × Interest Rates / 12 Months)

For example, consider a loan of $5,000 with a 6% interest rate per annum and fixed monthly repayments of $430.33. The interest expense amounts to $25 (5,000 x 0.5%) in the first month of amortization. In subsequent years, the same rate of interest is used, but the liability is expected to reduce due to repayment of the loan.

If the loan costs are significant, they must be amortized to interest expense over the life of the loan because of the matching principle. For example, if a company incurs loan costs of $120,000 to obtain a $4 million loan at an annual interest rate of 9%misleading to report the entire $120,000 of loan costs as an expense for the month. Instead, the matching principle requires that each month during the life of the loan, the company should report $2,000 of loan costs as interest expense in addition to the interest expense of $30,000 per month.

Detecting fraud

A loan receivable is a term used in banking to describe the amount of money owed to a creditor by a debtor. It is recorded as a "loan receivable" in the creditor's books and is considered an asset. Loan receivables are typically handled with a double-entry accounting system, which improves accuracy and helps prevent fraud or mismanagement of funds.

• Regular audits and robust internal controls are necessary to verify the accuracy and legitimacy of transactions and balances.
• Study your organisation's weaknesses and address areas of risk. Segregate accounts receivable duties such as bank deposits, editing accounts, and accessing revenue.
• Be vigilant about detecting and preventing internal fraudulent schemes, especially those involving fictitious accounts receivable.
• Watch out for statement revisions, where employees make subtle changes to business statements to conceal theft.
• Fraudsters may divert customer payments to personal accounts with similar names to the company to avoid suspicion.
• Improper revenue recognition, such as inflating or delaying revenue, is a common type of accounting fraud that can lead to significant financial losses and damage to the company's reputation.
• Other signs of potential fraud include bank deposit discrepancies, customer complaints about late payment notices, excessive discounts or returns, and unauthorised sales.

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