Loan Loss Reserves

CFA Level II
#1

Interesting article on WSJ.com today about loan loss reserves. kinda ties into some of the CFAI material. they say that when a bank increases their loan loss reserves, the amount going into that reserve gets charged off the income statement. i have two questions: 1) what effect on the balance sheet does this have? decrease in cash, increase in loan loss reserves? 2)when a firm uses a loan loss reserve for a bad loan, it says they take it out of this bucket. how does that affect the inc statement and balance sheet? i assume bal sheet is decrease in loan loss reserves and decrease in shareholders equity. how does it affect the inc statement? a loss already went through, so is there no new loss? thx

#2
  1. What cash? There is no cash just an accounting move. 2. It doesn’t, it was already charged off the income statement. The loan loss reserve is decreased and so is the outstanding loan item on the asset side since the particular loan won’t be repaid.
#3

mcpass Wrote: ------------------------------------------------------- > 1. What cash? There is no cash just an accounting > move. right, accounting move from x to loan loss reserves. what is the “x” though? if its not cash, is it loans? where is the money “moving” from? > 2. It doesn’t, it was already charged off the > income statement. The loan loss reserve is > decreased and so is the outstanding loan item on > the asset side since the particular loan won’t be > repaid. so when a company takes a loss on a loan it doesnt go to equity? at some point it has to hit equity, right? thanks mcpass

#4

First entry: Debit: Bad debt expense (on Inc Stmnt, gets closed into RE on balance sheet) Credit: Allowance for bad debts (Typical follow-up entry) Debit: Allowance for bad debts Credit: Loans (the specific loan that is being written-off)

#5

super I – thanks for this last question: so in the follow-up entry, nothing occurs on the Income Statement, because it already passed through in the first entry?

#6

mike0021 Wrote: ------------------------------------------------------- > super I – thanks for this > > last question: so in the follow-up entry, nothing > occurs on the Income Statement, because it already > passed through in the first entry? Correct. The only common future entry that would effect the income statement is a reversal of the reserve, where you find out in the future that the first entry in my example was for an amount that was too high, and you need to bring it down so you record the exact opposite entry for the amount that you need to reduce. To pre-emp a possible follow-up question, the reversal runs thru the income statement, not RE since it is a change in accounting estimate. (no special disclosure required)

#7

haha yeah i would have asked that next. thanks!