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received from customers for products or services provided
(net realizable value). Receivables are classified as current or noncurrent
assets. These transactions are recorded on the balance sheet. Current
receivables are cash and other assets a company expects to receive from
customers and use up in one year or as per operating cycle, whichever is
longer. Accounts receivables are either collected as bad debt or cash discount.
Noncurrent assets are long-term, meaning they are held by the company longer
than a year. Apart from the well known noncurrent assets, banks and other
mortgage lending institutions have a mortgage receivable account that is
reported as a noncurrent asset.
Bad debts also known as uncollectable expense is considered
as a contra asset (subtracted from an asset in the balance sheet). Contra asset
increases with credit entries and decreases with debit entries and will have a
credit balance. Bad debt is an expense account that represents accounts
receivables that are not expected to be collected by a company. Cash discount
is offered to a customer to entice prompt payment. When a customer pays a bill
within a stipulated time which normally is 10 days, a cash discount is offered
noted as 2/10 which means that if the account is paid within 10 days the
customer gets a 2 percent discount. The other credit terms offered could be n30
which means the full amount: has to be paid within 30 days. Cash discounts are recorded
in the income statement as a deduction from sales revenue.
Banks and other financial institutions that provide loans
experience or expect to have losses from loans they lend to customers. As the
country witnessed during the credit crunch, banks issued mortgages to customers
who, due to loss of jobs or other facts surrounding their circumstances at that
time could not repay their mortgages. As a result, mortgages were defaulted
causing foreclosure crisis and banks repossessing houses and losing money. For
better loss recovery, banks secured accounting procedures to assist bankers to
report accurate loan transactions at the end of each month or as per the bank's
mortgage cycle. Among those credit risk management systems, banks created a
loan loss reserve account and mortgage loss provisions. The mortgage lenders
also have a Mortgage Receivable account (noncurrent asset). By definition, a
mortgage is a loan (sum of money lent at interest) that a borrower uses to buy
property such as a house, land or building and there is an agreement that the
borrower will pay the loan on a monthly basis and loan installments are
amortized for some stipulated years
To safeguard losses from defaulted mortgage loans, banks
created a loan loss reserve account which is a contra asset account (a
deduction from an asset in the balance sheet) that represents the amount
estimated to cover losses in the entire loan portfolio. The loan loss reserve
account is reported on the balance sheet and it represents the amount of
outstanding loans that are not expected to be paid back by the borrowers (an
allowance for loan losses estimated by the mortgage lending financial
institutions). This account is adjusted every quarter based on the interest
loss in both performing and nonperforming (non-accrual and restricted) mortgage
loans. The loan loss provision is an expense that increases (or decreases) the
loan loss reserve. The loan loss expense is recorded in the Income statement.
It is designed to adjust the loan reserve so that the loan reserve reflects the
risk of default in the loan portfolio. The methodology of estimating the loan
loss reserve based on all loan accounts in the portfolio in my opinion, does
not give a good measure of the losses that could be incurred. There is still a
risk of overstating the loss or understating the loss. Therefore there is still
a possibility that the banks may run at a loss, and that defeat the purpose of
having the loan loss reserve and provision. If loans were categorized and then
estimated accordingly, that would eliminate further loan losses.
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