When entering into a new financing arrangement, or even renegotiating an existing one, there are often fees associated with the origination. The overarching accounting theory when accounting for these types of costs is the utilization of the matching principle. This means that to properly match these costs with the new loan, the costs should be capitalized and amortized over the term of the loan.
There are various types of potential costs that relate to financing arrangements, some of which are:
Fees charged to the borrower in connection with the process of originating, refinancing, or restructuring a loan, such as application and underwriting fees.
Fees charged to the borrower that relate directly to making the loan (for example, fees that are paid to the lender as compensation for granting a complex loan or agreeing to lend quickly).
These costs should be recorded as an asset and the related periodic expense should be charged to amortization expense. If these costs were expensed in full at the time of payment, expense for that period would be artificially higher than normal and potentially misleading. Utilizing the matching principle will allow a Company to align this expense with the term of the loan.
When capitalizing these types of costs on the balance sheet, consideration should be given to the classification of the asset as current (meaning it will be amortized in one year) vs. non-current (meaning it will be amortized after one year has passed). This may mean recording a current and non-current portion of the capitalized loan fees.
Illustration: A Company enters into a new line of credit agreement with their bank. The agreement requires a loan origination fee of $20,000 which is paid by the Company to the lender at the date of the line of credit closing. The line of credit agreement is valid for 5 years.
This fee should be recorded on the balance sheet when paid and amortized over the five year remaining term of the line of credit.
DR: Other Asset, current portion – Loan Origination Fees $4,000
DR: Other Asset, non-current portion – Loan Origination Fees $16,000
CR: Cash $20,000
Each year, amortize 1/5th of the fee:
DR: Amortization Expense $4,000
CR: Other Asset, current portion – Loan Origination Fees $4,000
Note that a Company can choose to set up a contra-asset general ledger account to track the accumulated amortization vs. reducing the asset directly, if it is preferred by the Company.
There are also certain disclosures relating to capitalized loan origination fees which are required to be made in a Company’s footnotes. These requirements include a description of the Company’s accounting policy related to the capitalization of these types of costs, the original amount of loan costs capitalized, accumulated amortization and the periodic expense amount.
As always, materiality plays a role in a Company’s decision to capitalize vs. expense the loan fees and also to classify a portion of the asset as current vs. non-current. See our blog post "Audit Materiality: It’s in the Eye of the Beholder" for further discussion of the concept of materiality.
This post was written by Courtney Eaton, a Senior Manager in Meaden & Moore’s Assurance Services Group. She provides public accounting services to a wide variety of clients in various industries, including manufacturing, private equity and distribution. Courtney assists in the planning of engagements, supervising staff accountants in fieldwork, preparing financial statements and tax work, working with clients and the accounting staff to find solutions to problem areas, and developing ideas for growth. Click here to learn more about Courtney.