The Financial Accounting Standards Board (FASB) provides certain guidelines, defining when to classify loans into FAS 5 (unimpaired loans) or FAS 114 (impaired loans) status.
Evaluating FAS 114 (ASC 310-10-35), also known as Accounting Standards Codification Subtopic 310-10, loans for impairment, and identifying the reserve for each one of those individually assessed loans is one of the most critical steps in the allowance for loan lease losses calculations process.
When Should a Loan be Classified as FAS 114?
Under certain conditions, the FASB provides straight-forward guidance for determining which loans should be evaluated under FAS 114 status. The FASB guidance clearly prescribes that loans labeled under Troubled Debt Restructure (TDR) or those that have entered nonaccrual status should be evaluated under FAS 114 status. At other times, like with loans that are considered impaired but aren’t labeled TDR or nonaccrual, latitude is given for the determination of the appropriate reserve.
A loan is evaluated for FAS 114 status when it is considered impaired, which means the creditor has some expectation that the repayment of the loan will not be fully realized, according to the Federal Reserve Systems' "Interagency Policy Statement". In other words, there is information available as of the evaluation date indicating the creditor will be unable to collect all amounts due according to the contractual terms (which includes both principal and interest). The resulting reserve for this particular loan would be the amount of loss that can be reasonably estimated. If the loss was actual, then the loan loss should be partially or completely charged off—the emphasis on what is probable and estimated versus actual comes from this difference.