Accountants' Handbook Special Industries and Special Topics 10th Edition_4

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Accountants’ Handbook Special Industries and Special Topics 10th Edition_4 29.2 BANKS AND SAVINGS INSTITUTIONS 29 23 • In addition to all of the customary considerations surrounding credit risk, sovereign risk lendinginvolves economic, social, and political considerations that bear on the ability of the borrower torepay foreign currency obligations.Trade Finance • Letters of Credit. Letters of credit are instruments used to facilitate trade (most commonly in- ternational trade) by substituting an institution’s credit for that of a commercial importing com- pany. A letter of credit provides assurance to a seller that he will be paid for goods shipped. At the same time, it provides assurance to the buyer that payment will not be made until conditions specified in the sales contract have been met. Letter of credit transactions can vary in any number of ways. The issuing and advising in- stitutions may deal with each other through their own local correspondent banks. Some of the documents may flow in different patterns. The requirements for payment and security will cer- tainly vary from transaction to transaction. One of the attractive features of letter of credit fi- nancing from the customer’s point of view is its flexibility. Facilities can be tailored to individual transactions or groups of transactions. • Bankers’ Acceptances. A bankers’ acceptance is like a letter of credit in that it provides a seller of goods with a guarantee of payment, thus facilitating trade. The institution’s customer is the buyer who, having established an acceptance facility with the bank, notifies the seller to draw up a bill of exchange. The bank “accepts” that bill (by physically stamping “accepted” on its face and having an authorized bank officer sign it) and, in so doing, commits itself to disburse funds on the bill’s due date. A banker’s acceptance represents both an asset and a liability to the accepting bank. The asset is a receivable from the bank’s customer, the buyer in the transaction. The liability is a payable to the holder of the acceptance. The bank’s accounting for open acceptances varies from country to country. In some countries, the asset and liability are both reflected on the bank’s balance sheet. In others, they are netted against each other and thus become, in effect, off-balance sheet items. In European Union (EU) countries, they appear as memorandum items on the face of the balance sheet. By substituting its own credit for that of the buying company, the accepting bank creates a financial instrument that is readily marketable. Bankers’ acceptances trade as bearer paper on active secondary markets.(ii) Accounting for LoansPrincipal. Loans expected to be held until maturity should be reported as outstanding princi-pal, net of charge-offs, specific valuation accounts and any deferred fees or costs, or unamortizedpremiums or discounts on purchased loans. Total loans should be reduced by the allowance forcredit losses. Loans held for sale should be reported at the lower of cost or market value. Mortgage loans heldfor sale should be reported at the lower of cost or market value in conformity with SFAS No. 65,“Accounting for Certain Mortgage Banking Activities.” Mortgage-backed securities held for sale inconjunction with mortgage banking activities shall be classified as trading securities and reported atfair value in conformity with SFAS No. 115, “Accounting for Certain Investments in Debt and Eq-uity Securities.”Interest. Interest income on all loans should be accrued and credited to interest income as it is earnedusing the interest method. Interest income on certain impaired loans should be recognized in accor-dance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” as amended by SFASNo. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures.” The accrual of interest is usually suspended on loans that are in excess of 90 days past due, un-less the loan is both well secured and in the process of collection. When a loan is placed on such29 24 FINANCIAL INSTITUTIONS •nonaccrual status, interest that has been accrued but not collected is reversed, and interest subse-quently received is recorded on a cash basis or applied to reduce the principal balance dependingon the bank’s assessment of ultimate collectibility of the loan. An exception to this rule is thatmany banks do not place certain types of consumer loans on nonaccrual since they automaticallycharge off such loans within a relatively short period of becoming delinq ...