What happens when there is a cash loss on reserves? Suppose that we have a cash loss of 10 on one of our loans.
Nothing happens to Income Statement.
CFO = -10
Cash = -10
Loan Asset = -10
Reserve = +10
Net Assets = -10
So, Equity has to fall by 10 but where does it show up if it doesn’t hit the Income Statement? Other comprehensive Income? My google searches show this is true for cash flow hedges where mark to market changes bypass the IS but is this also true for cash losses on previously recognized loss reserves?
I’m not sure that nothing happens to the income statement; I’d be inclined to think that you’d show a loss, just like losses on other write-downs of assets.
Don’t you create an allowance by taking a non-cash (accrual) expense on the IS? So, why should it show up on the IS again in the year of the cash loss?
Let me add to the initial prompt. Suppose that the initial reserve balance was 100 and thus the actual cash loss of 10 is still less than the reserve (no additional reserves are necessary).
You either book an accrual once you anticipate a probability of more than 50% that the loss is going to happen in the future (you book an accrued liability against net income/ equity and once the loss is realized you book the accrual directly against the asset with no further impact on the income stament).
If you did’nt anticipate the loss you book the loss directly on the income statemtent at the moment it happens (you book net income/ equity directly against the asset).
Right, so this accrued liability would be the reserve account (contra-asset account or liability, if you prefer). I’m with you up to this point. Isn’t that what I’m doing in my 1st post?
I’m not getting the part about realizing the loss. Cash should fall by 10, right?
You are right. You accrue for the asset, so the Asset side goes down. At the same time you realize the loss in the income statement reducing equity by the same amount keeping the balance sheet equation intact.
Do not mix up accounting loss and and cash loss. The loss is realized on the income statement by either an accrued liability or directly via an impariment in the income statement. This does not mean thatt here is an equivalent cash outflow. In fact, if you write-off a receivable you will have the negative impact on the income statement. However, there won’t be any impact on your cash-flow statement. (There will not be any money flowing out of the company). The only cash flow effect is that future cash flows might be lowered by the ammount written of.
My original question was, what happens when the actual loss is realized (not recognized)? Meaning the loan/receivable is actually delinquent. What COMPONENT of equity will show this? OCI?
I misread YOUR response. I think you’re right. It should mean reduced CFO in the future, as you said. The GROSS Receivable/Debt will decrease but will be offset by an increase in the contra asset account, so the Asset side of the BS will have a net change of zero. Thus equity should not be impacted in net.
My confusion was due to the add-back in the initial year of the accrual. My logic was that in cumulation (over all years) CFO should decrease since we are not collecting the recognized amount.
If you’ve created an Allowance for Doubtful Accounts account (a contra asset account), then you’ve already written off your estimated bad debts on your income statement.
When an account defaults and you write it down, you credit the account for the amount of the write-down and you debit AFDA for the same amount.
I don’t know what you mean by a cash loss. You haven’t lost any _ cash _; you’ve lost prospective future cash from a receivable.