Allowance for bad debts

The Statement of Financial Accounting Standards 5 (SFAS 5) states that a contingent loss should be recognized in cases where a financial asset is “probable " to be impaired and the loss can be "reasonably estimated". However, the standard does not set parameters or more detailed information for defining precisely what is meant by "probable" and "reasonably estimated". The FASB Interpretation 14 (FIN 14) - Reasonable Estimation of the Amount of a Loss, deepens the understanding of the rule defining that, if a range of loss cannot be reasonably estimated, the amount most within the range should be considered, if possible. If there is no most likely value within the range, then the range lower extremity value should be recognized.
Thus, there is evidence of restriction to conservatism, since the contingent losses are recognized only when probable and estimated with confidence, in accordance with SFAS 5, in addition to being measured on the basis of lower extremities within a range of possible values in the absence of a best estimate, as provided in FIN 14. The language used by SFAS 5 and FIN 14 provides interpretations and broad concepts about the measurement of the allowance for doubtful accounts. The FASB itself by issuing SFAS 114 - Accounting by Creditors for Impairment of a Loan, acknowledged that the application of subjective concepts in the SFAS5 resulted in significant differences in when and how different types of financial institutions recognizing losses. Rules that establish criteria for measuring the allowance for bad debts are SFAS 5 and SFAS 114 only, being all other pronouncements and interpretations of these two rules a result of the complexity of accounting norms in the United States. Thus, it is important to clarify that SFAS 114 establishes criteria for loss allocation of specific loans subject to individual assessment, through which it has determined are impaired. The SFAS No. 5, on the other hand, establish rules about recognition of impairment losses related to groups of loans evaluated collectively. The Staff Accounting Bulletin 102 (SAB 102) - Selected Loan Loss Allowance Methodology and Documentation Issues requires that financial institutions have systematically, consistently applied, documented and auditable measurement methods of allowance for doubtful accounts. SFAS 114 and SFAS 118 - Accounting by Creditors for Impairment of a Loan: Income Recognition and Disclosure set out the criteria for the measurement and disclosure of information about the operations of credit impaired. SFAS 118 provides that a loan is impaired when the present value of estimated future cash flows is less than the carrying amount of the loan. SFAS 114 states that a loan is impaired when, based on current information and events, it is likely that the entity is not able to collect all amounts due according to contractual terms, meaning payments of principal and interest made in accordance with the conditions and deadlines. The standard does not specify how the entity should be determined not likely to receive the amounts owed, only recommends that the entity holds its usual procedures for revision of lending to such arbitration. Additionally, SFAS 114 also clarifies that a loan is not impaired during a period of late payment if the entity expects to receive all amounts due, including interest with appropriate contractual basis during the period of delay. The definitions given by SFAS 114 and SFAS 118 are not fully converged, since the 118 emphasizes the concept of expectation of future cash flows while the 114 provides that the employer should use his trial to determine when it is likely that money flows provided by the contract terms are not met.
The set of U.S. standards makes no restriction on the use of data that reflect trends and projections of future events, so that might be considered as a model based on expected losses. This feature is one of the main differences between the models of measurement proposed by the U.S. GAAP and IFRS, since the model established by the international accounting standards is based on loss experience. Another conceptual difference between the two models (international and U.S.) can be seen in the following hypothetical situation. A large group of homogeneous loans is typically composed of some operations that immediately after booking goes into default, a situation in which SFAS 5 requires to immediately recognizing the corresponding allowance for doubtful accounts. In applying this model to recognize a loss on the initial operation could distort the comparison of revenue and expenditure, bearing in mind that while the loss is recognized at once at the beginning of the operation, the interest income is appropriate in function of the duration of the loan.