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Statement of Federal Financial Accounting Standards 2:
Accounting for Direct Loans and Loan Guarantees
Status
Summary
The Statement provides accounting standards for federal direct loans and loan guarantees. The
standards require that direct loans obligated and loan guarantees committed after September 30,
1991, be accounted for on a present value basis. The use of the present value accounting
method is consistent with the intent of the Federal Credit Reform Act of 1990.
The standards contain the following essential requirements:
• Direct loans disbursed and outstanding are recognized as assets at the present value of
their estimated net cash inflows. The difference between the outstanding principal of the
loans and the present value of their net cash inflows is recognized as a subsidy cost
allowance.
• For guaranteed loans outstanding, the present value of estimated net cash outflows of the
loan guarantees is recognized as a liability. Disclosure is made of the face value of
guaranteed loans outstanding and the amount guaranteed.
• For direct or guaranteed loans disbursed during a fiscal year, a subsidy expense is
recognized. The amount of the subsidy expense equals the present value of estimated cash
outflows over the life of the loans minus the present value of estimated cash inflows.
• The subsidy cost allowance for direct loans and the liability for loan guarantees are
reestimated each year, taking into account all factors that may have affected the estimated
cash flows. Any adjustment resulting from the reestimates is recognized as a subsidy
expense (or a reduction in subsidy expense).
Issued August 23, 1993
Effective Date For fiscal years beginning after September 30, 1993.
Affects None.
Affected by • SFFAS 18
• SFFAS 19
• SFFAS 32 amends par. 56
Related Guidance • TR 3 (Revised), Auditing Estimates for Direct Loan and Loan
Guarantee Subsidies under the Federal Credit Reform Act –
Amendments to Technical Release No. 3 Preparing and Auditing
Direct Loan and Loan Guarantee Subsidies under the Federal
Credit Reform Act
• TR 6, Preparing Estimates for Direct Loan and Loan Guarantee
Subsidies under the Federal Credit Reform Act – Amendments to
Technical Release No. 3 Preparing and Auditing Direct Loan and
Loan Guarantee Subsidies under the Federal Credit Reform Act
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• When direct loans or loan guarantees are modified, the cost of modification is recognized
at an amount equal to the decrease in the present value of the direct loans or the increase in
the present value of the loan guarantee liabilities measured at the time of modification.
• Upon foreclosure of direct or guaranteed loans, the acquired property is recognized as an
asset at the present value of its estimated future net cash inflows.
The standards permit but do not require restating pre-credit reform direct loans and loan
guarantees at present value.
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Executive Summary
1. The Statement provides accounting standards for federal direct loans and loan guarantees.
The standards require that direct loans obligated and loan guarantees committed after
September 30, 1991, be accounted for on a present value basis. The use of the present
value accounting method is consistent with the intent of the Federal Credit Reform Act of
1990.
2. The standards contain the following essential requirements:
• Direct loans disbursed and outstanding are recognized as assets at the present value
of their estimated net cash inflows. The difference between the outstanding principal of
the loans and the present value of their net cash inflows is recognized as a subsidy
cost allowance.
• For guaranteed loans outstanding, the present value of estimated net cash outflows of
the loan guarantees is recognized as a liability. Disclosure is made of the face value of
guaranteed loans outstanding and the amount guaranteed.
• For direct or guaranteed loans disbursed during a fiscal year, a subsidy expense is
recognized. The amount of the subsidy expense equals the present value of estimated
cash outflows over the life of the loans minus the present value of estimated cash
inflows.
• The subsidy cost allowance for direct loans and the liability for loan guarantees are
reestimated each year, taking into account all factors that may have affected the
estimated cash flows. Any adjustment resulting from the reestimates is recognized as a
subsidy expense (or a reduction in subsidy expense).
• When direct loans or loan guarantees are modified, the cost of modifications is
recognized at an amount equal to the decrease in the present value of the direct loans
or the increase in the present value of the loan guarantee liabilities measured at the
time of modification.
• Upon foreclosure of direct or guaranteed loans, the acquired property is recognized as
an asset at the present value of its estimated future net cash inflows.
3. The standards permit but do not require restating pre-credit reform direct loans and loan
guarantees at present value.
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Introduction
Background
4. The federal government, in discharging its responsibility to promote the nation’s general
welfare, makes DIRECT LOANS
1
and guarantees loans to segments of the population not
adequately served by nonfederal financial institutions. Examples of federal CREDIT
PROGRAMS include farmers’ home loans, small business loans, veterans’ mortgage loans,
and student loans. For those unable to afford credit at the market rate, federal credit
programs provide subsidies in the form of direct loans offered at an interest rate lower than
the market rate. For those to whom nonfederal financial institutions would be reluctant to
grant credit because of the high risk involved, federal credit programs guarantee the
payment of these nonfederal loans, absorbing the costs of defaults.
5. Because federal credit programs provide interest subsidies and sustain losses caused by
defaults, the costs of these programs are significant. It is crucial, therefore, that the actual
and expected costs of federal credit programs be fully recognized in both budget and
financial reporting.
The Federal Credit Reform Act Of 1990
6. The primary intent of the Federal Credit Reform Act of 1990 is to ensure that the SUBSIDY
COSTS of direct loans and LOAN GUARANTEES are taken into account in making
budgetary decisions. To achieve this general result, the Act has the following specific
purposes: (a) ensure a timely and accurate measure and presentation in the President’s
budget of the costs of direct loan and loan guarantee programs, (b) place the cost of credit
programs on a budgetary basis equivalent to other federal spending, (c) encourage the
delivery of benefits in the form most appropriate to the needs of beneficiaries, and (d)
improve the allocation of resources among credit programs and between credit and other
spending programs.
7. The major provisions of the Act, which is effective for fiscal year 1992 and thereafter, are to:
1
Terms included in Appendix C: Glossary are printed in CAPITAL LETTERS when they appear for the first time. (Note:
See “Appendix E: Consolidated Glossary”.)
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• Require that, for each fiscal year in which the direct loans or the loan guarantees are to
be obligated, committed, or disbursed, the President’s budget reflect the long-term cost
to the government of the subsidies associated with the direct loans and loan
guarantees. The subsidy cost estimate for the President’s budget is to be based on the
PRESENT VALUE of specified cash flows discounted at the average rate of
marketable Treasury securities of similar maturity.
• Require that, before direct loans are obligated or loan guarantees are committed,
annual appropriations generally be enacted to cover these costs. (However, mandatory
programs have permanent indefinite appropriations.)
• Provide for borrowing authority from Treasury to cover the non-subsidy portion of direct
loans.
• Establish budgetary and financing control for each credit program through the use of
three types of accounts: the PROGRAM ACCOUNT (budgetary), the FINANCING
ACCOUNT (non-budgetary), and the LIQUIDATING ACCOUNT (budgetary).
The Need For Accounting Information
8. Accounting information on credit programs provides the basis for evaluating program
performance by comparing actual accounting data with estimated budget data. Budget
analysts and decision-makers can use accounting information to compare actual cash flows
with projected cash flows and actual costs of direct loans and loan guarantees with their
estimated costs.
9. For credit program managers, information on estimated default losses and related liabilities,
when recognized in a timely manner, can be an important tool in evaluating credit program
performance. The information can help determine a credit program’s overall financial
condition and identify its financing needs.
10. Furthermore, cost and performance information on loans and loan guarantees maintained
by COHORT and RISK CATEGORY can highlight those groups that are not expected to
meet budget estimates because of increased risk. Based on such information, program
managers can take timely action to reduce costs, control risks where possible, and improve
credit program performance.
Present Value Accounting
11. The Federal Credit Reform Act of 1990 requires that effective October 1, 1991, the cost of
direct loans and loan guarantees be estimated at present value for the budget. The
objectives of using the present value measurement in federal credit reform are to measure
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recognize, and control subsidy costs of direct loans and loan guarantees.
2
12. For direct loans, the effect of using the present value measurement is to estimate the extent
of the disbursed amounts that would be recovered, and the extent of the disbursed amounts
that is a subsidy cost. The portion that can be recovered is the present value of projected
net cash inflows discounted at the Treasury rate of similar maturity. This portion is not
considered a cost to the government because it is expected to be returned to the
government in future amounts. The remaining portion of the cash disbursement represents
a cost to the government, resulting either from lending at a rate lower than the Treasury
interest rate, or from default losses, or both.
13. Under credit reform, the subsidy portion of direct loans is financed by appropriations, and
the unsubsidized portion of the loans, which equals the present value of the government
collections from the borrowers, is financed with funds borrowed from Treasury. The subsidy
cost of loans must be REESTIMATED and updated annually.
14. The present value measurement basis is also applied to loan guarantees. Before credit
reform, as in the case of direct loans, loan guarantees were measured for the budget on a
cash basis. Thus, loan guarantees could appear to be virtually cost free, since cash
payments by the government were not required unless and until the guaranteed loans
defaulted at a future date. Under credit reform, the future cash outflows required by LOAN
GUARANTEE COMMITMENTS must be projected and discounted at an appropriate
Treasury interest rate. The present value of the cash outflows is the cost of the loan
guarantees. Before loan guarantees are committed, annual appropriations generally must
be enacted to cover the cost of the loan guarantees.
Financial Reporting
15. The Board believes that present value measurement should be adopted for financial
accounting and reporting on direct loans and loan guarantees that have been or will be
obligated or committed after September 30, 1991. Since the Act requires that the costs of
these POST-1991 DIRECT LOANS AND LOAN GUARANTEES be estimated at present
value for budget purposes, financial reports on actual results measured at present value can
be used as feedback to compare with budget estimates. Such comparisons can be used as
a basis to improve future estimates and REESTIMATES.
2
Congressional Budget Office, “Credit Reform: Comparable Budget Costs for Cash and Credit” (Dec. 1989), p.33.
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16. The Board recognizes that effective use of the present value accounting method depends
on accurate projections of future cash flows over the life of direct or guaranteed loans. The
efforts to make accurate projections should begin with establishing and using reliable
records of historical credit performance data, and should take into consideration current and
forecasted economic conditions.
17. The Board recognizes the value of having financial accounting support the budget. It
endorses the logic underlying credit reform, and it recommends that accounting standards
for credit be consistent with budgeting under credit reform. The Board is aware that as more
experience is gained, some modifications may be made in budgetary requirements. It is the
intention of the Board that so long as the modifications are made on a credit reform basis
and do not materially affect the basic recognition and measurement principles embodied in
the accounting standards, accounting practices for direct loans and loan guarantees should
change as needed in order to be consistent with the budget.
18. The Board considered the expected costs and efforts that would be required in restating
PRE-1992 DIRECT LOANS AND LOAN GUARANTEES at present value. Based on this
consideration, the standards permit but do not require restating those loans and loan
guarantees on a present value basis.
19. The standards were proposed in an Exposure Draft issued in September 1992. Comments
were received from 36 organizations and individuals. Oral comments were also presented at
a meeting by representatives of federal agencies with major credit programs. The Board
considered all the comments received and incorporated changes, as appropriate. Issues
raised by those who responded to the Exposure Draft and the Board’s conclusions are
presented in Appendix A, “Basis of the Board’s Conclusions.”
Effective Date
20. The FASAB recommends that the accounting standards recommended in this Statement
become effective for fiscal years beginning after September 30, 1993. An earlier
implementation is encouraged.
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The Accounting Standards
Explanation
21. These standards concern the recognition and measurement of direct loans, the liability
associated with loan guarantees, and the cost of direct loans and loan guarantees. The
standards apply to direct loans and loan guarantees on a group basis, such as a cohort or a
risk category of loans and loan guarantees. Present value accounting does not apply to
direct loans or loan guarantees on an individual basis, except for a direct loan or loan
guarantee that constitutes a cohort or a risk category.
Accounting Standards
Post-1991 Direct Loans
22. Direct loans disbursed and outstanding are recognized as assets at the present value of
their estimated net cash inflows. The difference between the outstanding principal of the
loans and the present value of their net cash inflows is recognized as a subsidy cost
allowance.
Post-1991 Loan Guarantees
23. For guaranteed loans outstanding, the present value of estimated net cash outflows of the
loan guarantees is recognized as a liability. Disclosure is made of the face value of
guaranteed loans outstanding and the amount guaranteed.
Subsidy Costs of Post-1991 Direct Loans and Loan Guarantees
24. For direct or guaranteed loans disbursed during a fiscal year, a subsidy expense is
recognized. The amount of the subsidy expense equals the present value of estimated cash
outflows over the life of the loans minus the present value of estimated cash inflows,
discounted at the interest rate of marketable Treasury securities with similar maturity to the
cash flows, applicable to the period during which the loans are disbursed (hereinafter
referred to as the applicable Treasury interest rate).
25. For the fiscal year during which new direct or guaranteed loans are disbursed, the
components of the subsidy expense of those new direct loans and loan guarantees are
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recognized separately among interest subsidy costs, default costs, fees and other
collections, and other subsidy costs.
26. The interest subsidy cost of direct loans is the excess of the amount of the loans disbursed
over the present value of the interest and principal payments required by the loan contracts,
discounted at the applicable Treasury rate. The interest subsidy cost of loan guarantees is
the present value of estimated interest supplement payments.
27. The default cost of direct loans results from projected deviations by the borrowers from the
payment schedules for principal, interest, and fee payments in the loan contracts. However,
the measurement of default costs does not include prepayments. The default cost is
measured at the present value of projected payment deviations due to defaults minus
projected net recoveries. Projected net recoveries include the amounts that would be
collected from borrowers at a later date or the proceeds from the sales of acquired assets
minus the costs of foreclosing, managing, and selling the assets.
27A. The default cost of loan guarantees results from paying lenders’ claims upon default of the
guaranteed loans. The default cost of loan guarantees is measured at the present value of
projected payments to lenders required by the guarantee, plus uncollected fees, minus
interest supplements not paid as the result of the default, and minus projected net
recoveries as defined in paragraph 27.
28. The present value of fees and other collections is recognized as a deduction from subsidy
costs.
29. Other subsidy costs consist of cash flows that are not included in calculating the interest or
default subsidy costs, or in fees and other collections. They include the effect of
prepayments within contract terms.
Subsidy Amortization and Reestimation
30. The subsidy cost allowance for direct loans is amortized by the INTEREST METHOD using
the interest rate that was used to calculate the present value of the direct loans when the
direct loans were disbursed, after adjusting for the interest rate re-estimate. The amortized
amount is recognized as an increase or decrease in interest income.
31. Interest is accrued and compounded on the liability for loan guarantees at the interest rate
that was used to calculate the present value of the loan guarantee liabilities when the
guaranteed loans were disbursed, after adjusting for the interest re-estimate. The accrued
interest is recognized as interest expense.
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32. Credit programs should re-estimate the subsidy cost allowance for outstanding direct loans
and the liability for outstanding loan guarantees as required in this standard. There are two
kinds of re-estimates: (a) interest rate re-estimates, and (b) technical/default re-estimates.
2a
Entities should measure and disclose each program’s re-estimates in these two
components separately. An increase or decrease in the subsidy cost allowance or loan
guarantee liability resulting from the re-estimates is recognized as an increase or decrease
in subsidy expense for the current reporting period.
(A) An interest rate re-estimate is a re-estimate due to a change in interest rates from
the interest
rates that were assumed in budget preparation and used in calculating the subsidy expense
to
the interest rates that are prevailing during the time periods in which the direct or
guaranteed loans are disbursed. Credit programs may need to make an interest rate re-
estimate for cohorts from which direct or guaranteed loans are disbursed during the
reporting year. If the assumed interest rates that were used in calculating the subsidy
expense for those cohorts differ from the interest rates that are prevailing at the time of loan
disbursement, an interest rate re-estimate for those cohorts should be made as of the date
of the financial statements.
(B) A technical/default re-estimate is a re-estimate due to changes in projected cash flows of
outstanding direct loans and loan guarantees after reevaluating the underlying assumptions
and other factors that affect cash flow projections as of the financial statement date, except
for any effect of the interest rate re-estimates explained in (a) above. In making
technical/default re-estimates, reporting entities should take into consideration all factors
that may have affected various components of the projected cash flows, including defaults,
delinquencies, recoveries, and prepayments. The technical/default re-estimate should be
made each year as of the date of the financial statements.
Criteria for Default Cost Estimates
33. The criteria for default cost estimates provided in this and the following paragraphs apply to
both initial estimates and subsequent reestimates. Default costs are estimated and
reestimated for each program on the basis of separate cohorts and risk categories. The
reestimates take into account the differences in past cash flows between the projected and
realized amounts and changes in other factors that can be used to predict the future cash
flows of each risk category.
34. In estimating default costs, the following risk factors are considered: (1) loan performance
experience; (2) current and forecasted international, national, or regional economic
2a
The term “technical/default re-estimate” used in this statement is identical in meaning to the term "technical re-
estimate" used in OMB Circular A-11, as revised in July 1999.
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conditions that may affect the performance of the loans; (3) financial and other relevant
characteristics of borrowers; (4) the value of collateral to loan balance; (5) changes in
recoverable value of collateral; and (6) newly developed events that would affect the loans’
performance. Improvements in methods to reestimate defaults are also considered.
35. Each credit program should use a systematic methodology, such as an econometric model,
to project default costs of each risk category. If individual accounts with significant amounts
carry a high weight in risk exposure, an analysis of the individual accounts is warranted in
making the default cost estimate for that category.
36. Actual historical experience of the performance of a risk category is a primary factor upon
which an estimation of default cost is based. To document actual experience, a data base
should be maintained to provide historical information on actual payments, prepayments,
late payments, defaults, recoveries, and amounts written off.
Revenues and Expenses
37. Interest accrued on direct loans, including amortized interest, is recognized as interest
income. Interest accrued on the liability of loan guarantees is recognized as interest
expense. Interest due from Treasury on uninvested funds is recognized as interest income.
Interest accrued on debt to Treasury is recognized as interest expense.
38. Costs for administering credit activities, such as salaries, legal fees, and office costs, that
are incurred for credit policy evaluation, loan and loan guarantee origination, closing,
servicing, monitoring, maintaining accounting and computer systems, and other credit
administrative purposes, are recognized as administrative expense. Administrative
expenses are not included in calculating the subsidy costs of direct loans and loan
guarantees.
Pre-1992 Direct Loans and Loan Guarantees
39. The losses and liabilities of direct loans obligated and loan guarantees committed before
October 1, 1992, are recognized when it is more likely than not that the direct loans will not
be totally collected or that the loan guarantees will require a future cash outflow to pay
default claims. The allowance of the uncollectible amounts and the liability of loan
guarantees should be reestimated each year as of the date of the financial statements. In
estimating losses and liabilities, the risk factors discussed in the previous section should be
considered. Disclosure is made of the face value of guaranteed loans outstanding and the
amount guaranteed.
40. Restatement of pre-1992 direct loans and loan guarantees on a present value basis is
permitted but not required.
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Modification of Direct Loans and Loan Guarantees
41. The term “modification” means a federal government action, including new legislation or
administrative action, that directly or indirectly alters the estimated subsidy cost and the
present value of outstanding direct loans, or the liability of loan guarantees.
42. Direct modifications are actions that change the subsidy cost by altering the terms of
existing contracts or by selling loan assets. Existing contracts may be altered through such
means as forbearance, forgiveness, reductions in interest rates, extensions of maturity, and
prepayments without penalty. Such actions are modifications unless they are considered
reestimates, or workouts as defined below, or are permitted under the terms of existing
contracts.
43. Indirect modifications are actions that change the subsidy cost by legislation that alters the
way in which an outstanding portfolio of direct loans or loan guarantees is administered.
Examples include a new method of debt collection prescribed by law or a statutory
restriction on debt collection.
44. The term “modification” does not include subsidy cost reestimates, the routine
administrative workouts of troubled loans, and actions that are permitted within the existing
contract terms. Workouts are actions taken to maximize repayments of existing direct loans
or minimize claims under existing loan guarantees. The expected effects of work-outs on
cash flows are included in the original estimate of subsidy costs and subsequent
reestimates.
A. MODIFICATION OF DIRECT LOANS
45. With respect to a direct or indirect modification of pre-1992 or post-1991 direct loans, the
cost of modification is the excess of the PRE-MODIFICATION VALUE
3
of the loans over
their POST-MODIFICATION VALUE
4
The amount of the modification cost is recognized as a
modification expense when the loans are modified.
3
The term “pre-modification value” is the present value of the net cash inflows of direct loans estimated at the time of
modification under pre-modification terms and discounted at the interest rate applicable to the time when the
modification occurs on marketable Treasury securities that have a comparable maturity to the remaining cash flows of
the direct loans under pre-modification terms (simply stated, the pre-modification terms at the current rate).
4
The term “post-modification value” is the present value of the net cash inflows of direct loans estimated at the time of
modification under post-modification terms and discounted at the interest rate applicable to the time when the
modification occurs on marketable Treasury securities that have a comparable maturity to the remaining cash flows of
the direct loans under post-modification terms (simply stated, the post-modification terms at the current rate).
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46. When post-1991 direct loans are modified, their existing BOOK VALUE is changed to an
amount equal to the present value of the loans’ net cash inflows projected under the
modified terms from the time of modification to the loans’ maturity and discounted at the
ORIGINAL DISCOUNT RATE (the rate that was originally used to calculate the present
value of the direct loans, when the direct loans were disbursed, after adjusting for the
interest rate re-estimate).
47. When pre-1992 direct loans are directly modified, they are transferred to a financing
account and their book value is changed to an amount equal to their post-modification
value. Any subsequent modification is treated as a modification of post-1991 loans. When
pre-1992 direct loans are indirectly modified, they are kept in a liquidating account. Their
bad debt allowance is reassessed and adjusted to reflect amounts that would not be
collected due to the modification.
48. The change in book value of both pre-1992 and post-1991 direct loans resulting from a
direct or indirect modification and the cost of modification will normally differ, due to the use
of different discount rates or the use of different measurement methods. Any difference
between the change in book value and the cost of modification is recognized as a gain or
loss. For post-1991 direct loans, the MODIFICATION ADJUSTMENT TRANSFER
5
paid or
received to offset the gain or loss is recognized as a financing source (or a reduction in
financing source).
B. MODIFICATION OF LOAN GUARANTEES
49. With respect to a direct or indirect modification of pre-1992 or post-1991 loan guarantees,
the cost of modification is the excess of the POST-MODIFICATION LIABILITY
6
of the loan
guarantees over their PRE-MODIFICATION LIABILITY.
7
The modification cost is recognized
as modification expense when the loan guarantees are modified.
5
OMB instructions provide that if the decrease in book value exceeds the cost of modification, the reporting entity
receives from the Treasury an amount of modification adjustment transfer equal to the excess; and that if the cost of
modification exceeds the decrease in book value, the reporting entity pays to the Treasury an amount of modification
adjustment transfer to offset the excess. (See OMB Circular A-11.)
6
The term “post-modification liability” is the present value of the net cash outflows of the loan guarantees estimated at
the time of modification under the post-modification terms, and discounted at the interest rate applicable to the time
when the modification occurs on marketable Treasury securities that have a comparable maturity to the remaining
cash flows of the guaranteed loans under post-modification terms (simply stated, the post-modification terms at the
current rate).
7
The term “pre-modification liability” is the present value of the net cash outflows of loan guarantees estimated at the
time of modification under the pre- modification terms and discounted at the interest rate applicable to the time when
the modification occurs on marketable Treasury securities that have a comparable maturity to the remaining cash flows
of the guaranteed loans under pre-modification terms (simply stated, the pre- modification terms at the current rate.)
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50. The existing book value of the liability of modified post-1991 loan guarantees is changed to
an amount equal to the present value of net cash outflows projected under the modified
terms from the time of modification to the loans’ maturity, and discounted at the original
discount rate (the rate that was originally used to calculate the present value of the liability,
when the guaranteed loans were disbursed, after adjusting for the interest rate re-estimate).
51. When pre-1992 loan guarantees are directly modified, they are transferred to a financing
account and the existing book value of the liability of the modified loan guarantees is
changed to an amount equal to their post-modification liability. Any subsequent modification
is treated as a modification of post-1991 loan guarantees. When pre-1992 direct loan
guarantees are indirectly modified, they are kept in a liquidating account. The liability of
those loan guarantees is reassessed and adjusted to reflect any change in the liability
resulting from the modification.
52. The change in the amount of liability of both pre-1992 and post-1991 loan guarantees
resulting from a direct or indirect modification and the cost of modification will normally differ,
due to the use of different discount rates or the use of different measurement methods. Any
difference between the change in liability and the cost of modification is recognized as a
gain or loss. For post-1991 loan guarantees, the modification adjustment transfer
8
paid or
received to offset the gain or loss is recognized as a financing source (or a reduction in
financing source).
C. SALE OF LOANS
53. The sale of post-1991 and pre-1992 direct loans is a direct modification. The cost of
modification is determined on the basis of the pre-modification value of the loans sold. If the
pre-modification value of the loans sold exceeds the net proceeds from the sale, the excess
is the cost of modification, which is recognized as modification expense.
54. For a loan sale with RECOURSE, potential losses under the recourse or guarantee
obligations are estimated, and the present value of the estimated losses from the recourse
is recognized as subsidy expense when the sale is made and as a loan guarantee liability.
55. The book value loss (or gain) on a sale of direct loans equals the existing book value of the
loans sold minus the net proceeds from the sale. Since the book value loss (or gain) and the
cost of modification are calculated on different bases, they will normally differ. Any
8
OMB instructions provide that if the increase in liability exceeds the cost of modification, the reporting entity receives
from the Treasury an amount of modification adjustment transfer equal to the excess; and that if the cost of
modification exceeds the increase in liability, the reporting entity pays to the Treasury an amount of modification
adjustment transfer to offset the excess. (See OMB Circular A-11.)
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difference between the book value loss (or gain) and the cost of modification is recognized
as a gain or loss.
9
For sales of post-1991 direct loans, the modification adjustment transfer
10
paid or received to offset the gain or loss is recognized as a financing source (or a reduction
in financing source).
D. DISCLOSURE
56. Disclosure is made in notes to financial statements to explain the nature of the modification
of direct loans or loan guarantees, the discount rate used in calculating the modification
expense, and the basis for recognizing a gain or loss related to the modification. The U.S.
government-wide financial statements need not include this disclosure.
Foreclosure of Post-1991 Direct Loans and Guaranteed Loans
57. When property is transferred from borrowers to a federal credit program, through
FORECLOSURE or other means, in partial or full settlement of post-1991 direct loans or as
a compensation for losses that the government sustained under post-1991 loan guarantees,
the foreclosed property is recognized as an asset at the present value of its estimated future
net cash inflows discounted at the original discount rate adjusted for the interest rate re-
estimate.
58. If a legitimate claim exists by a third party or by the borrower to a part of the recognized
value of the foreclosed assets, the present value of the estimated claim is recognized as a
special contra valuation allowance.
59. At a foreclosure of guaranteed loans, a federal guarantor may acquire the loans involved.
The acquired loans are recognized at the present value of their estimated net cash inflows
from selling the loans or from collecting payments from the borrowers, discounted at the
original discount rate adjusted for the interest rate re-estimate.
60. When assets are acquired in full or partial settlement of post-1991 direct loans or
guaranteed loans, the present value of the government’s claim against the borrowers is
reduced by the amount settled as a result of the foreclosure.
9
If there is a book value gain, the gain to be recognized equals the book value gain plus the cost of modification.
10
See footnote No. 5 for an explanation of “modification adjustment transfer.”
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Write-off of Direct Loans
61. When post-1991 direct loans are written off, the unpaid principal of the loans is removed
from the gross amount of loans receivable. Concurrently, the same amount is charged to the
allowance for subsidy costs. Prior to the WRITE-OFF, the uncollectible amounts should
have been fully provided for in the subsidy cost allowance through the subsidy cost estimate
or reestimates. Therefore, the write-off would have no effect on expenses.
[See SFFAS 18, par. 10 and 11 for additional disclosure requirements.]
The provisions of this Statement need not be applied to information if the effect of applying the
provision(s) is immaterial. Refer to Statement of Federal Financial Accounting Concepts 1,
Objectives of Federal Financial Reporting, chapter 7, titled Materiality, for a detailed discussion
of the materiality concepts.
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Appendix A: Basis Of The Board’s Conclusions
This appendix discusses the substantive comments that the Board received from respondents to
the Exposure Draft, Accounting for Direct Loans and Loan Guarantees, issued in September
1992. The Appendix explains the Board’s conclusions on issues raised by the respondents.
This Statement may be affected by later Statements. The FASAB Handbook is updated annually
and includes a status section directing the reader to any subsequent Statements that amend this
Statement. Within the text of the Statements, the authoritative sections are updated for changes.
However, this appendix will not be updated to reflect future changes. The reader can review the
basis for conclusions of the amending Statement for the rationale for each amendment.
Present Value Accounting
62. Several respondents were opposed to using present value accounting for direct loans and
loan guarantees. They pointed out that although the Federal Credit Reform Act of 1990
requires the use of present value to measure the subsidy costs of direct loans and loan
guarantees for the budget, the law does not require using present value for financial
reporting. They believed that since there are no legal requirements, the adoption of present
value accounting should be based on cost-benefit considerations.
63. These respondents emphasized the complexity and cost of implementing and maintaining
present value accounting. Because of the need to separately account for the direct loans or
loan guarantees obligated or committed by each credit program in a fiscal year by cohort, as
years go by, the number of cohorts would multiply. An agency with a number of loan and
loan guarantee programs estimated that within 5 years, there would be more than 200
cohorts, one for each year and each program. Since most of its loans are long-term,
maturing in 30 or more years, the number of cohorts would be staggering.
64. The respondents who were opposed to present value accounting doubted whether there
would be any significant improvement in financial information on loans and loan guarantees
reported on a present value basis compared with information traditionally reported on a
nominal value basis. They contended that both present value accounting and nominal value
accounting rely on historical experience and management judgment to evaluate risk as the
primary variable in determining a default allowance. They further argued that since present
value calculations involve cash flow estimates over future years, information based on the
estimates is not necessarily more reliable than information reported under the nominal value
accounting method.
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65. A number of respondents expressed support of the Board’s proposal to use present value
accounting for direct loans and loan guarantees. They believed that it is a positive step to
bring budgeting and financial reporting together. They also believed that implementation of
the proposed standards would present useful information for monitoring programs with
direct loans and loan guarantees.
66. In proposing present value accounting, the Board’s primary considerations were to carry out
the intent of the Federal Credit Reform Act of 1990 and to make financial reporting
compatible with the budget. (See Exposure Draft, Vol. 1, par. 15.) The Board believes that
one of the objectives of financial reporting is to enable the reader to determine the status of
budgetary resources, and whether those resources were acquired and used in accordance
with the enacted budget.
11
67. The Federal Credit Reform Act of 1990 requires using present value for the budget. The
Board does not believe that this requirement should be ignored for financial reporting. Since
budgetary resources for direct loan and loan guarantee subsidies are provided on a present
value basis, financial reporting on the acquisition, use, and status of the resources should
be on the same basis. Only by using the same basis can financial information be used to
compare the actual results with the budget.
68. Indeed, distortion in information would result if present value were not used to report direct
loans or loan guarantees that are budgeted on a present value basis. This can be illustrated
by the following example.
69. Suppose a group of 5-year term loans in the aggregate amount of $100,000 were disbursed
by a federal credit program at the end of fiscal year 1992. The loans require paying an
annual interest of 5 percent and repaying the principal in fiscal year 1997. It was estimated
that the interest would be collected each year, but only $80,000 of the principal would be
repaid when the loans mature. During the year the loans were disbursed, the average
interest rate of Treasury securities of the same maturity was 9 percent.
70. Based on the cash flow projection shown in Table 1 below, at the end of the 1992 fiscal year,
the present value of the direct loans was $71,440 and the loans’ subsidy cost was $28,560.
It is assumed in this example, that as required by credit reform, the subsidy cost ($28,560)
was funded with appropriations, and the remaining amount ($71,440) was financed with
borrowing from Treasury at 9 percent.
11
FASAB Exposure Draft, Objectives of Federal Financial Reporting, Vol. 1, par. 13.
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Table 1: The Present Value Of Direct Loans
71. If the nominal value accounting method were used in financial reporting, the $20,000 of the
principal that was estimated to be uncollectible would have been reported as a bad debt
expense. The estimated uncollectible amount of $20,000 would have been recognized as
the cost of the loans in financial statements. In reality, however, the agency spent $28,560 of
budgetary resources to fund the cost of the loans.
72. Also, if the nominal value accounting method were used, the loans as assets would have
been reported at $80,000 at the end of the 1992 fiscal year, which equals the $100,000
principal of the loans minus an allowance of $20,000 for the uncollectible amount. On the
other hand, debt to Treasury would have been reported at $71,440, which was the amount
actually borrowed to finance the loans. The financial information would have shown an
excess of the assets over the liability by $8,560. In reality, however, even if the default
estimate was correct, the entire collection of interest and principal would be used to pay
interest and principal to Treasury. The credit program in fact would have no excess in
assets. The following is a comparison of the loans reported on a present value basis and on
a nominal value basis.
12
Fiscal Years Expected Payments
1993 $5,000
1994 5,000
1995 5,000
1996 5,000
1997 $85,000
Present value at 9% $71,400
12
Tables are provided only for illustration. They do not represent a reporting format.
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Table 2: Reporting On The Direct Loans At Present Value On September 30, 1992
Table 3: Reporting On The Direct Loans At Nominal Value On September 30, 1992
73. A similar distortion would result in reporting loan guarantees. The distortion would be
caused by reporting loan guarantee liabilities on a nominal value basis, whereas the
budgetary resources received to finance the liabilities are measured at a present value
basis.
74. In evaluating efforts and costs of implementing present value accounting for post-1991
direct loans and loan guarantees, one should keep in mind that the federal direct loan and
loan guarantee programs have modified or will have to modify their accounting systems in
order to implement the budgeting requirements of the Federal Credit Reform Act of 1990.
They will have to maintain data by cohort and risk category, compute interest on borrowing
from Treasury and on uninvested funds, and make subsidy estimates and reestimates. The
accounting standards provided in this statement do not require more than the budget
process requires in these respects, and thus they would not result in a substantial amount of
additional effort or cost.
75. Some respondents indicated that it would be burdensome if present value accounting were
to be implemented on a loan-by-loan (or transaction) basis. The Board does not propose
that the accounting standards be implemented on a loan-by-loan basis. The standards
Assets Liabilities
Loans receivable $100,000 Debt to Treasury $71,440
Subsidy cost
allowance (28,560)
(28,560)
Loans receivable,
net
$ 71,440
Net Position $0
Assets Liabilities
Loans receivable $100,000 Debt to Treasury $71,440
Subsidy cost
allowance (28,560)
(20,000)
Loans receivable,
net
$ 80,000
Net Position $8,560
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should apply to a cohort (or risk category) of direct loans or loan guarantees in the
aggregate.
76. In addition to making financial reporting consonant with the budget, the Board also believes
that the standards proposed in the Exposure Draft will produce better financial information
for the following reasons:
77. First, the proposed standards would require measuring and recognizing the subsidy costs of
direct loans and loan guarantees at their inception rather than at a later date. The current
accounting practice does not require this. In the absence of this requirement, the cost of
direct loans is not recognized when the loans are disbursed, and the liability to pay claims
under loan guarantees is not usually recognized when guaranteed loans are disbursed.
78. Second, the proposed standards would require a comprehensive evaluation of future cash
flows over the life of direct loans and guaranteed loans, including payments of interest,
principal, fees, prepayments, defaults, delinquencies, and recoveries. The current
accounting practice typically provides an allowance for the portion of the principal that would
not be collected. It does not take into account the impact of other cash flow elements.
79. Third, the proposed standards would require discounting the net cash flows at the
government’s borrowing rate on marketable Treasury securities. Discounting is a basic
feature of present value accounting that measures and recognizes the interest subsidy cost
of direct loans and loan guarantees, and the time value of all cash flows. The time value of
such cash flows is not accounted for under the nominal value accounting method, and the
interest subsidy cost is not accounted for when the loans are disbursed.
80. Finally, the proposed standards would require an annual systematic review of the projected
cash flows. The projections would be revised and updated to reflect newly developed
events, changes in economic conditions, and better understanding of the factors that cause
defaults. The subsidy costs would be reestimated accordingly. The reestimation
requirement assures that credit programs maintain an up-to-date data base by cohort and
risk category of actual collections, defaults, and amounts written off on federal loans and
loan guarantees. Such a complete data base was not available prior to credit reform.
81. In summary, the recognition of cost at inception, the comprehensive evaluation of all future
cash flows, and the discounting of future cash flows to present value are complementary
elements at the core of present value accounting. When taken together, they place an
economic value on the cost the federal government incurs in making direct loans and loan
guarantees. Likewise, they place an economic value rather than a nominal value on loan
assets and loan guarantee liabilities.
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82. Based on the view that financial accounting should be compatible with the budget, and
based on the other advantages of using the present value accounting, the Board has
concluded that the present value accounting method should be used in the accounting
standards for post-1991 direct loans and loan guarantees.
Subsidy Cost Component
83. The Exposure Draft proposed that when direct or guaranteed loans are disbursed, their
subsidy expense be recognized separately among interest subsidy costs, default costs, fees
(as a deduction from the costs), and other subsidy costs.
84. The Exposure Draft also proposed the following requirement: The interest subsidy
allowance shall be amortized using the interest method. Compound interest shall be
accumulated on the allowances for default losses, fees, and other cost components.
85. The Exposure Draft posed a question: Should the subsidy cost components, if material, be
recognized separately in financial reporting? Some respondents agreed that the subsidy
cost components should be separately recognized. They believed that separate recognition
would provide the level of detail needed to understand the program better and improve their
component estimates for budget formulation.
86. Some respondents were opposed to reporting subsidy costs by component on the grounds
that (1) only the aggregate amount of subsidy costs is needed for budget execution
purposes, (2) information on cost components may not be used by management, and (3)
the cost of complex record-keeping and calculations outweigh the benefit.
87. After considering the benefits and efforts required in accounting for subsidy cost
components, the Board has concluded that when direct or guaranteed loans are disbursed,
the subsidy expense of the direct loans or loan guarantees should be recognized in
separate components. The Board believes that by reporting the subsidy expense
components of direct or guaranteed loans disbursed during the reporting year, the cost
components of newly disbursed direct loans and loan guarantees can be compared with
those of prior years. The cost component information would be valuable for making credit
policy decisions, monitoring portfolio quality, and improving credit performance. Information
on interest subsidies and fees would help in making decisions on setting interest rates and
fee levels. Information on default costs would help in evaluating credit performance.
88. In calculating the present value of the subsidy costs for the budget, agencies must first
develop data on cash flow components. OMB requires agencies to use the OMB credit
subsidy model, which takes these cash flows as inputs and automatically calculates the
components of the subsidy cost. Since the information on subsidy cost components of new
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direct loans and loan guarantees is available, reporting the information would not require
significant additional efforts.
89. However, the Board realizes that it would require considerable efforts to maintain records for
the present value of cost components for each existing cohort of loans and loan guarantees,
amortize or accumulate interest on each component each year, adjust each component
each year for reestimates, and, if applicable, adjust each component for modifications when
they occur. After considering the efforts that would be required and the benefits that could
be derived, the Board decided not to recommend the requirement to amortize or accumulate
interest on each subsidy cost component. Without this requirement, credit programs may
amortize the subsidy allowance of each cohort in aggregate, using the interest method.
They would not have to maintain records for the present value of each cost component and
adjust them annually. This would greatly ease the record-keeping and calculation burden.
90. By eliminating the requirement to amortize and accumulate interest on each component of
the subsidy cost allowance, the Board realizes that information would not be available to
track changes in the present values of the components. However, data would still be
available to track changes in the total amount of a cohort’s subsidy allowance affected by
annual reestimates. The primary factor that causes changes in the subsidy allowance would
be default reestimates. Furthermore, the Board believes that it is of a critical importance that
each credit program maintain a data base for actual collections, defaults, delinquencies, and
recoveries. For purposes of monitoring program performance and estimating future losses,
the actual default and collection data base is more important than tracking changes in the
allowance for the present value of subsidy costs by component. The actual default and
collection data base is also necessary for estimating and reestimating subsidy costs.
Accounting For Fees
91. In the Exposure Draft, the Board proposed that the present value of estimated fee receipts
be recognized as a deduction from the subsidy expense. The Board posed a question: How
should fees be recognized on an entity’s financial reports? Should they be recognized as a
deduction of subsidy expense, or as a revenue?
92. Many respondents agreed with the proposal that the present value of estimated fee
collections be recognized as a deduction of subsidy expense. Some respondents
contended that fees should be recognized as a revenue rather than as an expense
component. They stated that offsetting revenues against expenses would not provide clear
revenue/expense information concerning the operating results of a credit program. Some of
the respondents also said that to the extent some of the fees are used to defray
administrative costs, they should not offset subsidy expenses because the Federal Credit
Reform Act of 1990 excludes administrative costs from subsidy expenses.
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93. The Board is not persuaded by the arguments that fees should be reported as a revenue.
The subsidy expense of direct loans and loan guarantees is the focal point of credit reform,
and it is measured as the present value of the net cash flows of the direct loans and loan
guarantees. Since the estimated fees are a component of the cash flows, the Board
believes that the present value of fees should be reported as a component of the subsidy
expense. Since the Board has concluded that all of the subsidy expense components,
including the present value of fees, are to be reported separately, reporting the present
value of fees as an expense component would not reduce information on the collection of
fees. Furthermore, the administrative expenses that are excluded from subsidy costs are
often covered by appropriations, rather than paid by fee collections. Thus, it is not
necessary to allocate a portion of the fee collections to pay the administrative costs that are
not a part of the subsidy costs.
Pre-1992 Direct Loans And Loan Guarantees
94. The phrase pre-1992 direct loans and loan guarantees refers to direct loans obligated and
loan guarantees committed before October 1, 1991, the effective date of the Federal Credit
Reform Act of 1990. In the Exposure Draft, the Board did not recommend restating pre-1992
direct loans and loan guarantees at present value. The Board’s position was that the costs
of restating those direct loans and loan guarantees would outweigh the benefits.
95. Most respondents who commented on this issue agreed with the Board’s position. They
emphasized that the restatement of pre-1992 direct loans and loan guarantees would be a
complex process and would require substantial resources. They pointed out that a major
difficulty is caused by the lack of complete and accurate historical data that a restatement
needs to be based upon. Because of the lack of accurate data, even if the agencies incurred
a great deal of cost, the restated loans and loan guarantees could not be accurately
compared with post-1991 loans and loan guarantees on the same basis. The respondents
pointed out that since the pre-1992 direct loans and loan guarantees were obligated or
committed in the past, restated information would be of limited usefulness to current budget
decisions. They also pointed out that the amount of pre-1992 direct loans and loan
guarantees outstanding would diminish over time as loans matured, defaulted, or were
modified.
96. In addition to considering the comments on the Exposure Draft, the Board also considered
the findings of a GAO report presented to the Board.
13
The GAO report suggested that by
not requiring a restatement of pre-1992 direct loans and loan guarantees at present value,
13
GAO Report to the Chairman, Senate Budget Committee, Federal Credit Programs: Agencies Had Serious Problems
Meeting Credit Reform Accounting Requirements (GAO/AFMD-93-17, Jan. 1993).
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poor information would be perpetuated, which could affect the ability to (1) forecast the
future budgetary impact of pre-credit reform credit activity, (2) minimize losses, and (3)
judge the reasonable accuracy of subsidy estimates for post-1991 credit. The GAO report
recommended using simplified methods, such as sampling techniques, to restate pre-1992
direct loans and loan guarantees at present value.
97. However, there was a strong indication in the comments the Board received and in the
findings of the GAO report that agencies have been experiencing serious difficulties in
implementing the credit reform requirements related to post-1991 direct loans and loan
guarantees. A restatement of pre-1992 direct loans and loan guarantees, even on a
sampling basis, would require additional use of the agencies’ limited accounting resources.
The Board also agrees with the view that as the pre-1992 direct and guaranteed loans are
approaching their maturity and are paid off, liquidated, or written off, the difference between
their present value and nominal value becomes less significant. Thus, the Board concludes
that it is appropriate not to require restating pre-1992 direct loans and loan guarantees at
present value.
98. The Department of Veterans Affairs stated in its comments that it had accounted for
pre-1992 loan guarantees on a present value basis. The Department of Education indicated
in its comments that it planned to report pre-1992 loans on a present value basis. Their
efforts to account for pre-1992 loans and loan guarantees at present value, although not at
the same level of detail as required by credit reform, could very well result in improved
information for credit management. Other agencies may follow their examples. The Board
believes that reporting those pre-1992 direct loans and loan guarantees on a present value
basis should be permitted.
99. Although a restatement of pre-1992 direct loans and loan guarantees at present value is not
required, the Board continues to believe that it is of fundamental importance to estimate and
recognize losses and liabilities for those direct loans and loan guarantees. Loss estimation
and recognition are necessary to support federal government financial planning and
management. The information on both current and potential liabilities related to federal
credit programs alerts Congress and federal officials to the long-term costs and future
financing needs.
100. The recommended standards would require that losses of pre-1992 direct loans and
liabilities related to pre-1992 loan guarantees be recognized when it is more likely than not
that the loans will not be totally collected or the loan guarantees will require a future cash
outflow to pay default claims. This is the same standard that the Board recommended for
the recognition of losses on receivables in FASAB Statement of Recommended Accounting
Standards No. 1, Accounting for Selected Assets and Liabilities.
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101. The Board believes that each loan guarantee program should disclose the aggregate
amount of outstanding guaranteed loans. In addition, it should also disclose its risk
exposure, which is the guaranteed portion of the total outstanding guaranteed loans.
Modifications
102. A modification is a government action that alters the estimated subsidy cost of outstanding
direct loans or loan guarantees. Both a government action and an alteration in subsidy cost
are necessary conditions for a modification. A subsidy reestimate is not a modification.
103. Direct modifications change the subsidy cost by legislation or administrative actions that
alter the terms of existing contracts or by selling loan assets. Existing contracts may be
altered by such means as forgiveness, forbearance, reductions in interest rates, extensions
of maturity, and prepayments without penalty. Such actions are modifications unless they
are considered workouts as explained below or are permitted by the existing contract terms.
104. Indirect modifications change the subsidy cost by legislation that alters the way in which an
outstanding portfolio of direct loans or loan guarantees is administered. Examples include a
new method of debt collection prescribed by law or a statutory restriction on debt collection.
Such new legislation would produce a one-time effect on the subsidy cost of outstanding
direct loans and loan guarantees only. After the enactment of the legislation, the effects of
the legislation are included in the original subsidy cost estimates of newly obligated direct
loans and newly committed loan guarantees. Thus, the legislation is not a modification with
respect to direct loans obligated and loan guarantees committed subsequent to its
enactment.
105. The term “modification” does not include the routine administrative work-outs of troubled
loans or loans in imminent default. Work-outs are actions undertaken to maximize the
repayments to the government under existing direct loans or to minimize claim payments
that the government would make under loan guarantees. The expected effects of work-outs
on cash flows are included in the original estimate and the reestimates of the subsidy cost.
Therefore, a workout effort is not a government action that alters the estimated subsidy cost
of direct loans or loan guarantees.
106. The term “modification” also does not include actions that are permitted within the existing
contract terms, such as prepayments without penalty permitted by existing loan contracts.
The expected effects of such actions on cash flows are included in the original estimate and
the reestimates of the subsidy cost.
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107. Neither the term “modification” nor the term “workout” includes additional disbursements to
borrowers that increase the amount of direct loans outstanding. These disbursements are
considered to be new loans in the amount of the increment.
108. When direct loans and loan guarantees are modified, the subsidy cost of the modification
must be calculated. The book value of the modified loans and the liabilities of the modified
loan guarantees must be restated. The Exposure Draft used two types of discount rates to
calculate the present values of post-1991 direct loans and loan guarantees that are
modified: CURRENT DISCOUNT RATES and original discount rates.
109. The term “current discount rate” refers to the interest rate applicable to the time when the
modification occurs on marketable Treasury securities that have a comparable maturity to
the remaining maturity of the direct or guaranteed loans, under either pre-modification
terms, or post-modification terms, whichever is appropriate. The cost of modification is
measured as the excess of the present value of pre-modification net cash flows over the
present value of post-modification cash flows, both discounted at a current discount rate.
This is consistent with the measurement method described in OMB instructions.
110. The term “original discount rate” refers to the discount rate that is originally used to calculate
the present value of the direct loans or the present value of loan guarantee liabilities, when
the direct or guaranteed loans were disbursed. The value of modified loans or the liability of
modified loan guarantees equals the present value of modified cash flows discounted at the
original discount rate. The original discount rate is used to determine the value of modified
loans because this is the interest rate that the Treasury charges on funds that it lends to the
credit program to finance the loans. The original discount rate is also used to determine the
liability of modified loan guarantees because this is the interest rate that the Treasury pays
on funds that it holds for the credit program to pay future claims.
111. Because of using the two different rates, a difference will normally occur between the
change in the book value of modified direct loans and the cost of the modification. In the
case of loan guarantees, there will normally also be a difference between the change in the
liability of modified loan guarantees and the cost of modification.
112. The Exposure Draft used an example to illustrate the difference.
14
The example used the
original discount rate of 6 percent to calculate the book value of a modified loan, and it used
the current discount rate of 8 percent to calculate the cost of modification. The calculations
resulted in a difference between the change in book value and the cost of modification.
14
See Exposure Draft, Vol. 2, pars. 221 through 231, and Appendix 2, pages 139 through 143.
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113. OMB instructions require that an amount equal to the difference between the change in
book value and the cost of modification either be returned to, or received from, the Treasury
to offset the difference. The amount transferred to offset the difference is referred to in OMB
instructions as the modification adjustment transfer. This transfer does not constitute a part
of the cost of modification and is not a budget outlay or collection.
114. Several respondents objected to use of the current rate for measuring the modification cost.
They believed that both the modification cost and the value of the modified loans (or the
liability of modified loan guarantees) should be measured on the same basis, using the
original discount rate. They said that by using the original discount rate for measuring both
the cost and the book value or the liability, there would be no difference between the
modification cost and change in book value (or change in loan guarantee liability). They
argued that the additional computations at current discount rate do not result in any
additional meaningful information for use by management. They contended that the
complexity of the computation, the effect of changing discount rates, and the resulting
difference between the change in book value and the cost of modification would only detract
from management’s ability to analyze the results of modification.
115. The Board realizes that it is undesirable to calculate the cost of modification and change in
book value on different bases. Because the cost of modification and the book value are
calculated on different bases, the modification expense recognized would not equal the
decrease in the book value of direct loans (or the increase in the liability of loan guarantees)
resulting from the modification.
116. However, it is also undesirable to recognize a modification expense at a measurement basis
that differs from the budget and appropriation basis. The OMB instructions concerning the
definition and the cost of modification have carried a great weight on the Board’s
consideration of the subject. The OMB instructions require that the cost of modification be
measured at the current rate, and appropriations approved for a modification will equal the
cost of modification. The Board believes that financial reporting should reflect the
modification cost recognized in the budget and the modification appropriations received.
117. The Board also appreciates the rationale in OMB instructions. The Federal Credit Reform
Act of 1990 requires that the calculation of modification cost be based on the estimated
present value of the direct loans or loan guarantees at the time of modification. This
requirement has been interpreted as calculating the present value of modification cost at the
discount rate applicable at the time of modification. The Board also agrees with the
substantive rationale for using the current rate. By using the current rate, the calculation of
the modification cost will reflect the economic cost of the modification at the time when the
modification decision is made.
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118. The Board found that some of the opposition to the use of the current rate for modifications
arose because of a misunderstanding about the difference between modifications and
work-outs. Once the distinction was clarified between work-outs (which are included in the
initial subsidy estimates and are quantified using the original rates) and modifications (which
require separate action as described, but are less frequent in occurrence), much of the
opposition to using current rates for modifications disappeared.
119. In considering a solution for the measurement difference between the modification cost and
the book value of the loan (or the loan guarantee liability), the Board has considered as an
alternative whether the current rate could also be used to calculate the value of modified
direct loans (or the liability of modified loan guarantees) so that the change in direct loan
book value or loan guarantee liability could equal the cost of modification. The Board has
decided against this for the two reasons explained below.
120. First, under credit reform, the un-subsidized portion of direct loans is financed by funds
borrowed from Treasury, while the subsidy cost of the direct loans is financed by
appropriations. Thus, the carrying amount of direct loans at any point should equal the
balance of debt to Treasury. Proceeds from collecting direct loan principal and interest will
be used to repay debt to Treasury. This exact match between loan assets and liabilities
(debt to Treasury) is a unique feature that makes credit reform loans and loan guarantees
different from private sector lending.
121. When a modification occurs, the book value of the direct loans is affected. An amount of
modification appropriation, plus or minus the modification adjustment transfer, would be
used to reduce the debt to Treasury. By doing so, the book value of the modified loans and
the balance of the debt to Treasury would continue to be equal. It is important to note that
the interest rate on the debt to Treasury does not change as a result of the modification; it
remains the original rate. Thus, the debt balance to Treasury in fact equals the present
value of future payments to Treasury discounted at the original rate. Since the debt to
Treasury is based on the original rate, that rate should also be used to calculate the book
value of modified loans, so that the book value of the loans and the balance of debt to
Treasury would be kept equal.
122. A parallel situation exists with loan guarantees. The financing account of each loan
guarantee program maintains a fund balance with the Treasury equal to the liability of the
loan guarantees. The fund balance and the liability grow at the same compound interest
rate. The fund balance will accrue interest at the original rate applicable at the time the
guaranteed loans were disbursed. The interest rate will not change because of a
modification of the loan guarantees. Thus, only by measuring the liability of the modified
loan guarantees at the original rate could the liability be kept equal to the fund balance.
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123. Second, even if the current rate were used to calculate the book value of modified loans, the
difference between the change in book value (or the change in liability balance) and the
modification cost would not disappear. In measuring the change in book value (or the
change in liability balance), the starting point is the pre-modification book value (or the
pre-modification liability balance), which is based on the original discount rate. If the current
rate is used to calculate the post-modification book value of modified direct loans, the
change in book value would equal the difference between the pre-modification book value
(based on the original rate) and the post-modification book value (based on the current
rate). Similarly, if the current rate is used to calculate the post-modification balance of
modified loan guarantee liabilities, the change in liability balance would equal the difference
between the pre-modification balance (based on the original rate) and the post-modification
balance (based on the current rate).
124. The cost of modification, on the other hand, is calculated differently. The starting point of the
calculation is not the existing pre-modification book value of the modified loans (or the
existing pre-modification book value of the liability of the modified loan guarantees). For
both direct loans and loan guarantees, the calculation uses the present value of
pre-modification net cash flows discounted at the current discount rate as the starting point.
This pre-modification value differs from the existing pre-modification book value because
the latter is based on the original discount rate. The cost of modification equals the
difference between the present value of pre-modification net cash flows (discounted at the
current rate) and the present value of post-modification net cash flows (also discounted at
the current rate). Since the calculations take a different starting point, the cost of
modification would not equal the change in book value.
125. Because of the two reasons above, the Board believes that the best solution available is to
measure the cost of modification at the current discount rate, and to calculate the carrying
amount of modified loans and loan guarantee liabilities at the original discount rate.
126. However, while it makes sense to determine the cost of modification based on the current
discount rate, financial reporting cannot discard the pre-modification balance of direct loans
or loan guarantee liabilities that are carried in the accounting records. Because of the use of
different discount rates, the change in book value will be different from the cost of
modification. The Board believes that the effect of a modification on assets or liabilities
should be reflected in the operating statement. The Board believes that in addition to
recognizing the cost of modification as a modification expense, any difference between the
change in book value and the modification expense should be recognized as a gain or loss.
Thus, the net effect of the modification on the operating statement equals the decrease in
loan assets or the increase in the liability of loan guarantees resulting from the modification.
127. Based on this view, the Board has concluded that, with respect to a modification of direct
loans, any difference between the change in the book value of the direct loans resulting
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from the modification and the cost of modification should be recognized as a gain or loss in
the operating statement. Similarly, any difference between the change in the amount of
liability of loan guarantees resulting from the modification and the cost of modification
should be recognized as a gain or loss in the operating statement. The gain or loss is to be
recognized in a category distinguished from the modification expense. The modification
adjustment transfer paid or received to offset the gain or loss is to be reported as a financing
source or a reduction in financing source.
128. The Board further believes that agency financial statements should include a footnote to
explain the calculation of the cost of modifications and nature of gain or loss on
modifications.
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Appendix B: Technical Explanations And Illustrations
This Appendix explains and illustrates the accounting standards for direct loans and loan
guarantees. The explanations and illustrations are presented to show how the standards may be
applied but are not standards themselves. They also take into account OMB and Treasury
regulations on credit reform.
This Appendix has 4 parts:
• Part I: Post-1991 Direct Loans
• Part II: Pre-1992 Direct Loans
• Part III: Post-1991 Loan Guarantees
• Part IV: Pre-1992 Loan Guarantees
Topics covered include:
• the measurement and recognition of direct loans, subsidy costs, and the liability of loan
guarantees;
• the reestimation and the amortization of the subsidy cost allowance;
• the reestimation of loan guarantee liabilities and the accumulation of interest on the liabilities;
• the recognition of revenues and expenses;
• modifications of direct loans and loan guarantees (including the sale of direct loans);
• the write-off of direct loans; and
• the foreclosure of assets upon default.
The Appendix does not illustrate financial statements, journal entries, or accounting procedures.
Readers should consult OMB, GAO, and Treasury for guidance.
Part I: Post-1991 Direct Loans
Post-1991 direct loans are direct loans obligated after September 30, 1991. The accounting for
post-1991 direct loans is explained and illustrated in this part of the Appendix through an
example described below:
At the end of fiscal year 1994, a federal credit program disburses a number of direct loans with a
total principal of $10 million. Those loans constitute a cohort for that year. The maturity term of
that cohort is 5 years and the stated annual interest rate is 4 percent.
All of the amounts used in the text below are in thousands of dollars.
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The loan contracts require an annual payment of $2,246 per year for 5 years, paid at the end of
each year. In Table 1 below, the required annual payments are shown in column (a).
15
The
amounts in column (b) equal the beginning loan balance of each period multiplied by the stated
interest rate of 4 percent. The amounts in column (c) are principal repayments, which equal the
amounts in column (a) minus the amounts in column (b). The amounts in column (d) are the
ending principal balance of each period, which equal the beginning balance minus the principal
repayment of that period, shown in column (c).
Table 1: Payment Schedule (in thousands of dollars)
It is also assumed that:
• The average interest rate of Treasury marketable securities of a similar maturity for the period
during which the loans are disbursed is 6 percent.
• Fees totaling $500 are received when the loans are disbursed. The fees are used to reduce
the need to borrow from Treasury.
A. Reporting Post-1991 Direct Loans And Their Subsidy Costs
The accounting standard for post-1991 direct loans requires that direct loans disbursed and
outstanding be recognized as assets at the present value of their estimated net cash inflows. The
difference between the outstanding principal of the loans and the present value of their net cash
inflows is recognized as a subsidy cost allowance.
16
15
The annual payment is derived by dividing the present value factor of 4.45182 into the principal of $10,000. The
present value factor can be found in any ordinary annuity table, and it equals the present value of $1 paid over 5
periods discounted at 4 percent. Alternatively, knowing the loan principal, the number of pay back periods, and the
interest rate, one can use computer software or a financial calculator to find the required payment per period.
FY
Payment
(a)
Interest
(b)
Principal
(c)
Year-End
Loan Balance
(d)
1994 $10,000
1995 $2,246 $400 $1,846 8,154
1996 2,246 326 1,920 6,234
1997 2,246 249 1,997 4,237
1998 2,246 169 2,077 2,160
1999 2,246 86 2,160 0
16
In this Appendix, the requirements of the accounting standards are summarized to address specific situations.
However, the standards are not quoted verbatim. Readers should refer to the text of the standards for their exact
wording.
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To implement the standard in the example, a cash flow projection and present value calculations
are prepared. Based upon the risk factors and other criteria for default cost estimates that are
enumerated in the accounting standards, it is estimated that losses in cash flows due to the
defaults would equal 30 percent of the scheduled payments for fiscal year 1997 and each year
thereafter.
17
Table 2 below displays the cash flow projections and present value calculations.
Table 2: Projected Cash Flows Discounted To The End Of FY 1994 (in thousands of dollars)
a
The term “P & I Payments” used in this table as well as other tables throughout this Appendix denotes scheduled principal and
interest payments required in loan contracts.
The present value of the loans’ estimated net cash inflows is $8,358. The direct loans are
recognized as assets at that amount. Since the loans’ outstanding principal is $10,000, the
difference between the loans’ outstanding principal and their present value is $1,642, which is
recognized as the subsidy cost allowance.
The accounting standard for post-1991 direct loans requires that for direct loans
disbursed during a fiscal year, a subsidy expense be recognized. The amount of the
subsidy expense equals the present value of estimated cash outflows over the life of the
loans minus the present value of estimated cash inflows, discounted at the interest rate of
marketable Treasury securities with a similar maturity term, applicable to the period
during which the loans are disbursed (hereinafter referred to as the applicable Treasury
interest rate).
17
The standard defines losses in cash flows due to default as being due to defaults net of recoveries. However, to
simplify computations, recoveries are assumed to be zero throughout Parts I and II of this Appendix. References to
defaults throughout Parts I and II should be understood to mean defaults net of recoveries for all cases where
recoveries are expected. The accounting standard for recoveries is illustrated in Part III of this Appendix.
FY
Fee
Collections
P & I
Payments
a
Default
Losses
Net Cash
Inflows
1994 $500 $500
1995 $2,246 2,246
1996 2,246 2,246
1997 2,246 $(674) 1,572
1998 2,246 (674) 1,572
1999 2,246 (674) 1,572
PV at 6% $500 $9,461 $(1,603) $8,358
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In the example, the present value of the loans’ cash outflows is the disbursed amount of $10,000.
The present value of the loans’ estimated net cash inflows is $8,358. The difference between
those two amounts is $1,642, which is recognized as subsidy expense.
The accounting standard for post-1991 direct loans requires that for the fiscal year during
which new direct loans are disbursed, the components of the subsidy expense of those
new direct loans be recognized separately among interest subsidy costs, default costs,
fees and other collections, and other subsidy costs.
The interest subsidy cost of direct loans is the excess of the amount of the loans disbursed over
the present value of the interest and principal payments required by the loan contracts,
discounted at the applicable Treasury interest rate (6 percent in this example). In this example,
the amount of the loans disbursed is $10,000. The present value of the scheduled interest and
principal payments is $9,461. The difference between those two amounts is $539, which is
recognized as the interest subsidy cost.
The default cost of direct loans results from any anticipated deviation, other than prepayments,
by the borrowers from the payment schedules in the loan contracts. The deviations include
delinquencies and omissions in interest and principal payments. The default cost is measured at
the present value of the projected payment delinquencies and omissions minus net recoveries.
(See footnote 3.) In this example, the present value of the projected payment omissions minus
net recoveries is $1,603, which is recognized as the default cost.
The present value of fee collections is $500, which is recognized as a deduction from subsidy
costs.
There are no other subsidy costs
18
in this example.
The subsidy expense of the loans is the sum of the above cost components, which is $1,642,
calculated as follows:
The loan disbursements are financed by three sources: subsidy payments, borrowing from
Treasury, and fee collections. The subsidy cost of $1,642 is provided by appropriated funds; and
18
The term “other subsidy costs” is explained in the standard for subsidy costs of post-1991 direct loans and loan
guarantees.
Interest subsidy cost $ 539
Fee collections (500)
Loan default cost 1,603
Total subsidy cost
$1,642
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the present value of loans, equal to $8,358, is provided by fee collections and funds borrowed
from Treasury at the Treasury interest rate of 6 percent.
The fees are collected when the loans are disbursed. Because all cash flows, including fee
collections, are used to calculate the subsidy cost allowance, the amount of the fee collections is
credited to the subsidy cost allowance. The collected amount reduces the amount that has to be
borrowed from the Treasury. As a result, the subsidy cost allowance is $2,142, which is the sum
of the interest subsidy cost of $539 and the default subsidy cost of $1,603. This is $500 more
than the total subsidy cost of $1,642. The debt to Treasury is $7,858, which is $500 less than the
present value of the loans of $8,358.
Table 3 displays the asset and liability balances at the end of fiscal year 1994.
Table 3: Assets And Liabilities As Of The End Of FY 1994 (in thousands of dollars)
B. Subsidy Reestimation And Amortization
(1) Subsidy Reestimation
The accounting standard for post-1991 direct loans requires that the subsidy cost
allowance for direct loans be reestimated each year as of the date of the financial
statements. Since the allowance represents the present value of the net cash outflows of
the underlying direct loans, the reestimation takes into account all factors that may have
affected the estimate of each component of the cash flows, including prepayments,
defaults, delinquencies, and recoveries. Any increase or decrease in the subsidy cost
allowance resulting from the reestimates is recognized as a subsidy expense (or a
reduction in subsidy expense).
The standard further states that reporting the subsidy cost allowance of direct loans and
reestimates by component is not required.
In Appendix A, the Basis of the Board’s Conclusions, it is pointed out that the primary factor that
causes changes in the subsidy cost allowance would be default reestimates. The accounting
Assets Liabilities
Loans receivable $10,000 Debt to Treasury $7,858
Less:
Allowance for subsidy costs (2,142)
Loans receivable, Net $7,858
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standard provides a number of risk factors and other default cost criteria to be considered in
making the default cost estimates and reestimates.
In this illustration, it is originally estimated that 30 percent of the loan payments would be lost due
to defaults for fiscal year 1997 and thereafter. The first reestimate is made early in fiscal year
1995. Because so little time has passed since the subsidy was initially estimated, the estimated
cash flows are unchanged and the reestimate is zero. (This illustration assumes that the interest
rates at the time of loan obligation and disbursement are the same, so no reestimate is needed
for the difference in interest rates.)
The second reestimation is performed early in fiscal year 1996, in preparing financial statements
for fiscal year 1995. It reestimates the subsidy cost allowance as of the end of fiscal year 1994.
After evaluating all of the risk factors, it is concluded that defaults would occur in fiscal year 1996,
instead of 1997, and that 60 percent, instead of 30 percent, of the cash flows would be lost due to
the defaults in fiscal year 1996 and thereafter. Table 4 below displays the present values of the
reestimated cash flows discounted to the end of fiscal year 1994.
Table 4: Subsidy Cost Reestimation: Projected Cash Flows Discounted To The End Of FY 1994 (in thousands
of dollars)
The present value of the reestimated net cash inflows discounted to the end of fiscal year 1994 is
$5,056, compared to the loans’ book value of $7,858, a decrease of $2,802. Thus, the subsidy
cost allowance is increased by $2,802, from $2,142 to $4,944. The amount of the increase in the
subsidy cost allowance (which is the decrease in the present value of the loans), resulting from
the reestimate, is recognized as subsidy expense reestimates.
A subsidy payment of $2,802, equal to the subsidy expense resulting from the reestimate, is
received under permanent indefinite authority. The amount is used to repay borrowing from
Treasury. Thus, the outstanding balance of the debt to Treasury is reduced by $2,802 to $5,056.
Furthermore, the direct loan program also receives a payment under permanent indefinite
authority to cover the interest accrued on the reestimate subsidy payment of $2,802 for the
FY P & I Payments Default Losses Net Cash Flows
1995 $2,246 $0 $2,246
1996 2,246 (1,348) 898
1997 2,246 (1,348) 898
1998 2,246 (1,348) 898
1999 2,246 (1,348) 898
PV at 6% $9,461 $(4,405) $5,056
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period from the end of fiscal year 1994 to the end of fiscal year 1995. The payment is $168,
which equals $2,802 times the applicable Treasury interest rate of 6 percent. This amount is
recognized as interest income reestimates, and the money is used to pay the interest on the
$2,802 borrowed from Treasury but repaid with the reestimate subsidy.
Table 5 displays the asset and liability balances as of the end of fiscal year 1994, adjusted for the
reestimate that was calculated early in fiscal year 1996.
Table 5: Assets And Liabilities As Of The End Of FY 1994: Amounts Adjusted For Reestimate Calculated In
Early FY 1996 (in thousands of dollars)
(2) Subsidy Amortization
The accounting standard for post-1991 direct loans requires that the subsidy cost
allowance for direct loans be amortized by the interest method using the interest rate that
was originally used to calculate the present value of the direct loans when the direct loans
were disbursed. The amortized amount is recognized as an increase or decrease in
interest income.
The subsidy cost allowance is amortized as a whole, not by components. Under the interest
method of amortization, the amortization of each period equals the effective interest of the
outstanding direct loans minus the nominal interest. For any period for which interest is to be paid
(a fiscal year in this example), the effective interest equals the book value (which is also the
present value) of the direct loans at the beginning of the period times the applicable Treasury
rate. The nominal interest equals the outstanding nominal balance of the loans at the beginning
of the period times the interest rate stated in the loan contracts.
In the example, the book value of the direct loans, as reestimated, is $5,056. The effective
interest for fiscal year 1995 is $303, which equals the book value of $5,056 times the applicable
Treasury rate of 6 percent. The nominal interest for that year is $400, which equals the nominal
principal of the direct loans $(10,000) times the stated rate of 4 percent. The amortized amount is
a negative amount of $97 for fiscal year 1995, which equals the effective interest minus the
nominal interest. The subsidy cost allowance is increased by $97, from $4,944 to $5,041. The
Assets Liabilities
Loans receivable $10,000 Debt to Treasury $5,056
Less:
Allowance for subsidy cost (4,944)
Loans Receivable, Net $5,056
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amortized amount is recognized as a reduction in interest income. (Interest income for fiscal year
1995 is calculated in section C: Revenues and Expenses.)
19
The same procedure of amortization is applied for each of the subsequent years so long as the
direct loans are outstanding. The collection of interest and principal payments must be properly
accounted for together with the amortization, so that the asset and liability balances can be
updated.
At the end of fiscal year 1995, payments of $2,246 are received from the borrowers as
scheduled. Of this amount, $400 is interest payments, and the remaining amount of $1,846 is
principal repayments. Thus, the outstanding nominal balance of the loans is reduced by $1,846
to $8,154.
The $2,246 received from the borrowers was paid to Treasury. Although the debt to Treasury
outstanding at the end of fiscal year 1994 was $7,858, the amount of $2,802 has been paid off by
the subsidy payment for the reestimate. This left $5,056 of debt to Treasury. The interest that
accrued on this remaining debt to Treasury is $303; the interest that accrued on the amount of
debt paid off by the subsidy reestimate is $168, but it is covered by the interest on the reestimate.
Therefore, of the $2,246 collected from the borrowers, $303 is interest paid to Treasury. The
remaining $1,943 is principal repayment to Treasury. After the principal repayment, the
outstanding debt to Treasury becomes $3,113.
Table 6 below displays the asset and liability balances after the amortization and the collection of
interest and principal payments at the end of fiscal year 1995.
Table 6: Assets And Liabilities After Amortization At The End Of FY 1995 (in thousands of dollars)
19
Amortization can alternatively be computed as interest expense other than reestimates $(471) minus the sum of
interest income from borrowers $(400), interest income from reestimates $(168), and interest income on fund balance
with Treasury $(0). These figures are derived in section C below.
Assets Liabilities
Loans receivable $8,154 Debt to Treasury $3,113
Less:
Allowance for subsidy costs (5,041)
Loans Receivable, Net $3,113
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C. Revenues And Expenses
The accounting standard for post-1991 direct loans requires that interest accrued on
direct loans, including amortized interest, be recognized as interest income. Interest
accrued on debt to Treasury is recognized as interest expense.
In this example, interest income for fiscal year 1995 is $471, which consists of the following
items:
Interest expense on the debt to Treasury for the fiscal year is also $471, which equals the debt to
Treasury of $7,859 at the beginning of the year times 6 percent. It is financed with the following
sources:
Costs of administering credit activities, such as salaries, legal fees, and office costs, that are
incurred for credit policy evaluation, loan origination, closing, servicing, monitoring, maintaining
accounting and computer systems, and other credit administrative purposes, are recognized
separately as administrative expenses. Administrative expenses are not included in calculating
the subsidy costs of direct loans.
D. Modification Of Post-1991 Direct Loans
The accounting standard on modifications states that the term “modification” means a
federal government action, including new legislation or administrative action, that directly
or indirectly alters the estimated subsidy cost and the present value of outstanding direct
loans.
Readers should refer to the text of the standard and to Appendix A, Basis of the Board’s
Conclusions, for a more detailed definition of modifications.
Assume that in October 1995, shortly after the close of fiscal year 1995, Congress passed
legislation to aid the borrowers. The legislation forgave some of the outstanding loans, and
extended the maturity of the remaining loans for one additional year (to the end of fiscal year
2000). It is estimated that 70 percent of the outstanding amounts, or $5,708, is forgiven.
Nominal interest $400
Amortized interest (97)
Interest reestimates 168
Total interest income $471
Collections from borrowers $303
Interest on reestimated subsidy payments 168
Total interest expense $471
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The legislative action is within the definition of direct modification because it is a federal
government action that directly changes the estimated subsidy cost and the present value of
outstanding direct loans by altering the terms of existing contracts.
The accounting standard on modifications states that with respect to a direct or indirect
modification of pre-1992 or post-1991 direct loans, the cost of modification is the excess
of the pre-modification value of the loans over their post-modification value. The amount
of the modification cost is recognized as a modification expense when the loans are
modified.
The accounting is implemented in the steps described below.
(1) Calculate The Pre-Modification Value
The pre-modification value is the present value of the net cash inflows of the direct loans
estimated at the time of modification under pre-modification terms and discounted at the current
discount rate.
As used in this part and Part II of this Appendix, the current discount rate is the interest rate
applicable at the time of modification on marketable Treasury securities with a similar maturity to
the remaining maturity of the direct loans under pre-modification terms or post-modification
terms, whichever is appropriate.
20
The cash flows of the loans under pre-modification terms during 1996-99 are assumed to be the
same as the cash flows that were reestimated early in fiscal year 1996 for these years and that
are shown in Table 4. Those cash flows are used to calculate the loans’ pre-modification value. It
is assumed that the Treasury rate for a comparable maturity (4 years) and applicable to the time
of modification is 4.5 percent. As Table 7 below shows, the present value of the pre-modification
cash flows discounted at 4.5 percent is $3,223.
20
The definition of the current discount rate is provided in Appendix C, Glossary. [See Appendix E of this Volume.]
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Table 7: Pre-Modification Value (in thousands of dollars, calculated at the current discount rate)
(2) Calculate The Post-Modification Value
The loans’ post-modification value is the present value of the loans’ net cash inflows estimated at
the time of modification under post-modification terms and discounted at the current discount
rate (for a 5-year maturity).
The modification forgives 70 percent of the outstanding principal amounts, and requires the
remaining 30 percent, or $2,446, be paid back in 5 years (instead of 4 years) starting with year
1996. The stated interest rate remains at 4 percent. As shown in Table 8 below, under the
modified terms, the required annual principal and interest payment is $549.
Table 8: Payment Schedule Of The Modified Loans (in thousands of dollars)
It is estimated that 20 percent of the scheduled cash inflows of the modified loans would be lost
due to defaults. The current discount rate for a maturity of 5 years is 5 percent. As Table 9 shows,
the present value of the post-modification cash inflows discounted at 5 percent is $1,902.
FY P & I Payments Default Losses Net Cash Flows
1996 $2,246 $(1,348) $ 898
1997 2,246 (1,348) 898
1998 2,246 (1,348) 898
1999 2,246 (1,348) 898
PV AT 4.5% $8,058 $(4,835) $3,223
FY Payment Interest Principal
Year-end Loan
Balance
1995 $2,446
1996 $549 $97 $452 1,994
1997 549 79 470 1,524
1998 549 61 488 1,036
1999 549 41 508 528
2000 549 21 528 0
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Table 9: Post-Modification Value (in thousands of dollars, calculated at the current discount rate)
(3) Calculate And Recognize The Cost Of Modification
The cost of modification is the excess of the pre-modification value over the post-modification
value. Since the pre-modification value is $3,223, and the post-modification value is $1,902, the
cost of modification is $1,321, which is recognized as a subsidy expense for modifications.
(4) Calculate The Change In The Loans’ Book Value
The accounting standard on direct loan modifications requires that when post-1991 direct loans
are modified, their existing book value be changed to an amount equal to the present value of the
loans’ net cash inflows projected under the modified terms from the time of modification to the
loans’ maturity and discounted at the original discount rate (the rate that is originally used to
calculated the present value of the direct loans, when the direct loans were disbursed).
In this example, the original discount rate is 6 percent. As Table 10 below shows, the present
value of the net cash inflows estimated under the modified terms and discounted at 6 percent is
$1,849.
FY P & I Payments Default Losses Net Cash Flows
1996 $549 $(110) $439
1997 549 (110) 439
1998 549 (110) 439
1999 549 (110) 439
2000 549 (110) 439
PV AT 5% $2,377 $(475) $1,902
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Table 10: Post-Modification Book Value (in thousands of dollars, calculated at the original discount rate)
At the time the modification action is taken, the existing book value of the loans is $3,113. The
book value is changed to $1,849. This represents a decrease in book value by $1,264.
Table 11 displays the effect of the modification on the book amounts. The table shows that, due to
the forgiveness, (1) the outstanding balance of the loans receivable is reduced from $8,154 to
$2,446, (2) the book value is reduced from $3,113 to $1,849, and (3) the subsidy cost allowance,
which is the difference between the gross amount and the book value, is changed from $5,041 to
$597.
Table 11: Change In The Value Of Modified Loans (in thousands of dollars)
(5) Calculate The Gain Or Loss And The Debt To Treasury
The accounting standard on direct loan modifications states that the change in book value of both
pre-1992 and post-1991 direct loans resulting from a direct or indirect modification and the cost
of modification will normally differ, due to the use of different discount rates or the use of different
measurement methods. Any difference between the change in book value and the cost of
modification is recognized as a gain or loss.
FY P & I Payments Default Losses Net Cash Flow
1996 $549 $(110) $439
1997 549 (110) 439
1998 549 (110) 439
1999 549 (110) 439
2000 549 (110) 439
PV AT 6% $2,312 $(463) $1,849
Gross
Amount
Book
Allowance Value
Before Modification $8,154 $(5,041) $3,113
After Modification $2,446 $(597) $1,849
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For post-1991 direct loans, the modification adjustment transfer
21
paid or received to offset the
gain or loss is recognized as a financing source (or a reduction in financing source).
The change in book value in this case is $1,264, compared to the cost of modification of $1,321.
The amount of the modification cost exceeds the change in book value by $57. This excess is
recognized as a gain.
The credit program receives a subsidy appropriation equal to the cost of modification. Since the
cost of modification exceeds the decrease in book value by $57, the credit program pays to the
Treasury a modification adjustment transfer of $57 to offset the excess. This is reported as a
reduction in financing source.
The $1,321 subsidy appropriation received minus the $57 modification adjustment transfer paid
is used to repay debt to Treasury. As a result, the debt to Treasury is reduced by $1,264 from
$3,113 to $1,849.
Table 12 displays the asset and liability balances after the modification in October 1995.
Table 12: Assets And Liabilities After Modification In October 1995 (in thousands of dollars)
(6) Provide Disclosures
The accounting standard requires that disclosure be made in notes to financial
statements to explain the nature of the modification of direct loans, the discount rate used
in calculating the modification expense, and the basis for recognizing a gain or loss
related to the modification.
21
OMB instructions provide that if the decrease in book value exceeds the cost of modification, the reporting entity
receives from the Treasury an amount of modification adjustment transfer equal to the excess; and if the cost of
modification exceeds the decrease in book value, the reporting entity pays to Treasury an amount of modification
adjustment transfer to offset the excess. (See OMB Circular A-11.)
Assets Liabilities
Loans Receivable $2,446 Debt to Treasury $1,849
Less:
Allowance for subsidy
cost
(597)
Loans Receivable, Net $1,849
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With respect to the modification described above, a footnote disclosure should be made in the
financial statements for fiscal year 1996. The disclosure would explain the following:
22
(a) The direct loans in the cohort of fiscal year 1994 were modified in October 1995. The
modification was to forgive 70 percent of the outstanding loans and to extend the
maturity of the remaining loans to the end of fiscal year 2000.
(b) The modification expense is $1,321, which is the decrease in the present value of the
cash flows from that estimated under pre-modification terms to that estimated under
post-modification terms, discounted at the current interest rate of marketable Treasury
securities of similar maturity. The pre-modification cash flows were discounted at the
current discount rate of 4.5 percent, which was applicable to a maturity of 4 years, and
the post-modification cash flows were discounted at the current discount rate of 5
percent, which was applicable to a maturity of 5 years.
(c) As a result of the modification, the book value of the loans receivable decreased by
$1,264, from $3,113, as reported at the end of fiscal year 1995, to $1,849. The
difference between this decrease in book value and the modification expense, which
amounts to $57, is recognized as a gain in the operating statement.
E. Write-off Of Direct Loans
The accounting standard on write-off of direct loans requires that when post-1991 direct
loans are written off, the unpaid principal of the loans be removed from the gross amount
of loans receivable. Concurrently, the same amount is charged to the allowance for
subsidy costs. Prior to the write-off, the uncollectible amounts should have been fully
provided for in the subsidy cost allowance through the subsidy cost estimate or
reestimates. Therefore, the write-off would have no effect on expenses.
Direct loans in this example that are determined to be uncollectible are written off as of the end of
fiscal year 1996. However, before the write-off, accounting is performed for the year-end
reestimation, the amortization of the allowance for subsidy costs, and the recording of collections
and payments. This takes the following steps:
(1) The Reestimation Of The Subsidy Cost Allowance
In early fiscal year 1997, before the write-off, the credit program makes a year-end reestimation
for the subsidy cost allowance. This reestimation is for the balances calculated as of the end of
fiscal year 1995 adjusted for the modification in October 1995 (Table 12). The result of the
22
The disclosure will not be illustrated for other modifications explained in this Appendix.
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reestimation indicates that 20 percent of the outstanding loan payments due after the
modification were lost because of defaults for fiscal year 1996, and the expected loss would be
30 percent in fiscal year 1997 and thereafter. The reestimated loss of 30 percent for fiscal year
1997 and the subsequent years is 10 percentage points more than the previous estimate made in
October 1995, when the loans were modified. As Table 13 below shows, the net present value of
the reestimated net cash inflows, discounted at the original rate of 6 percent to the end of fiscal
year 1995, is $1,670.
Table 13: Subsidy Cost Reestimation: Projected Cash Flows Discounted To The End of FY 1995 (in thousands
of dollars)
Based on the reestimate, the direct loans’ book value is reduced by $179, from $1,849 to the
reestimated present value of $1,670. This is accomplished by adjusting the subsidy cost
allowance upward by $179, from $597 to $776. The increase of $179 in the subsidy cost
allowance is recognized as subsidy expense reestimates.
A subsidy payment of $179 equal to the subsidy cost increase resulting from the reestimate is
received under permanent indefinite authority and is used to reduce debt to Treasury. As a result,
the debt to Treasury is reduced from $1,849 to $1,670. Furthermore, the direct loan program also
receives a payment under permanent indefinite authority to cover the interest accrued on the
increased subsidy expense of $179. The payment is $11, which equals $179 times the applicable
Treasury interest rate of 6 percent. This amount is recognized as interest income reestimates,
and the money is used to pay interest accrued for fiscal year 1996 on the $179 borrowed from
Treasury, that is repaid by the subsidy reestimate.
The following table displays the asset and liability balances as of the end of fiscal year 1995,
adjusted for the modification in October 1995 and the results of the reestimate that is calculated
in early fiscal year 1997.
FY P & I Payments Default Losses Net Cash Flows
1996 $549 $(110) $439
1997 549 (165) 384
1998 549 (165) 384
1999 549 (165) 384
2000 549 (165) 384
PV AT 6% $2,313 $(643) $1,670
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Table 14: Assets And Liabilities As Of The End Of FY 1995: Amounts Adjusted For Modification In October
1995 and Reestimates Calculated In Early FY 1997 (in thousands of dollars)
(2) The Amortization Of The Subsidy Cost Allowance
The subsidy cost allowance is amortized as of the end of fiscal year 1996. The amortized amount
equals the loans’ effective interest minus their nominal interest. The loans’ effective interest for
fiscal year 1996 is $100, which is the loan’s book value of $1,670, as reestimated, times the
original discount rate of 6 percent. The loans’ nominal interest is $98, which is the loans’ nominal
outstanding balance of $2,446 times the stated interest rate of 4 percent. Thus, the amortized
amount is $2, which is the effective interest minus the nominal interest. The amortized amount is
recognized as interest income, and the allowance for subsidy costs is reduced by $2, and
becomes $774.
(3) Collections and Payments
Of the scheduled annual payment of $549 for fiscal year 1996, payments of $439 are received
from the borrowers, which equal 80 percent of the scheduled payments. Of the amount received,
$78 is interest payment (which equals 80 percent of the loans’ balance of $2,446 times the stated
interest rate of 4 percent), and the remaining $361 is principal repayment. The outstanding
nominal principal of the loans is reduced by $361 to $2,085. There is unpaid accrued interest of
$20 (which equals 20 percent of the loans’ nominal balance as of the end of fiscal year 1995
times the stated interest rate of 4 percent). At this point of time, the loans’ book value is $1,331,
which equals the outstanding principal of $2,085, plus interest receivable of $20, minus the
subsidy cost allowance of $774.
The debt to Treasury was $1,849 after the modification in October 1995. Of that amount, $179
has been paid off with the subsidy payment received as a result of the reestimate, which reduces
the debt to $1,670; and the $11 of accrued interest on the $179 has been paid off with the interest
on the reestimate. The interest accrued on the remaining debt is $100, which equals the debt
balance of $1,670 times the Treasury interest rate of 6 percent. Of the $439 in payments
received from the borrowers, $100 is used to pay interest due Treasury, and the remaining $339
is used to reduce debt to Treasury. As a result, the balance of debt to Treasury becomes $1,331.
Assets Liabilities
Loans Receivable $2,446 Debt to Treasury $1,670
Less:
Allowance for subsidy
cost (776)
Loans Receivable, Net $1,670
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Table 15 displays the asset and liability balances after the amortization and the recording of
collections and payments at the end of fiscal year 1996.
Table 15: Assets And Liabilities After Amortization At The End Of FY 1996 (in thousands of dollars)
(4) Write-Off of Uncollectible Direct Loans
It is confirmed that non-performing loans with an outstanding balance of $489 (20 percent of the
direct loan balance after modification in October 1995) are in default and will not be collected.
The credit program is authorized to write off those loans, and the unpaid accrued interest of $20.
The total amount of the write-off is $509. Thus, the principal is reduced by $489 to $1,596, and
the interest receivable of $20 is written off. The subsidy cost allowance is reduced by $509, from
$774 to $265.
The loans’ book value is not changed by the write-off; it remains $1,331, which equals the
remaining principal of $1,596, minus the subsidy allowance of $265. Table 16 below shows the
asset and liability balances after the write-off.
Table 16: Assets And Liabilities After The Write-off As Of The End Of FY 1996 (in thousands of dollars)
The book value of $1,331, as indicated in the above table, equals the present value of estimated
net cash inflows of the remaining outstanding loans. The estimated cash flows and the present
value calculations are shown in Table 17.
Assets Liabilities
Loans Receivable $2,085 Debt to
Treasury
$1,331
Interest Receivable 20
Less:
Allowance for subsidy costs (776)
Loans & Interest Receivable, Net $1,331
Assets Liabilities
Loans Receivable $1,596 Debt to Treasury $1,331
Less:
Allowance for subsidy
costs (265)
Loans Receivable, Net $1,331
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In Table 17 the amounts in column (a) are the scheduled annual principal and interest payments.
Since the principal of the outstanding loans is $1,596 and the remaining life of the loans is 4
years, the required annual payment is $439. The amounts in column (b) equal the default
amounts reestimated at the end of fiscal year 1996 minus the scheduled payments of the loans
that have been written off (recoveries on those loans are assumed to be zero). The amounts in
column (c) are the projected net cash inflows of the outstanding loans.
Table 17: Projected Cash Flows After Loan Write-off: Discounted To The End Of FY 1996 (in thousands of
dollars)
It should be noted that to calculate the amortization correctly in subsequent periods, the unpaid
principal and interest should be written out of the nominal principal balance. The amortization
would be distorted if the unpaid amounts were kept in the nominal principal balance and
continued to accrue interest. However, direct loan programs may need to keep the non-paying
loans in their accounting records until collection efforts are exhausted and the loans are
authorized to be written off. The non-paying loans and interest accrued on them should be
accounted for separately, so that the amortization of the subsidy cost allowance of the performing
loans can be calculated correctly. Readers should consult Treasury, OMB, or GAO, for guidance
on accounting for non-paying loans.
F. Sale Of Direct Loans
The accounting standard on sale of loans states that the sale of post-1991 and pre-1992
direct loans is a direct modification.
23
It is assumed that after the close of fiscal year 1996, the credit program is authorized to sell the
loans. In October 1996, all of the loans are sold with recourse. The net proceeds from the sale
FY P & I Payments Default Losses Net Cash Flows
1996 $ 549 $(110) $ 439
1997 549 (165) 384
1998 549 (165) 384
1999 549 (165) 384
2000 549 (165) 384
PV AT 6% $2,313 $(643) $1,670
23
This assumes that the sales proceeds were not included in the cash flow estimates for the initial subsidy calculation.
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amount to $1,100. Accounting for the sales takes the steps explained in the paragraphs that
follow.
(1) Recognize The Cost of Modification
The accounting standard on sale of loans requires that the cost of modification be
determined on the basis of the pre-modification value of the loans sold. If the
pre-modification value of the loans sold exceeds the net proceeds from the sale, the
excess is the cost of modification, which is recognized as modification expense.
The pre-modification value of the loans sold is the present value of the loans’ net cash inflows
estimated under pre-modification terms and discounted at the current discount rate.
The net cash inflows of the direct loans estimated prior to the sale are assumed to be the same
as those estimated after the loan write-off at the end of fiscal year 1996 (shown in Table 17). It is
assumed that the current discount rate for a similar maturity (4 years) is 5 percent. To calculate
the pre-modification value, the net cash flows are now discounted at the current discount rate of
5 percent. As Table 18 shows, the pre-modification value of the loans sold is $1,362.
Table 18: Pre-Modification Value Of The Loans Sold, As Of October 1996 (in thousands of dollars, calculated at
the current discount rate)
The pre-modification value of the loans sold exceeds the net proceeds of $1,100 from the sale by
$262, which is recognized as a modification expense. The credit program receives an
appropriation equal to that amount to cover the modification cost. (The credit program must have
an appropriation equal to the modification cost before it can sell the loans.)
(2) Recognize Book Value Gain Or Loss
The accounting standard on sale of direct loans states that the book value loss (or gain)
on a sale of direct loans equals the existing book value of the loans sold minus the net
proceeds from the sale. Since the book value loss (or gain) and the cost of modification
are calculated on different bases, they will normally differ. Any difference between the
FY P & I Payments Default Losses Net Cash Flows
1997 $439 (55) $384
1998 439 (55) 384
1999 439 (55) 384
2000 439 (55) 384
PV AT 6% $1,557 $(195) $1,362
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book value loss (or gain) and the cost of modification is recognized as a gain or loss.
24
For
sales of post-1991 direct loans, the modification adjustment transfer paid or received to
offset the gain or loss is recognized as a financing source (or a reduction in financing
source).
The existing book value of the loans sold is $1,331. Upon the sale, this amount is removed from
the books. At the same time, the net proceeds of $1,100 from the sale are recorded. The book
value loss is $231. The accounting standard requires that any difference between the book value
loss and the cost of modification be recognized as a gain or loss. In this case, the cost of
modification is $262 and the book value loss is $231. The difference of $31 is recognized as a
gain. Under the OMB instructions, this amount will be paid to Treasury as a modification
adjustment transfer, and is recorded as a reduction in financing sources.
(3) Recognize the Subsidy Expense on Recourse
The accounting standard on sale of loans requires that for a loan sale with recourse,
potential losses under the recourse or guarantee obligations be estimated, and that the
present value of the estimated losses from the recourse be recognized as subsidy
expense when the sale is made and as a loan guarantee liability.
It is estimated that 10 percent of the loans sold with a principal of $160 would default at the end
of fiscal year 1997. Upon their default, the federal credit program will pay the loan purchaser an
amount equal to the defaulted principal plus accrued interest. The estimated future default
payment is $166, which equals the principal of the loans that are expected to default plus the 4
percent nominal interest of $6 accrued on those loans for one year.
At the time the loans are sold, the interest rate of Treasury securities of a similar maturity is 5
percent. The present value of the estimated default payment discounted at 5 percent is $158.
This amount is recognized as a subsidy expense and a loan guarantee liability. The credit
program receives an appropriation of $158 to cover the guarantee expense, which is paid to the
loan guarantee financing account and becomes part of the fund balance of that account. (An
appropriation must be available to cover the subsidy expense before the loans can be sold, since
the payment to the loan guarantee financing account must be made in order for the guarantee to
take effect.)
24
If there is a book value gain, the gain to be recognized equals the book value gain plus the cost of modification.
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At this point, the credit program has $1,489 in cash, which was derived from the following events:
The credit program uses $1,331 to pay off the debt to Treasury, which was borrowed to finance
the direct loans. The remaining balance of $158 has been paid to the loan guarantee financing
account (as stated above). That amount, together with interest for one year at 5 percent, is to
cover the recourse liability of the loan guarantee financing account.
Part II: Pre-1992 Direct Loans
Pre-1992 direct loans are direct loans obligated prior to October 1, 1991, and are recorded in
liquidating accounts. The accounting standard requires that the losses of pre-1992 direct
loans be recognized when it is more likely than not that the direct loans will not be totally
collected. The allowance of the uncollectible amounts should be reestimated each year as
of the date of the financial statements. In estimating losses, the risk factors discussed in
the standard for post-1991 direct loans should be considered.
The standard further states that restatement of pre-1992 direct loans on a present value
basis is permitted but not required.
All of the amounts used in the text that follows are in thousands of dollars.
A. Provision For Uncollectible Amounts
Assume that at the end of fiscal year 1994 a credit program has pre-1992 direct loans with
outstanding principal of $5,000 at 7 percent interest rate, maturing in three years (at the end of
fiscal year 1997). The program management evaluates the risk factors enumerated in the
accounting standard, and estimates that the net loss of principal due to defaults would be $2,000.
Thus, the program management provides an allowance of $2,000 for uncollectible amounts, and
Net proceeds from the loan sale $1,100
Appropriation to cover the modification cost 262
Appropriation to cover estimated recourse liability 158
Less: modification adjustment transfer (31)
Total in fund balance $1,489
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charges that amount to bad debt expense.
25
Thus, the book value of the loans is $3,000, as
shown below:
B. Modification Of Pre-1992 Direct Loans
Assume that in October 1994, shortly after the close of fiscal year 1994, a decision is made to
take the following actions: (1) forgive 50 percent of the amounts due, (2) lower the interest rate to
4 percent, and (3) extend the due date to the end of fiscal year 2000.
These actions are within the definition of direct modification because they are federal
government actions that would directly change estimated subsidy costs and the present value of
outstanding direct loans by altering the terms of existing contracts.
The accounting standard on direct loan modifications states that with respect to a direct or
indirect modification of pre-1992 direct loans, the cost of modification is the excess of the
pre-modification value of the loans over their post-modification value. The amount of the
modification cost is recognized as a modification expense when the loans are modified.
Accounting for the cost of modification takes the following steps:
(1) Calculate The Pre-Modification Value
The pre-modification value is the present value of the net cash inflows of the direct loans
estimated at the time of modification under pre-modification terms and discounted at the current
discount rate.
It is estimated that under the pre-modification terms, 40 percent of the cash flows would be lost
due to defaults in fiscal year 1995 and each year thereafter. The current discount rate for a
maturity of 3 years is 4 percent. As Table 19 below shows, the present value of the estimated net
cash inflows discounted at 4 percent is $3,172. This is the pre-modification value of the loans.
25
This assumes that no allowance for uncollectible amounts was provided prior to fiscal year 1994. If there is an
allowance for uncollectible amounts, that allowance should be adjusted to the current estimate and the difference
between the current estimate and the existing allowance should be charged to bad debt expense.
Loans receivable $5,000
Less uncollectible amounts (2,000)
Loan receivable, net $3,000
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Table 19: Pre-Modification Value (in thousands of dollars, calculated at the current discount rate)
(2) Calculate The Post-Modification Value
The loans’ post-modification value is the present value of the loans’ net cash inflows estimated at
the time of modification under post-modification terms and discounted at the current discount
rate.
The modification reduces the outstanding principal by 50 percent to $2,500, lowers the nominal
interest rate to 4 percent, and extends the maturity by 3 years to the end of fiscal year 2000. As
shown in Table 20 below, under the post-modification terms, the required payments will be $477
per year for six years.
Table 20: Payment Schedule Of The Modified Loans (in thousands of dollars)
Taking into consideration that the loans owed by borrowers with poor conditions have been
forgiven, it is estimated that only 10 percent of the cash flows would be lost due to defaults. The
current discount rate for a maturity of 6 years is 5 percent. As shown in Table 21, the present
value of the estimated net cash inflows discounted at 5 percent is $2,179. This is the loans’
post-modification value.
FY P & I Payments Default Losses Net Cash Flows
1995 $1,905 $(762) $1,143
1996 1,905 (762) 1,143
1997 1,905 (762) 1,143
PV at 4% $5,287 $(2,115) $3,172
FY Payment Interest Principal
Year-end Loan
Balance
1994 $477 $2,500
1995 477 $100 $377 2,123
1996 477 85 392 1,731
1997 477 69 408 1,323
1998 477 53 424 899
1999 477 36 441 458
2000 477 19 458 0
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Table 21: Post-modification Value (in thousands of dollars, calculated at the current discount rate)
(3) Calculate And Recognize The Cost Of Modification
The cost of modification is the excess of the loans’ pre-modification value over the loans’
post-modification value. Since the loans’ pre-modification value is $3,172, and their
post-modification value is $2,179, the cost of modification is $993, which is recognized as a
subsidy expense for modifications.
The credit program receives an appropriation of $993 to cover the modification expense, which is
paid to the financing account. The financing account, in turn, pays this amount to the liquidating
account as part of its payment to acquire the loans. (A subsidy appropriation equal to the cost of
modification must be available before the modification can take place.)
(4) Calculate The Change In Book Value And The Gain Or Loss
With respect to modifications of pre-1992 direct loans, the standard requires that when
pre-1992 direct loans are directly modified, they be transferred to a financing account and
their book value be changed to an amount equal to their post-modification value.
Any subsequent modification is treated as a modification of post-1991 loans.
26
The change in book value of pre-1992 direct loans resulting from a direct or indirect
modification and the cost of modification will normally differ, due to the use of different
discount rates or the use of different measurement methods. Any difference between the
FY P & I Payments Default Losses Net Cash Flows
1995 $477 $(48) $429
1996 477 (48) 429
1997 477 (48) 429
1998 477 (48) 429
1999 477 (48) 429
2000 477 (48) 429
PV at 5% $2,421 $(242) $2,179
26
The accounting standard provides that when pre-1992 direct loans are indirectly modified, they are kept in a
liquidating account; and that their bad debt allowance is reassessed and adjusted to reflect amounts that would not be
collected due to the modification. Indirect modifications of pre-1992 direct loans are not illustrated.
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cost of modification and the change in the loans’ book value due to modification is
recognized as a gain or loss.
Prior to the modification, the book value of the loans was recorded in the liquidating account at
$3,000. Upon modification, the loans are transferred from the liquidating account to the financing
account and recorded at their post-modification value of $2,179. The change in book value is a
decrease of $821. Since the cost of modification is $993, and the change in book value is $821,
the difference of $172 is recognized as a gain.
The financing account pays the liquidating account an amount equal to the loans’
pre-modification value of $3,172. This comes from two sources. First, the financing account
receives the $993 that is appropriated for the cost of modification. Second, the financing account
borrows from Treasury the remainder, which is $2,179, the post-modification value of the loans.
In exchange, the liquidating account transfers to the financing account the loan assets that had a
book value of $3,000 before the modification was made. The gain to the liquidating account is
$172, which, as shown above, equals the difference between the cost of modification and the
change in book value of the loans.
Post-1991 loan guarantees are loan guarantees committed after September 30, 1991. The
accounting standards for post-1991 loan guarantees are explained and illustrated through the
use of an example described below:
A cohort of 5-year term loans that amounts to $10 million in face value is guaranteed by a federal
loan guarantee program. The guarantee covers 60 percent of the principal and interest
payments. The borrowers are required to pay interest annually at 7 percent, and to repay the
principal when the loans mature at the end of the the year. The government agrees to pay a 1
percent interest supplement to the lenders at the end of each year over the loans’ life. The loans
are disbursed on September 30, 1994. The federal loan guarantee program collects a fee of 5
percent, when the loans are disbursed. The average interest rate of marketable Treasury
securities of a similar maturity for the period in which the guaranteed loans are disbursed is 6
percent.
All of the amounts used in the text that follows are in thousands of dollars.
Part III: Post-1991 Loan Guarantees
A. Reporting The Liability Of Post-1991 Loan Guarantees And Their Subsidy Costs
The accounting standard for post-1991 loan guarantees requires that for guaranteed loans
outstanding, the present value of estimated net cash outflows of the loan guarantees be
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recognized as a liability. Disclosure is made of the face value of the guaranteed loans
outstanding and the amount of the outstanding balance that is guaranteed.
To implement the standard in the example, cash flow estimates and present value calculations
are prepared. It is projected that the borrowers would pay interest when due, but would default on
60 percent, or $6,000, of the principal repayments. Upon default, the federal credit program will
pay 60 percent of the defaulted principal, equal to $3,600, to the lenders. It is projected that a net
recovery of $2,000 will be realized a year later through the foreclosure and sale of pledged
assets. The fees of $500 are received when the guaranteed loans are disbursed.
Table 22 below shows the estimated cash flows and the present values of the cash flows.
Table 22: Projected Cash Flows Discounted To The Time Of Disbursement (in thousands of dollars)
The present value of the estimated net cash outflows of the loan guarantees is $1,201. This
amount is recognized as a liability.
Disclosure is made in a footnote to the financial statements for fiscal year 1994 that guaranteed
loans have an outstanding principal of $10,000, and the guaranteed amount is $6,000. (A similar
disclosure is made in each year so long as the guaranteed loans are outstanding.)
The accounting standard for post-1991 loan guarantees requires that for guaranteed loans
disbursed during a fiscal year, a subsidy expense be recognized. The amount of the
subsidy expense equals the present value of estimated cash outflows over the life of the
guaranteed loans minus the present value of estimated cash inflows, discounted at the
interest rate of marketable Treasury securities with a similar maturity term, applicable to
the period during which the loans are disbursed (hereinafter referred to as the applicable
Treasury interest rate).
FY
Fee
Receipts
Interest
Supplements
Net Default
Payments Recoveries Cash Flows
1994 $(500) $(500)
1995 $100 100
1996 100 100
1997 100 100
1998 100 100
1999 100 $3,600 $3,700
2000 $(2,000) (2,000)
PV at 6% $(500) $421 $2,690 $(1,410) $1,201
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In the example, the present value of the cash outflows minus the present value of the cash
inflows is $1,201, which is recognized as a subsidy expense.
The accounting standard for post-1991 loan guarantees requires that for the fiscal year
during which new guaranteed loans are disbursed, the components of the subsidy
expense of those new loan guarantees be recognized separately among interest subsidy
costs, default costs, fees and other collections, and other subsidy costs.
The interest subsidy cost of the loan guarantees is the present value of the interest supplement
payments to the lenders, which, in this example, is $421.
The default cost is the present value of the projected default payments minus the present value
of net recoveries. The present value of the default payments is $2,690, and the present value of
the net recoveries is $1,410. Thus, the default cost is $1,280.
The present value of fee collections, which is $500, is recognized as a deduction from subsidy
costs.
There are no other subsidy costs in this example.
The subsidy expense of the loan guarantees is the sum of the above cost components, which is
$1,201, calculated as follows:
The loan guarantee program receives an appropriation equal to the subsidy cost of $1,201.
When the guaranteed loans are disbursed, the appropriated amount is paid to the loan guarantee
financing account and is recorded in fund balance with Treasury. The $500 of fees are collected
at the same time. The amount of the fees is debited to fund balance with Treasury and credited to
the liability of the loan guarantees. Thus, the fund balance is raised to $1,701, on which Treasury
pays 6 percent interest. The loan guarantee liability is also raised from $1,201 to $1,701.
Table 23 shows the projected cash flows and their present values after the receipt of fees.
Interest subsidy cost $421
Fee collections (500)
Loan default cost 1,280
Total subsidy cost $1,201
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Table 23: Projected Cash Flows Discounted To The End Of FY 1994, After The Receipt Of Fees (in thousands of
dollars)
Table 24 displays the asset and liability balances at the end of the 1994 fiscal year.
Table 24: Assets And Liabilities At The End Of FY 1994 (in thousands of dollars))
B. Liability Reestimation And Interest Compounding
(1) The Reestimation Of The Liability Of Loan Guarantees
The accounting standard for post-1991 loan guarantees requires that the liability for loan
guarantees be reestimated each year as of the date of the financial statements. Since the
liability represents the present value of the net cash outflows of the underlying loan
guarantees, the reestimation takes into account all factors that may have affected the
estimate of each component of the cash flows, including prepayments, defaults,
delinquencies, and recoveries. Any increase or decrease in the loan guarantee liability
resulting from the reestimates is recognized as a subsidy expense (or a reduction in
subsidy expense). Reporting the liability of loan guarantees and reestimates by
component is not required.
In Appendix A, the Basis of the Board’s Conclusions, it is pointed out that the primary factor that
causes changes in the subsidies would be default reestimates. The accounting standard
provides a number of risk factors and other default cost criteria to be considered in making the
default cost estimates and reestimates.
FY
Interest
Supplements
Default
Payments
Net
Recoveries
Net Cash
Flows
1994
1995 $100 $100
1996 100 100
1997 100 100
1998 100 100
1999 100 $3,600 3,700
2000 $(2,000) (2,000)
PV at 6% $421 $2,690 $(1,410) $1,701
Assets Liabilities
Fund Balance with Treasury $1,701 Loan Guarantee Liability $1,701
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In the example, it is initially estimated that 60 percent of the loans will default on the principal
repayments when the loans mature at the end of fiscal year 1999, and that $2,000 will be
recovered from the sale of foreclosed assets. The first reestimate is made early in fiscal year
1995. Because so little time has passed since the subsidy was initially estimated, the estimated
cash flows are unchanged and the reestimate is zero. (This illustration assumes that the interest
rates at the time of commitment and disbursement are the same, so no reestimate is needed for
the difference in interest rates.)
The second reestimation of the subsidy cost is made early in fiscal year 1996, in preparing
financial statements for fiscal year 1995. It reestimates the loan guarantee liability as of the end
of fiscal year 1994. It indicates that the initial default estimate is correct. However, it also
indicates that the net recovery realized at the end of fiscal year 2000 would be $1,000, rather
than $2,000. As shown in Table 25, because of the decrease in the amount of recovery, the
present value of the net cash outflows discounted to the end of fiscal year 1994, is $2,406, rather
than $1,701, as previously estimated for the end of fiscal year 1994 and shown in Table 23.
Table 25: Subsidy Cost Reestimation: Projected Cash Flows Discounted To The End Of FY 1994 (in thousands
of dollars)
The reestimated liability is $2,406, compared to the existing liability of $1,701, an increase of
$705. The increase of $705 is added to the loan guarantee liability and is recognized as a
subsidy expense reestimates.
The credit program receives a subsidy payment under permanent indefinite authority equal to
$705 to cover the cost increase resulting from the reestimate. In addition, a payment of $42 is
also received under permanent indefinite authority to cover the interest accrued on the $705
reestimate payment for the period from the end of fiscal year 1994 to the end of fiscal year 1995,
and is reported as interest income. The total amount of $747 received is added to the fund
balance.
FY
Interest
Supplements
Default
Payments
Net
Recoveries
Net Cash
Flows
1995 $100 $100
1996 100 100
1997 100 100
1998 100 100
1999 100 $3,600 3,700
2000 $(1,000) (1,000)
PV at 6% $421 $2,690 $(705) $2,406
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(2) Interest Compounding
The accounting standard for post-1991 loan guarantees requires that interest be accrued
and compounded on the liability of loan guarantees at the interest rate that was originally
used to calculate the present value of the loan guarantee liabilities when the guaranteed
loans were disbursed. The accrued interest is recognized as interest expense.
With the passage of time, the present value of the liability of the loan guarantees increases at a
rate equal to the rate of interest used to discount the liability. The increase for fiscal year 1995 is
$144, which equals the balance of the liability of $2,406, as reestimated, multiplied by the interest
rate of 6 percent. The amount of the increase in the present value of the liability is added to the
liability balance, and concurrently it is recognized as interest expense. As a result, the liability
becomes $2,550.
Interest is also accrued on the credit program’s fund balance of $1,701 at 6 percent. The amount
of interest accrued is $102, which is added to the fund balance, and is recognized as interest
income. As mentioned previously, the payments of $747 to cover the reestimated subsidy cost
and the accrued interest are also added to the fund balance.
The interest supplement of $100 is paid for fiscal year 1995. Both the fund balance and the
liability are reduced by $100.
As a result of the above transactions, the fund balance becomes $2,450, calculated as follows:
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The loan guarantee liability is also $2,450 at the end of fiscal year 1995, calculated as follows:
Table 26 displays the asset and liability balances at the end of the 1995 fiscal year.
Table 26: Assets And Liabilities After Interest Accumulations At The End Of FY 1995 (in thousands of dollars)
C. Revenues And Expenses
The accounting standard for post-1991 loan guarantees requires that interest accrued on
the liability of loan guarantees be recognized as interest expense, and that interest due
from Treasury on uninvested funds be recognized as interest income. Interest accrued on
debt to Treasury, if any, is recognized as interest expense.
In the example, interest accrued on the liability of loan guarantees is $144, which equals the
reestimated liability of $2,406 times 6 percent. The amount is recognized as interest expense,
and the same amount is added to the liability, as explained above.
Interest income recognized for fiscal year 1995 is also $144, consisting of (a) interest income of
$102 on the fund balance, which equals the fund balance of $1,701 times 6 percent, and (b)
interest income of $42 on the subsidy payment reestimates.
Costs of administering loan guarantee activities, such as salaries, legal fees, and office costs,
that are incurred for credit policy evaluation, origination, closing, servicing, monitoring,
maintaining accounting and computer systems, and other credit administrative purposes, are
Fund balance at the end of FY 1994 $1,701
Interest on the fund balance 102
Subsidy payment reestimates 705
Interest on subsidy payment reestimates 42
Interest supplement paid
(100)
Fund balance at the end of FY 1995
$2,450
Liability balance at the end of FY 1994, as reestimated $2,406
Increase due to passage of time 144
Interest supplement paid (100)
Liability balance at the end of FY 1995 $2,450
Assets Liabilities
Fund Balance with Treasury $2,450 Loan Guarantee Liability $1,701
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recognized separately as administrative expenses. Administrative expenses are not included in
calculating the subsidy costs of loan guarantees.
D. Modification Of Post-1991 Loan Guarantees
Assume that in October 1995, shortly after the close of fiscal year 1995, the loan guarantee
program takes action to expand its guarantee from 60 percent of the outstanding loan principal to
80 percent. This action is within the definition of direct modification because it is a government
action that directly changes the estimated subsidy cost and the present value of the loan
guarantee liability by altering the terms of the loan guarantee agreement.
The accounting standard on modifications of loan guarantees states that with respect to a
direct or indirect modification of pre-1992 or post-1991 loan guarantees, the cost of
modification is the excess of the post-modification liability of the loan guarantees over
their pre-modification liability. The modification cost is recognized as modification
expense when the loan guarantees are modified.
The accounting is implemented in the steps described below.
(1) Calculate the Pre-modification Liability
The pre-modification liability is the present value of the net cash outflows of loan guarantees
estimated at the time of modification under the pre-modification terms and discounted at the
current discount rate.
As used in this part and Part IV of this Appendix, the current discount rate is the interest rate
applicable at the time of modification on marketable Treasury securities with a similar maturity to
the remaining maturity of the guaranteed loans under pre-modification terms or post-modification
terms, whichever is appropriate.
27
The cash flows for the loan guarantees under pre-modification terms during 1996-2000 are
assumed to be the same as the cash flows that were reestimated early in fiscal year 1996 for
these years and that are shown in Table 25. Assume that the current discount rate for a
comparable maturity (4 remaining years) is 4 percent. As Table 27 shows, the present value of
the pre-modification net cash outflows discounted at 4 percent is $2,618.
27
The definition of the current discount rate is provided in Appendix C, Glossary. [See Appendix E of this Volume.]
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Table 27: Pre-modification Liability (in thousands of dollars; calculated at the current discount rate)
(2) Calculate Post-modification Liability
The loan guarantees’ post-modification liability is the present value of the loan guarantees’ net
cash outflows estimated at the time of modification under post-modification terms and discounted
at the current discount rate.
The modification increases the guarantee percentage from 60 percent to 80 percent. It is
estimated that 60 percent or $6,000 in principal repayments will default. This estimate is not
affected by the modification. However, with the expansion of the guarantee percentage, the credit
program will pay 80 percent of the defaulted amounts, equal to $4,800, to the lenders. The net
cash outflows estimated under the post-modification terms are discounted at the current rate of 4
percent. As shown in Table 28 below, the present value of the estimated net cash outflows is
$3,644. This is the post-modification liability of the loan guarantees.
FY
Interest
Supplements
Default
Payments
Net
Recoveries
Net
Cash Flows
1996 $100 $100
1997 100 100
1998 100 100
1999 100 $3,600 3,700
2000 $(1,000) (1,000)
PV at 4% $363 $3,077 $(822) $2,618
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Table 28: Post-modification Liability (in thousands of dollars; calculated at the current discount rate)
(3) Calculate And Recognize The Cost Of Modification
The cost of modification is the excess of the loan guarantee’s post-modification liability over their
pre-modification liability. Since the loan guarantees’ post-modification liability is $3,644, and their
pre-modification liability is $2,618, the cost of modification is $1,026, which is recognized as a
subsidy expense for modifications.
(4) Calculate The Change In The Book Value Of The Liability
The accounting standard on loan guarantee modifications requires that the existing book
value of the liability of modified post-1991 loan guarantees be changed to an amount
equal to the present value of the net cash outflows projected under the modified terms
from the time of modification to the loans’ maturity, and discounted at the original
discount rate (the rate that is originally used to calculate the present value of the liability,
when the guaranteed loans were disbursed).
In this example, the original discount rate is 6 percent. The present value of the loan guarantees’
net cash outflows estimated under the modified terms and discounted at 6 percent is $3,401.
(See Table 29.)
FY
Interest
Supplements
Default
Payments
Net
Recoveries
Net Cash
Flows
1996 $100 $100
1997 100 100
1998 100 100
1999 100 $4,800 4,900
2000 $(1,000) (1,000)
PV at 4% $363 $4,103 $(822) $3,644
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Table 29: Post-modification Book Value Liability (in thousands of dollars; calculated at the original discount
rate)
At the time the modification action was taken, the existing book value of the loan guarantee
liability was $2,450 (See Table 26). The book value is changed to $3,401. This is an increase of
$951 in the book value of the loan guarantee liability.
(5) Recognize A Gain Or Loss
The accounting standard on loan guarantee modifications states that the change in the
amount of liability of both pre-1992 and post-1991 loan guarantees resulting from a direct
or indirect modification and the cost of modification will normally differ, due to the use of
different discount rates or the use of different measurement methods. Any difference
between the change in liability and the cost of modification is recognized as a gain or
loss. For post-1991 loan guarantees, the modification adjustment transfer
28
paid or
received to offset the gain or loss is recognized as a financing source (or a reduction in
financing source).
The change in book value in this case is $951, compared to the cost of modification of $1,026.
The difference between those two amounts is $75, which is recognized as a gain.
The credit program receives a subsidy appropriation equal to the cost of modification. Since the
cost of modification exceeds the increase in book value by $75, the credit program pays to
Treasury a modification adjustment transfer of $75 to offset the gain. This is reported as a
reduction in financing source. The net effect of the modification is to increase the fund balance of
the credit program by $951 to $3,401.
FY
Interest
Supplements
Default
Payments
Net
Recoveries
Net Cash
Flows
1996 $100 $100
1997 100 100
1998 100 100
1999 100 $4,800 4,900
2000 $(1,000) (1,000)
PV at 6% $346 $3,802 $(747) $3,401
28
OMB instructions provide that if the increase in liability exceeds the cost of modification, the reporting entity receives
from the Treasury an amount of modification adjustment transfer equal to the excess; and if the cost of modification
exceeds the increase in liability, the reporting entity pays to Treasury an amount of modification adjustment transfer to
offset the excess. (See OMB Circular A-11.)
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Table 30 displays the asset and liability balances after the modification in October 1995.
Table 30: Assets And Liabilities After The Modification In October 1995 (in thousands of dollars)
E. Default And Foreclosure
Assume that for fiscal year 1996 and thereafter, annual reestimations do not result in any
changes in cash flow estimates.
29
After accumulating interest at 6 percent and paying the $100
interest supplement annually, the credit program has $3,856 in its fund balance with Treasury at
the end of fiscal year 1999, prior to paying any default claims. Table 31 shows annual changes in
the fund balance.
Table 31: Fund Balance (in thousands of dollars)
At the same time, the program’s loan guarantee liability at the end of fiscal year 1999 is also
$3,856, which equals the estimated default claim payment of $4,800 minus $943, the present
value of the estimated net recovery from foreclosing assets. It has been estimated that the net
recovery would be $1,000 and would be realized at the end of fiscal year 2000. The present
value of the net recovery discounted to the end of fiscal year 1999 at the original discount rate of
6 percent is $943.
As expected, when the guaranteed loans mature at the end of 1999, $6,000 of the principal is in
default. To meet its guarantee obligation, the loan guarantee program must pay 80 percent of the
default amount, or $4,800, to the lenders. When the defaults occur, the loan guarantee program
Assets Liabilities
Fund Balance with Treasury $3,401 Loan Guarantee Liability $3,401
29
This assumption is made only to avoid repetitious illustrations.
At the End of FY Interest Accrued
Interest
Supplement Paid Fund Balance
1995 $3,401
1996 $204 $(100) 3,505
1997 210 (100) 3,615
1998 217 (100) 3,732
1999 224 (100) 3,856
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in this example has the options to foreclose property pledged by the borrowers who defaulted,
and/or to acquire the loans involved, as a compensation for the default payment.
The accounting standard on foreclosure requires that when property is transferred from
borrowers to a federal credit program, through foreclosure or other means, as a compensation
for losses that the government sustained under post-1991 loan guarantees,
30
the foreclosed
property be recognized as an asset at the present value of its estimated future net cash inflows
discounted at the original discount rate.
The accounting standard states that at a foreclosure of guaranteed loans, a federal
guarantor may acquire the loans involved. The acquired loans are recognized at the
present value of their estimated net cash inflows from selling the loans or from collecting
payments from the borrowers, discounted at the original discount rate.
In this example, the default occurs at the loans’ maturity and virtually no cash inflows can be
realized either from selling the loans or collecting payments from the borrowers. The loan
guarantee program therefore forecloses the assets. It continues to estimate that the net cash
inflow from possessing and selling the foreclosed property will be $1,000 and will be received at
the end of fiscal year 2000. The present value of the estimated net cash inflow discounted at the
original rate of 6 percent to the end of fiscal year 1999 is $943.
The accounting standard requires that if a legitimate claim exists by a third party or by the
borrower to a part of the recognized value of the foreclosed assets, the present value of
the estimated claim be recognized as a special contra valuation allowance.
In this example, no such claim is assumed. Thus, the present value of the foreclosed property is
recorded as an asset at $943. Concurrently, the amount of $943 is credited to the loan guarantee
liability, so that the loan guarantee liability is increased from $3,856 to $4,800.
The default payment of $4,800 is more than the fund balance of $3,856, and the loan guarantee
program does not receive cash from selling the foreclosed assets until one year later. The loan
guarantee program borrows the difference of $943 from Treasury.
31
Thus, the fund balance is
increased by $943 to $4,800, allowing the default payment to be made.
30
The accounting standard is the same for property transferred in partial or full settlement of post-1991 direct loans,
and the application of the standard to direct loans is illustrated by the present example of loan guarantees.
31
Borrowing from Treasury is necessary in this example because all default payments occur at the same time. If they
occurred in different years, the default payments in most cases might be covered by the fund balance and the
proceeds from selling foreclosed assets. Borrowing would only be needed for defaults near the maturity date of the
guaranteed loans.
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When the default payment is made, both the fund balance and the loan guarantee liability are
reduced to zero. The credit program takes collection action against the borrowers. However,
further recovery is not anticipated. At this time, the loan guarantee program has the following
asset and liability balances as shown in Table 32.
Table 32: Assets And Liabilities At the End of FY 1999 (in thousands of dollars)
F. Disposition Of The Foreclosed Property
The foreclosed property is initially recorded at the present value of the estimated net cash
inflows. Until the property is sold, the present value of the property must be updated to recognize
changes in value due to the passage of time. The recognition is made through an accrual of
interest at the original discount rate. The amount of interest accrued for fiscal year 2000 is $57,
which equals the book value of the foreclosed property at the beginning of the fiscal year, which
is $943, times the original discount rate of 6 percent. This amount of interest is recognized as
interest income, and is added to the book value of the foreclosed property. As a result, the book
value of the foreclosed property becomes $1,000 at the end of fiscal year 2000.
Interest is also accrued on the debt to Treasury of $943 at the rate of 6 percent. The amount of
interest for fiscal year 2000 is $57, and is recognized as interest expense. The amount is added
to the debt to Treasury. As a result the debt to Treasury becomes $1,000 at the end of fiscal year
2000.
It is assumed that the property is sold at the end of fiscal year 2000 and the amount of net
proceeds from the sale is $1,000. The amount of the net proceeds is used to pay off the debt to
Treasury. As a result, the asset and liability balances for this cohort of loan guarantees are
reduced to zero.
A reestimation should be performed for the net cash flow of the property after the end of fiscal
year 2000. If the reestimation resulted in a reduction of the present value of the property, the
amount of the reduction would be recognized as subsidy expense reestimates. As illustrated in
preceding sections on reestimates, a payment from permanent indefinite authority would be
available to cover the subsidy reestimate expense. In this case, because the property was sold at
the estimated time for the estimated amount, there is no reestimate subsidy expense.
Assets Liabilities
Foreclosed property $943 Debt to Treasury $943
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Part IV: Pre-1992 Loan Guarantees
Pre-1992 loan guarantees are loan guarantees committed prior to October 1, 1991, and the
liabilities under pre-1992 loan guarantees are recorded in liquidating accounts. The accounting
standard requires that the liabilities of pre-1992 loan guarantees be recognized when it is
more likely than not that the loan guarantees will require a future cash outflow to pay
default claims. The liability of loan guarantees should be reestimated each year as of the
date of the financial statements. In estimating liabilities, the risk factors discussed in the
standard for post-1991 loan guarantees should be considered. Disclosure is made of the
face value of guaranteed loans outstanding and the amount guaranteed.
The standard states that restatement of pre-1992 loan guarantees on a present value basis
is permitted but not required.
All of the amounts used in the text that follows are in thousands of dollars.
A. Recognition Of Liabilities
Assume that a federal credit program guarantees a group of loans and the guarantee was
committed prior to October 1, 1991. At the end of fiscal year 1994, the loans have outstanding
principal of $5,000 at 7 percent interest rate, maturing in three years. The borrowers are required
to pay interest annually and to repay the principal at the end of 1997. The guarantee covers 60
percent of the principal.
32
Disclosure is made in a footnote to the financial statements for fiscal year 1994 that guaranteed
loans have an outstanding principal of $5,000, and the guaranteed amount is $3,000. (A similar
disclosure is made in each year so long as the guaranteed loans are outstanding.)
The program management evaluates the risk factors enumerated in the accounting standard,
and estimates that $2,500 of the loans’ principal repayments would be defaulted when the loans
mature. The program will pay 60 percent of the defaulted amount, equal to $1,500. It is also
estimated that the credit program would realize a net recovery of $500 through acquiring and
selling pledged assets. Thus, the program management recognizes a liability of $1,000, which
equals the estimated default payment minus the net recovery. The $1,000 is charged to default
expense.
33
32
A loan guarantee may guarantee both principal and interest payments. In that case, the estimate and recognition of
loan guarantee liabilities should be based on defaults on both principal and interest payments.
33
This assumes that no liability was previously recognized. If a liability has been recognized for the loan guarantees,
the liability should be adjusted to the current estimate, and any increase in liability should be charged to default
expense.
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B. Modification Of Pre-1992 Loan Guarantees
Assume that in October 1994, shortly after the close of fiscal year 1994, a decision is made to
increase the guarantee from 60 percent of the loan payments to 80 percent. This action is within
the definition of direct modification because it is a federal government action that directly
changes the estimated subsidy cost and the present value of outstanding loan guarantees by
altering the terms of existing contracts.
The accounting standard on modifications of loan guarantees states that with respect to a direct
or indirect modification of pre-1992 or post-1991 loan guarantees, the cost of modification is the
excess of the post-modification liability of the loan guarantees over their pre-modification liability.
The modification cost is recognized as modification expense when the loan guarantees are
modified.
Accounting for the cost of modification takes the following steps:
(1) Calculate the Pre-modification Liability
The pre-modification liability is the present value of the net cash outflows of the loan guarantees
estimated at the time of modification under pre-modification terms and discounted at the current
discount rate.
It is estimated that under the pre-modification terms, a default payment of $1,500 would be made
at the end of fiscal year 1997, and a net recovery of $500 from the sale of foreclosed assets
would be received at the end of fiscal year 1998. The current discount rate for a maturity of 3
years is 4 percent. As shown in Table 33, the present value of the estimated net cash outflows
discounted at 4 percent is $906. This is the pre-modification liability of the loan guarantees.
Table 33: Pre-modification Liability (in thousands of dollars, calculated at the current discount rate)
(2) Calculate The Post-modification Liability
The loan guarantees’ post-modification liability is the present value of the loan guarantees’ net
cash outflows estimated at the time of modification under post-modification terms and discounted
at the current discount rate.
The modification expands the guarantee from 60 percent to 80 percent. It is estimated that
$2,500 of the principal repayments will default when the loans mature. With the expansion of the
FY
Default
Payments
Net
Recoveries
Net Cash
Outflow
1995
1996
1997 $1,500 $1,500
1998 $(500) (500)
PV at 4% $1,333 $(427) $ 906
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guarantee percentage, the credit program will pay 80 percent of the defaulted amounts, equal to
$2,000, to lenders at the end of fiscal year 1997. A net recovery of $500 would be received from
selling foreclosed assets at the end of fiscal year 1998. The cash outflows estimated under the
post-modification terms are discounted at the current discount rate of 4 percent. As shown in
Table 34 below, The present value of the estimated net cash outflow is $1,351. This is the
post-modification liability of the loan guarantees.
Table 34: Post-modification Liability (in thousands of dollars, calculated at the current discount rate)
(3) Calculate And Recognize The Cost of Modification
The cost of modification is the excess of the loan guarantees’ post-modification liability over their
pre-modification liability. Since the loan guarantees’ post-modification liability is $1,351, and their
pre-modification liability is $906, the cost of modification is $445, which is recognized as a
subsidy expense for modifications. A subsidy appropriation of that amount is required before the
modification can take place. The appropriated amount is paid to the financing account.
(4) Calculate The Change In The Book Value of The Liability
With respect to modifications of pre-1992 loan guarantees, the standard requires that
when pre-1992 loan guarantees are directly modified, they be transferred to a financing
account and the existing book value of the liability of the modified loan guarantees be
changed to an amount equal to their post-modification liability. Any subsequent
modification is treated as a modification of post-1991 loan guarantees.
34
Prior to the modification, the liability of the loan guarantees was recorded in a liquidating
account at $1,000. Upon modification, the loan guarantees are transferred from the
liquidating account to a financing account, since this is a direct modification. The liability
is recorded in the financing account at the post-modification liability of $1,351. The
change in book value of the liability is an increase of $351.
FY
Default
Payments
Net
Recoveries
Net Cash
Outflows
1995
1996
1997 $2,000 $2,000
1998 $(500) (500)
PV at 4% $1,778 $(427) $1,351
34
The accounting standard states that when pre-1992 loan guarantees are indirectly modified, they are kept in a
liquidating account, and that the liability of those loan guarantees is reassessed and adjusted to reflect any change in
the liability resulting from the modification. Indirect modifications of pre-1992 loan guarantees are not illustrated in the
Appendix.
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(5) Recognize a Gain or Loss
The accounting standard on loan guarantee modifications states that the change in the
amount of liability of both pre-1992 and post-1991 loan guarantees resulting from a direct
or indirect modification and the cost of modification will normally differ, due to the use of
different discount rates or the use of different measurement methods. Any difference
between the change in liability and the cost of modification is recognized as a gain or
loss.
In this case, the cost of modification is $445, and the change in book value is $351. The
difference of $94 is recognized as a gain.
When the loan guarantees are transferred from the liquidating account to the financing account,
the liquidating account pays the financing account an amount equal to the loan guarantees’
pre-modification liability of $906. The transfer of the loan guarantees has the following effects on
the liquidating account: (1) the existing liability of the transferred loan guarantees equal to $1,000
is removed, (2) the fund balance is reduced by $906, which is the amount paid to the financing
account, and (3) a gain of $94 is recognized.
The financing account records the liability of the loan guarantees at $1,351, which is their
post-modification liability. It also records a fund balance of $1,351, which consists of the $906
received from the liquidating account, and the $445 appropriated to cover the cost of
modification.
