Loan and Lease Losses

• Loan and lease losses must be identified for purposes of direct charge off.financial background red image by Nicemonkey from Fotolia.com
  
  Every bank must maintain a viable loan review system in order to classify loans according to risk. The system must identify any bad debts where the bank may not be repaid beyond the fair value of collateral, if any. If confirmed net losses are identified, they must be promptly charged off at a rate of 100 percent. The next levels of loan review are doubtful and substandard that must be partially charged off based upon estimates of repayment and circumstances. Many banks charge off 50 percent of loans classified as doubtful and 0 to 20 percent of those loans classified as substandard. All other firm commitments to lend such as off balance sheet items for standby letters of credit must be analyzed within the bank's classification system.
  
  

Securities and Investments

• Bank investments are also subject to charge off based upon valuation.bond of the state loan, russia, 1951 year image by air from Fotolia.com
  
  Securities and investments owned by a bank must be reviewed at least annually to determine whether their fair market value is appropriate for the amounts represented on the books. For example, private label mortgage backed securities not guaranteed by the U.S. government may not have sufficient carrying value to remain on the books without partial charge offs. These types of bonds may not be readily available for sale or the collateral may not be equal to its book value.
  
  

Extraordinary Charge Offs

• Extraordinary losses may occur due to legal or operational issues.Making a financial plan image by Allen Stoner from Fotolia.com
  
  Extraordinary charge offs represent losses from non recurring events. These events may arise from losses resulting from legal lawsuits, the payment of forged checks or letter of credits, and operational losses from inventory control along with any other unexpected loss. When these losses are not recoverable, they should be immediately charged off.
  
  

Reserves

• Reserve accounts are set up on the books of a bank to record charge offs.business accounts blank image by Nicemonkey from Fotolia.com
  
  Any charge off that results from the above mentioned assets review system must be recorded in liability reserve accounts. When actual charge offs are recorded, the reduction of the asset amount is charged off directly to the applicable reserve account. For example, reserves for loan and lease losses are established by debiting the expense account entitled "provision for loan losses" offset by a credit to "reserve for loan losses." The actual reduction of the loan account is debited to the reserve for loan loss account. These concepts are noted within Financial Accounting Standards 114 (FAS 114). It's important to note that any loan charge off does not represent forgiveness of the debt. On the contrary the borrower is still responsible for repayment of the accounting entry.
  
  

Regulatory Examinations

• The bank regulators make sure that banks abide by the charge off rules.Signs and Directions image by geophis from Fotolia.com
  
  The bank regulators review the charge off policy and procedures of every bank to determine whether the bank is properly monitoring and classifying its loans and other assets. The regulators ensure that the bank is charging off its assets whenever necessary in accordance with established regulatory guidelines.