Loan origination fees and the effective interest rate

Origination and processing fees that are integral to creating a loan are not recognized as fee income up front; instead they adjust the loan's initial carrying amount and are amortized into interest income over the expected life of the loan using the effective interest method, which materially changes the timing of reported income and can inflate current-period profit if fees are booked immediately instead.

Is the fee compensation for a distinct service already rendered (e.g., a separately priced advisory service), or is it integral to originating the loan itself? What expected life of the loan (informed by historical prepayment behavior, not just the contractual term) is used in the effective interest rate calculation? Are directly attributable incremental origination costs included symmetrically with the fee in the EIR computation?

1) Test whether the fee is integral to generating the loan (an origination/processing fee charged to all borrowers as part of underwriting) versus compensation for a genuinely separate, distinct service (e.g., an optional advisory service priced and deliverable independently of the loan). 2) If integral, include the fee in the initial carrying amount of the loan (net of the fee received) rather than recognizing it as income at disbursement. 3) Identify directly attributable incremental origination costs (e.g., a credit-check fee paid to a bureau) and include them symmetrically in the EIR calculation. 4) Estimate the expected life of the loan (considering historical prepayment behavior) to use in the EIR calculation, not just the contractual term, unless prepayment cannot be reliably estimated. 5) Compute the EIR that exactly discounts estimated future cash receipts through the expected life to the initial net carrying amount. 6) Recognize interest income each period as opening amortized cost x EIR, building an amortization table; only revise the EIR itself when the standard specifically permits it (not routinely for revised prepayment expectations under the general model).

Compute the effective interest rate using estimated future cash flows including the fee and directly attributable incremental origination costs over the expected life of the loan; reassess the EIR estimate only when required by the standard, not routinely; for floating-rate loans, periodically re-estimate future cash flows to reflect movements in the market rate, adjusting the carrying amount through profit or loss.

Disclose: interest income (inclusive of amortized origination fees) presented separately from transaction-based fee income; the accounting policy for treatment of origination fees and costs within the EIR; the weighted-average EIR by product; and a maturity/repricing profile of the loan book if material.

• Recognizing the full origination fee as income immediately on disbursement
• ignoring directly attributable incremental costs that should also be included in the EIR calculation
• using a static contractual term rather than an expected life reflecting historical prepayment patterns
• applying a simple straight-line spread of the fee over the term instead of the effective interest method (which front- or back-loads income depending on the cash flow pattern)
• failing to write off unamortized fees/costs on early repayment.