We have a non accrual loan secured by property that had been repossessed. A portion of the property (machinery) was given back to the borrower after a payment of $5,000 was received. The balance of the loan is $17,000 and will probably not be collected. The loan officer applied the $5000 received to fees related to the repossession, interest, late charges and principal. I know the payment can't be applied to the interest and late charges, but can the fees related to the repossession be collected or should the entire $5000 go to principal?

How you apply the payment will be based on the your payment application methods described in your loan contract. How you account for them internally is a whole other matter.

From an accounting perspective ... presuming your bank uses the cost-recovery method for non-accrual loans and since collection of the loan is in doubt ... you must apply the payment against loan principal. For what it's worth ... the OCC's Bank Accounting Advisory Series provides some excellent guidance on nonaccrual loans.