We are being told by examiners that we must reverse out interest at the time a loan is put on non-accrual. I have always thought that the only time you would have to reverse interest would be if your net value on collateral (after selling expense) is less than the principal and interest combined.
Any thoughts?

When you put a loan on non-accrual, usually your system will automatically remove any accrued interest out of the accrual GL for you.

Jim: If you are thinking that you want to keep the accrued balance and recoup at sale, then it sounds to me like you are thinking the loan doesn't belong on non-accrual.

When moving a loan to na, most systems (not ours - but that's another story!) will decrease the accrued amount and start tracking interest in a "shadow" method as LoanSuper stated. You can always keep up with the interest that would have been charged - you can even collect it - - you just aren't showing it as an accrual on your ledger. Does that help?

Technically speaking, if management believes that the unpaid interest will be collected, then you could leave the accrued interest on the books. However, in practice, most banks reverse the accrued interest at the time the loan is placed on non-accrual status (because management determined that the accrued interest may not be collected). Refer to "Nonaccrual Status" in the Glossary of the Call Report Instructions for guidance.

We charge-off any unpaid portion of accrued interest from prior year(s) when we place the loan on non-accrual and only reverse current years' interest.

"if management believes that the unpaid interest will be collected" - why would loan be placed in non-accural to begin with???

why would loan be placed in non-accural to begin with???

If unpaid loan principal is $100 and accrued interest is $10, and management believes that total collections from the borrower up to $110 is likely but that anything beyond $110 is questionable, then management places the loan on non-accrual status to cease income accrual and leaves the $100 of principal and $10 of accrued interest on the books. Very seldom does this occur, but technically speaking, accounting standards allow such treatment. So to answer jim mathews question, it is possible to leave the accrued interest on the books at the time a loan is placed on non-accrual status (but the accrued interest amount obviously would not increase further). In practice, however, the accrued interest is normally reversed against income (if accrued in the current year) and charged-off against the allowance (if accrued in previous years) --- as pointed out by Okie Banker.

Thanks. It has been a while since I have reviewed the current FASB guidance on this issue.