Explanation:
When a bank formally writes off a loan, it removes the uncollectible loan from its balance sheet. The standard accounting entry for a loan write-off involves reducing the gross loan balance (an asset) and simultaneously reducing the allowance for loan losses (loan loss reserves, which is a contra-asset).
Since Converse wrote off the loan, its gross assets and loan loss reserves were both reduced. Old Crow retained the asset, meaning it still carries the gross loan amount and the associated loan loss reserves on its balance sheet. To make Old Crow's financial statements comparable to Converse's under the assumption that the loan will never be recovered, the financial analyst needs to simulate a write-off on Old Crow's balance sheet. This requires reducing Old Crow’s asset values (gross loans) and reducing its loan loss reserves.
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24.5.2. Converse and Old Crow Bank each make a loan of $1,000,000 at 4% interest to a technology startup, Janzee, in January of 2022. Unfortunately, Janzee makes only 4 payments. Janzee defaulted and became unlikely to repay its debt. Old Crow decides to retain the asset in hopes of recovering part of the loan one day while Converse decides to write off the lost asset. For the purposes of this question, all other items between the banks are the same.
Dan, a financial analyst, is evaluating both banks' financials. He wants to make the firm's financial statements comparable. What would he need to change if he believes that the loan to Janzee will never be recovered?
A
Reduce Old Crow’s asset values only.
B
Increase Old Crow’s loan loss reserves only.
C
Reduce Old Crow’s asset values and its loan loss reserves.
D
Reduce Old Crow’s asset values and increase its loan loss reserves.
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