Accounting for delinquency fees and prepayment fees

February 5, 2012

Learn accounting for delinquency fees and prepayments fees.

1. Definition of delinquency and prepayment fees

Delinquency fees are the penalties for late payments.

For example, a debtor might be assessed a total fee proportional to the number of days (months) the payment is delinquent. In accordance with US GAAP, delinquency fees are recognized when chargeable, provided the collectability is reasonably assured.

Prepayment fees are the penalties for paying in excess of the scheduled payment.

For example, prepayment fees might be assessed when you reduce your outstanding mortgage balance ahead by paying in excess of the scheduled principal and interest payment. Prepayments are usually done in order to reduce the interest payment (i.e., prepayments reduce principal balance, and the interest payment is based on this balance). They are very common during the periods of falling interest rates. Prepayment fees (penalties), as the result, serve as the negative incentive to prepay or refinance. In the real estate industry, for example, prepayment fees might be assessed during the early term of the loan (e.g., first three years). In accordance with US GAAP, prepayment fees are recognized when prepayments have occurred. When a prepayment is done for the full amount, an unearned portion of the interest expense has to be rebated back.

2. Example of accounting for delinquency fees

Friends University (i.e., fictitious entity) charges 1.5% delinquency fee on late payments for tuition, housing, or parking. When delinquency fees are not paid within 30 days, the university deactivates the studentís account: without an active account, the student cannot register for classes, receive transcripts, use career services, etc. Also, the account balance and delinquency fees must be paid in full before a student can receive a diploma.

Joan Smith, a student at Friends University, hasnít paid $1,000 in tuition fees by the deadline. Since the university can deactivate Joan Smithís account and withhold her diploma, the collection of delinquency fees is reasonably assured. The university would make the following entry to record the delinquency fees:

Account Titles

Debit

Credit

Accounts Receivable ($1,000 x 1.5%)

15

 

      Delinquency Fees Income

 

15

3. Example of accounting for prepayment fees

Friends University (i.e., a fictitious entity), a private higher education institution, offers university loans to its faculty, staff, and students. While the majority of the university loans allow prepayments, the university charges a flat $100 fee on the private loan prepayments. Marc Jones, one of the faculty members at the university, has prepaid a private loan. The university should make the following journal entry to record the prepayment fee when Marc prepaid the loan:

Account Titles

Debit

Credit

Accounts Receivable

100

 

      Prepayment Fees Income

 

100

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