## How to Account for Closing Costs on Business Loan Refinancing
### Overview
Closing costs are a common expense associated with refinancing a business loan. They represent fees incurred to complete the refinancing process, such as lender fees, attorney fees, and appraisal fees. This article explores the accounting treatment of closing costs on business loan refinancing.
### Accounting Standards
The accounting for closing costs on business loan refinancing is governed by the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 320, “Investments – Debt and Equity Securities.” Specifically, the guidance in ASC 805-15 provides the framework for classifying and accounting for these costs.
### Capitalization vs. Expense
The primary distinction in accounting for closing costs lies in whether they are capitalized as an asset or expensed in the period incurred. This determination is based on whether the costs:
* **Meet the definition of an asset:** An asset is a resource controlled by the company that is expected to provide future economic benefits.
* **Benefit multiple periods:** If the costs are expected to benefit more than one accounting period, they should be capitalized.
### Capitalization Criteria
Closing costs that meet both the asset definition and the multi-period benefit test should be capitalized. Some examples of such costs include:
* **Loan fees:** These fees represent the lender’s compensation for providing financing. As they benefit the entire term of the loan, they are capitalized.
* **Attorney fees:** Attorney fees incurred specifically for the loan refinancing process can be capitalized if they are expected to benefit multiple periods.
* **Appraisal fees:** An appraisal is used to determine the value of the underlying collateral. If the appraisal is used for future refinancing or other purposes, it can be capitalized.
### Expense Criteria
Closing costs that do not meet the capitalization criteria should be expensed in the period incurred. These costs are usually non-recurring and provide benefits that are limited to the current period. Some examples include:
* **Title fees:** These fees cover the costs of searching and insuring the title of the property securing the loan. As they are related to the specific loan transaction, they are expensed.
* **Inspection fees:** Inspection fees are incurred to assess the condition of the property. Since they relate to the current loan transaction only, they are expensed.
* **Document preparation fees:** These fees cover the costs of preparing and filing loan documents. As they are specific to the loan refinancing process, they are expensed.
### Amortization
Capitalized closing costs should be amortized over the life of the loan. This means that a portion of the costs is recognized as an expense in each period, reducing the loan’s book value. The amortization period should align with the expected benefit period of the costs.
### Recording the Transactions
**To capitalize closing costs:**
“`
**Debit:** Loan Costs (Asset Account)
**Credit:** Cash or Accounts Payable
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**To amortize capitalized closing costs:**
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**Debit:** Loan Expense
**Credit:** Loan Costs (Asset Account)
“`
**To expense non-capitalized closing costs:**
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**Debit:** Loan Expense
**Credit:** Cash or Accounts Payable
“`
### Impact on Financial Statements
Capitalizing closing costs increases the book value of the loan, which can impact financial ratios such as debt-to-equity and leverage ratios. However, it also reduces the current period’s expenses, potentially improving reported profitability.
Expensing closing costs reduces the book value of the loan and has an immediate impact on net income. This can result in lower reported profitability but may provide a more accurate representation of the current period’s expenses.
### Conclusion
Accounting for closing costs on business loan refinancing requires careful consideration of the nature of the costs and whether they meet the capitalization criteria. By following the guidance outlined in ASC 805-15, companies can ensure accurate financial reporting and appropriate allocation of expenses.