Finance receivables include both interest‐bearing and discount loans. The face amount of an interest‐bearing or simple interest loan is equal to the amount of cash loaned; unearned interest is not computed. Conversely, for discount loans the amount of cash loaned is less than the face value of the loan. This difference represents unearned interest income to the borrower, and as such, is recognized by the lender over the life of the loan.
A finance company should maintain an allowance for loan losses that is adequate to cover estimated losses. The allowance for loan losses decreases the carrying amount of loans receivable to net realizable value. FAS 5 and 114 provide guidance for the recognition of estimated losses from the uncollectibility of receivables. FAS 5 requires that an allowance for loan losses be established when it is probable that a loan has been impaired and the amount can be reasonably estimated. FAS 114 requires that impairment of a loan be based on the present value of expected future cash flows discounted at the loan's effective interest rate or at the loan's market price or at the fair value of the collateral of the loan if applicable.