Is interest rate cap payment received by the borrower considered income?

Question

Is the following statement true:

Under Generally Accepted Accounting Principles (GAAP), interest cap premium payments received by the borrower are typically treated as a liability rather than income. Here is a possible journal entry for the borrower when receiving interest cap premium payments:

• Initial receipt of interest cap premium payment:Debit: Cash (or a specific cash account) - Increase the cash asset account
Credit: Unearned Interest Cap Premium (or a liability account) - Record the liability for the received premium payment
• Recognition of interest expense over the term of the interest cap agreement:Debit: Interest Expense - Recognize the portion of the premium related to each accounting period Credit: Unearned Interest Cap Premium - Reduce the liability account as the premium is recognized as an expenseWhen a borrower first buys a cap rate it goes on the balance sheet (asset)  instead of the income statement right?

Debit: Cash (or a specific cash account) - Increase the cash asset account

Credit: Unearned Interest Cap Premium (or a liability account) - Record the liability for the received premium payment

Debit: Interest Expense - Recognize the portion of the premium related to each accounting period

Credit: Unearned Interest Cap Premium - Reduce the liability account as the premium is recognized as an expense

When a borrower first buys a cap rate it goes on the balance sheet (asset)  instead of the income statement right?

Brian Burke · Answer

The payment for the purchase of the cap goes on the balance sheet but is then amortized over the life of the cap. If the residual cap is subsequently sold, the money received is income or capital gain.

While you could certainly do the multi-step journal entry you described, it’s easier to just create a separate expense account for the rate cap payment received. Money received is a negative expense and offsets interest expense. GAAP compliant? Probably not. But practically, the effect is the same. If you have to do GAAP, fine, but most don’t have to fully comply with GAAP.

Brandon Wong · Answer

I've seen some lenders want cap payments above the line and others below the line on the PL. Not sure their reasoning but we roll with what they ask. It definitely doesn't belong above the line but we're following their guidance.

Jason Malabute · Answer

Smart! Thank you.

Brian Burke · Answer

That's how we do it, except that we have a separate subaccount under interest for the rate cap reimbursements, that way we can track the interest paid and the rate cap payments received separately, as well as the net of the two.

Jason Malabute · Answer

For example, if let's say you paid $8k in interest this month on a variable rate, but you are only obligated to pay $6k because anything above that is covered by the rate cap then after the lender reimburses you from the rate cap you would take the deposit of $2k and lessen your interest expense?

In my head, here's how I picture it:

When interest expense is accrued:

DR Interest expense $8k

CR Cash                                 $8k

When rate cap is triggered:

CR Interest expense                   $2k

DR Cash             $2k

As you can see income is not affected by the rate cap payment and I am keeping in mind that the rate cap is being amortized on the balance sheet.

Is my understanding correct?

Jason Malabute · Answer

thank you

Brian Burke · Answer

Generally you pay the full interest payment to the lender, so you are recording the full interest expense when the payment is made. The rate cap provider pays the lender for the amount under the rate cap agreement, which goes into a lender controlled account. The lender then sweeps the payment to you, at which time you record the offsetting “negative expense”.

What sucks about this is there is always a lag between the time you pay the extra interest and when you actually get “reimbursed” for it.

Jason Malabute · Answer

Thank you. If the cap rate cap is triggered how do you record the cap rate payment to offset the interest expense increase over the cap rate?

Is interest rate cap payment received by the borrower considered income?

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