Unearned Discount

What Is an Unearned Discount?

An unearned discount is a interest or a fee that has been collected on a loan by a lending institution yet has not yet been considered income (or earnings). All things being equal, it is initially recorded as a liability. As the life of the loan progresses, proportionate parts of the fee or interest collected up front are eliminated from the liability side of the balance sheet and considered income. In the event that the loan is paid off right on time, the unearned interest portion must be returned to the borrower.

An unearned discount is all the more generally alluded to as unearned interest.

Grasping Unearned Discounts

An unearned discount account perceives interest deductions before being classified as income earned all through the term of the outstanding debt. After some time, then, the unearned discount makes an increase in the lender's profit and a subsequent lessening in liability.

Not all interest that is received by a lender is classified as "earned". This is on the grounds that lenders frequently pre-plan customary payments to be made toward the beginning of every month. Be that as it may, the interest paid by the borrower toward the beginning of the month applies to the cost of borrowing for the entire month and, subsequently, has not been earned by the lender.

For instance, say that a homeowner gets a mortgage that expects them to make a regularly scheduled payment on the first of every month in the amount of $1,500, with $500 addressing the interest portion. Notwithstanding, this $500 in interest is intended to cover the entirety of the month, and it's viewed as unearned on the first as it is prepaid. As the month progresses, a pro-rata amount of that interest is credited to the bank's earnings while the liability of the unearned discount is made more modest.

Working out an Unearned Discount

Unearned discounts might be estimated under the supposed Rule of 78, which is a method utilized for loans with precomputed finance charges. On the off chance that the loan is repaid or early or refinanced, the Rule of 78 can determine the unearned discount to the lender. This functions as follows:

Unearned discount = F [k (k + 1)/n (n + 1)]

where:

• F = total finance charge, which is equivalent to (n x M - P)
• M = ordinary month to month loan payment
• P = original loan amount
• n = original number of payments
• k = number of residual payments on the loan after the current payment

Illustration of Unearned Discount

Snuffy's Bank and Trust have made a loan to Ernie's Brokerage. As part of the up-front costs of the loan, Ernie was required to pay a financing charge of 6% of the total loan amount. The total loan amount is $10,000 and will be repaid more than 5 years in regularly scheduled payments. The amount of the finance charge paid up front by Ernie was $600.

Initially, Snuffy's Bank and Trust record the $600 unearned discount as a liability on its books. As Ernie pays every one of the 60 loan payments (12 every year for quite some time), 1/60th of the $600 will be eliminated from the liability side of the balance sheet and recognized as income.

Features

• Unearned discount alludes to loan interest that has been collected however isn't yet recognized as income.
• Unearned discount is all the more regularly known as unearned interest.
• All things being equal, an unearned discount is recorded as a liability that is slowly changed over into income as the load develops after some time.