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Prepayment options are usually exercised by borrowers when financing is no longer needed or when financing at a lower rate is available. As a result, prepayments are more common during periods in which interest rates have declined. Sometimes the terms of a loan or debt instrument require the borrower to pay a penalty for prepayment. Prepayment penalties serve as a deterrent to prepaying outstanding debt.
ASC 310 addresses the accounting for prepayment penalties.

ASC 310-10-25-12

Prepayment penalties shall not be recognized in income until loans or trade receivables, if applicable, are prepaid, except that the existence of prepayment penalties may affect the accounting resulting from the application of paragraph 310-20-35-18(a).

ASC 310-20-35-18(a)

If the loan's stated interest rate increases during the term of the loan (so that interest accrued under the interest method in early periods would exceed interest at the stated rate), interest income shall not be recognized to the extent that the net investment in the loan would increase to an amount greater than the amount at which the borrower could settle the obligation. Prepayment penalties shall be considered in determining the amount at which the borrower could settle the obligation only to the extent that such penalties are imposed throughout the loan term. (See Section 310-20-55.) Accordingly, a limit is imposed on the amount of periodic amortization that can be recognized. However, that limitation does not apply to the capitalization of costs incurred (such as direct loan origination costs and purchase premiums) that cause the investment in the loan to be in excess of the amount at which the borrower could settle the obligation. The capitalization of costs incurred is different from increasing the net investment in a loan through accrual of interest income that is only contingently receivable.

6.6.1 Recording a prepayment penalty in interest income

In the guidance regarding when a refinanced loan should be accounted for as a modification or new loan (i.e., extinguishment), ASC 310-20-35-9 states that "any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted." Although this guidance is not directly applicable, this accounting treatment could be used for loans that are paid off without being refinanced by a new loan by analogy. In addition, Example 2 in ASC 310-20-55-23 through ASC 310-20-55-25, indicates that unamortized net fees should be recognized in interest income when a loan is prepaid and not refinanced. Under this approach, prepayment fees are viewed as compensation for interest income to which the investor would otherwise have been entitled. Accordingly, prepayment fees should be included in interest income even though the loan has been extinguished.
Alternatively, some believe because the loan no longer exists, prepayment penalties should not be reported in interest income, but rather should be recognized in another income statement line item, such as other income.
We believe that either view is acceptable but represents an accounting policy that should be applied consistently.

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