What are “loan reserves” at Bank of America?

According to a recent Wall Street Journal article (“Big Banks Are Adding Profits With ‘Reserve’ Cash, October 25, 2013” , Bank of America has indicated that its credit quality has increased since the financial crisis of 2008, due both to increased loan standards and rising house prices. Bank of America released $1.4 billion of loan reserves (29% of pretax income) in the third quarter of 2013. Several other large banks have also released significant amounts of loan reserves (Wells Fargo, J.P. Morgan Chase, and Citigroup.)

The same article goes on to state that “…accounting rules allow the money to flow directly into profits.”

Questions

1)      What are “loan reserves”?  What is the comparable account name that is used for loan reserves in a typical chart of accounts?

2)      What is the journal entry when the percentage of bad loans decreases (assume that the aging schedule method for estimating bad debts is used)? What happens to profits when the percentage of bad loans decreases?

3)      From an investor standpoint, what issue(s) might you see with these releases of loan reserves?

4)      The same article goes on to state that “…accounting rules allow the money to flow directly into profits.”  What may be misleading about that statement to uninformed readers of the article?

Instructor Resources

These resources are provided to give the instructor flexibility for use of Accounting in the Headlines articles in the classroom. The blog posting itself can be assigned via a link to this site OR by distributing the student handout below. †Alternatively, the PowerPoint file below contains a bullet point overview of the article and the discussion questions. †The YouTube video link below is a narration of the blog post article (no discussion questions are included in the YouTube video; those can be assigned separately.)

• Student handout (pdf) (contains entire blog posting + discussion questions)
• PowerPoint file†(brief article overview + discussion questions)
• YouTube video (narrated article in shareable YouTube link)

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