Many companies have restructured or modified their outstanding debt arrangements during the COVID-19 pandemic — some for the first time ever. In recent months, the Financial Accounting Standards Board (FASB) has received many questions about how to apply the accounting guidance on debt restructurings and modifications. As a result, it recently published an educational staff paper to help financially distressed borrowers work through the details.
“The nature and extent of a debt modification will determine the accounting effects on an entity’s statement of operations and statement of financial condition,” FASB staff wrote. “Consequently, entities will need to evaluate all facts and circumstances to ensure that the debt modification is appropriately accounted for.”
The FASB recommends borrowers review the following two sections of the debt guidance.
1. Accounting Standards Codification (ASC) Subtopic 470-60, Debt — Troubled Debt Restructurings by Debtors
Based on ASC 470-60, Troubled Debt Restructurings by Debtors, a troubled debt restructuring (TDR) occurs when a:
- Borrower is experiencing financial troubles, and a
- Lender makes concessions it wouldn’t consider under normal circumstances.
The staff paper explains accounting for TDRs and provides guidance in determining whether a TDR has or hasn’t occurred, also explaining what constitutes financial difficulties on the part of a borrower. A lender is described as granting a concession when the effective borrowing rate on the restructured debt is less than the effective borrowing rate on the original debt. The effective borrowing rate of the restructured debt is calculated by solving for the discount rate that equates the present value of the cash flows under the new terms to the current carrying amount of the old debt. Determining whether modifications to a debt agreement constitute a TDR can be complex and requires close analysis.
Let’s assume a debtor has met the two criteria for a TDR, and the TDR involves only a modification of terms. If the future undiscounted cash flows of the restructured debt are greater than the net carrying amount of the original debt prior to the restructuring, then no gain or loss is recognized and there is no adjustment to the carrying amount of the debt. A new effective interest rate is established based on the carrying value of the original debt and the revised cash flows. If the future undiscounted cash flows are less than the net carrying amount of the original debt prior to the restructuring, the debtor realizes a gain equal to the carrying amount of the debt in excess of future cash payments.
2. ASC Subtopic 470-50, Debt — Modifications and Extinguishments
This section helps determine if a nontroubled modification or exchange of debt with the same creditor should be accounted for as either an extinguishment or a modification. Under ASC 470-50, modifications and exchanges not considered TDRs are accounted for as either:
- An extinguishment, if the terms are substantially different, or
- A modification.
Substantially different means present value of the cash flows under the terms of the new debt are at least 10% different from the present value of the remaining cash flows under the original debt. If the terms in fact prove to be substantially different, the debtor accounts for the transaction as a debt extinguishment. The original debt is de-recognized and the new debt is recorded at fair value, with the difference recognized as an extinguishment gain or loss.
If terms are not substantially different, meaning the present value of the cash flows under the new debt is less than 10% from that of the remaining cash flows under the original debt, the debtor would account for the transaction as a debt modification.
Accounting for any newly or previously incurred fees or costs depends on whether you have a modification or extinguishment, so it’s important to treat the situation appropriately on the financial statements.
If your company has modified or restructured loans in 2020, work with your audit team to understand how to report these transactions in your year-end financial statements.
Contact Gino Scipione at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.