Chapter 10 — Debt Modifications and Exchanges

ASC 470-50-40-6 through 40-20 address the debtor’s accounting for (1) modifications of the terms of existing debt instruments and (2) exchanges of debt instruments with the same creditor. This guidance, which applies to all entities, also addresses:

• The contemporaneous exchange of cash and debt instruments with the same creditor (see Section 10.2.2).
• A binding commitment to modify, exchange, or redeem debt on terms that differ from the original debt terms (see Section 10.2.3).
• The payment of consent fees to obtain a waiver of a covenant violation (see Section 10.2.4).
• For consolidated financial statements, the exchange of debt issued by one entity within the consolidated group for debt issued by another entity within that group (see Section 10.2.10).
• An exchange of debt for liability-classified shares of common or preferred stock (see Section 10.2.12).

ASC 470-50-40-21 through 40-23 contain separate guidance for the evaluation of modifications and exchanges of line-of-credit and revolving-debt arrangements (see Section 10.6).

ASC 470-50 does not address:

• Nonbinding offers to modify, exchange, or redeem debt (see Section 10.2.3).
• TDRs (see Section 10.2.5 and Chapter 11).
• Debt modifications or exchanges at or near the maturity date of the original debt (see Section 10.2.6).
• Prespecified changes in cash flows as a result of the application of contractual provisions (e.g., the exercise of a contractual redemption feature; see Section 10.2.7).
• Transactions among debt holders (see Section 10.2.8).
• Transactions with parties other than the creditor (see Section 10.2.9).
• Conversions of debt into equity-classified shares of preferred or common stock (see Section 10.2.11).
• Exchanges of debt for equity-classified common or preferred shares (see Section 10.2.12).
• The creditor’s accounting for modifications and exchanges of investments in debt instruments.
• Modifications or exchanges of derivatives (e.g., forwards, swaps, warrants, or options).

Further, a debtor may elect not to apply the guidance in ASC 470-50 to certain market issuances of new debt to replace old debt (see Section 10.2.13).

ASC 848 permits debtors to elect not to apply extinguishment accounting to certain debt modifications made in connection with reference-rate reform even if ASC 470-50 would have required such accounting to be applied (see Section 14.2.5).

When a debtor repays debt for cash, the debt is generally considered extinguished (see Section 9.2). However, if a debtor (or its agent; see Section 10.5) repays outstanding debt for cash and contemporaneously issues new debt to the same creditor for cash, the net effect of the two transactions is an exchange of debt instruments. Therefore, the transactions generally need to be analyzed on a combined basis in accordance with the guidance in ASC 470-50.

In evaluating multiple transactions between the same debtor and creditor under ASC 470-50-40-9, an entity must consider whether the transactions were executed both contemporaneously and in contemplation of each other (i.e., contingent on one another). While it would generally be difficult to establish that contemporaneous transactions between a debtor and a creditor were not contingent on one another, the relevant facts and circumstances must be evaluated. For example, the following factors may suggest that two transactions should not be combined:

• Lack of legal or contractual linkage between the transactions.
• A sufficient period has elapsed between the two transactions during which the debtor and creditor are exposed to the risk that the second transaction will not take place (i.e., the second transaction is not firmly committed).

Under ASC 470-50, a debtor accounts for an exchange of debt instruments as an extinguishment of the existing debt instrument if the debt instruments have substantially different terms (see Section 10.4.2). A contemporaneous exchange of cash and debt instruments with the same creditor is accounted for as a modification of the original debt if the terms are not substantially different (see Section 10.4.3).

ASC 470-50-40-9 does not apply when new debt is issued to a different creditor. When a debtor or its agent repays debt by using proceeds from debt issued to a different creditor, the original debt is accounted for as extinguished even if there have been no or only insignificant changes to the debt terms.

If a debtor (or its agent; see Section 10.5) enters into a binding agreement with a creditor to redeem or exchange debt or otherwise modify its terms, the binding agreement represents a debt modification that should be evaluated under ASC 470-50. Therefore, the debtor should determine whether the debt terms as modified by the binding agreement are substantially different from the original debt terms (see Section 10.4).

The debtor’s mere announcement that it expects or intends to modify, exchange, or redeem debt is not evaluated as a modification or exchange under ASC 470-50. If a debtor provides the creditor with an offer to redeem the debt or otherwise modify the debt terms or exchange the debt and the creditor has not accepted the offer, a debt modification generally has not occurred. Therefore, ASC 470-50 does not apply. However, if a creditor accepts the offer and the revised debt terms therefore become binding on both the debtor and creditor, the debtor should determine whether the revised debt terms are substantially different from the terms of the original debt instrument (see Section 10.3).

If a modification or exchange is accounted for as a debt extinguishment, the debtor should apply the guidance in ASC 470-50-40-17(a) on debt extinguishments and include the fee paid in the calculation of the debt extinguishment gain or loss (see Section 10.4.2). Otherwise, it applies ASC 470-50-40-17(b), which states that an entity should defer such fees along with any existing unamortized premium and discount and use the interest method to amortize them as an adjustment to interest expense over the remaining life of the modified debt instrument (see Section 10.4.3).

ASC 470-50 does not apply to modifications or exchanges that qualify as TDRs. For a detailed discussion of the scope of the TDR guidance, see Section 11.2.

If none of the above three conditions are met and the modification or exchange of debt is at or near (e.g., within three months of) the debt’s stated maturity, the debtor recognizes the new debt instrument at fair value. The difference between this amount and the net carrying amount of the extinguished debt is recognized as an extinguishment gain or loss.

If the modification or exchange represents a TDR, the debtor should apply ASC 470-60 (see Chapter 11). In the event that the modification or exchange is not a TDR but the debtor would be unable to repay the debt at maturity or refinance it with another lender in the absence of the modification or exchange, the guidance in ASC 470-50 applies to the modification or exchange. If the modification or exchange is not substantive, the modified or exchanged instrument would not be considered extinguished under ASC 470-50.

ASC 470-50 does not apply to transactions in which the debtor is not a party. When a creditor sells or otherwise transfers debt to a different entity without any involvement of the debtor, there is no accounting required by the debtor (i.e., the debt is not accounted for as having been modified or extinguished even though the creditor has changed).

However, if a debtor or its agent receives or pays cash in connection with a transfer of debt between debt holders (e.g., as a transfer consent fee) or the terms are modified in connection with such a transfer (e.g., to remove transfer restrictions), the debtor should consider whether the substance of the transaction is a repayment of the existing debt by using proceeds from debt issued to a different creditor (which would be accounted for as an extinguishment of the original debt; see Section 9.3) or a modification of the debt terms (which would be evaluated under ASC 470-50). If a holder of debt initiates the transaction and pays the debtor a fee solely to remove a transfer restriction in connection with its transfer of the debt to a different holder, the substance of the transaction is likely that of a modification of existing debt, which should be evaluated to determine whether it should be accounted for as a modification or extinguishment under ASC 470-50. However, if a debtor initiates the transaction and the funds pass through the debtor or its agent, the substance of the transaction may be that of a repayment of the existing debt and the issuance of new debt to a different holder.

If a contractual modification and transfer of a debt instrument, in substance, represents a market issuance of new debt to replace old debt, the debtor may elect to treat it as an extinguishment of the original debt even if no funds pass through the debtor or its agent. This guidance is only applicable if the terms of the new debt are equivalent to those of an arm’s-length market offering (e.g., market yield and credit spread) that is independent of the redemption of the old debt (see Section 10.2.13).

ASC 470-50 does not apply to transactions between the debtor (or its agent) and a party other than the holder of the debt unless that other party is acting as an agent in the transaction (see Section 10.5.2). For example, if a debtor enters into a call option or forward purchase agreement that would result in a debt redemption upon settlement, that transaction would not be evaluated under ASC 470-50 if the counterparty does not hold the debt that is subject to redemption.

If an issuer modifies or exchanges an outstanding convertible debt instrument, it should assess whether the transaction should be accounted for as a modification or an extinguishment of the original instrument under ASC 470-50. This guidance does not apply to:

• Conversions that occur under the original terms of the instrument (see Chapter 12).
• Changes to the terms of the conversion privileges that represent an induced conversion under ASC 470-20 (see Section 12.3.4).
• Conversion price adjustments that are made in accordance with the original terms of the instrument. For example, an adjustment under a down-round protection feature is not evaluated as a modification under ASC 470-50. Instead, the issuer should evaluate such provisions under other applicable GAAP.

If a debtor settles outstanding debt by issuing equity-classified shares (including equity instruments classified in temporary equity), the guidance on modifications and exchanges in ASC 470-50 does not apply. Instead, the exchange is accounted for as a debt extinguishment under ASC 470-50-40-3 (see Section 9.3.3) unless it is a TDR (see Chapter 11) or represents a conversion (see Chapter 12).

If outstanding debt is exchanged for shares that must be classified as liabilities under ASC 480 (i.e., mandatorily redeemable financial instruments and certain variable-share obligations; see Deloitte’s Roadmap Distinguishing Liabilities From Equity), the guidance on modifications and exchanges of debt in ASC 470-50 should be applied.

In evaluating whether transactions with continuing investors should be analyzed as a debt exchange under ASC 470-50, the debtor should consider whether the redemption of the old debt and issuance of the new debt were negotiated together or in contemplation of one another (i.e., contingent upon one another). While this evaluation can be complex because it involves debt issued to multiple investors, if the facts suggest that the new debt offering was an arm’s-length market offering that was independent of the redemption of the old debt, it is acceptable to treat the redemption of the old debt and issuance of new debt as separate transactions. Example 10-2 illustrates the conditions that must be met for an entity to conclude that the repayment of existing debt and issuance of new debt are separate transactions.

If a conclusion is reached that the repayment of the old debt is a transaction that is separate from the issuance of the new debt, the old debt would be considered extinguished if any of the conditions in ASC 405-20-40-1 are met (see Section 9.2). If none of the conditions in ASC 405-20-40-1 are met, accounting for the repayment of the old debt and issuance of the new debt as separate transactions is unlikely to be appropriate (i.e., an entity should apply the guidance in ASC 470-50 to determine the appropriate accounting).

 

Connecting the Dots

It is always acceptable to apply ASC 470-50 on a creditor-by-creditor basis to the extent that the same investor(s) held old debt and purchased new debt (see Section 10.3.2). An entity’s decision to apply extinguishment accounting to all of the old debt (when the issuance and repayment transactions may be considered separate) as opposed to applying ASC 470-50 on a creditor-by-credit basis is an accounting policy election that must be consistently applied.

If the redemption of old debt and the issuance of new debt were negotiated together or in contemplation of one another (i.e., contingent on one another), they would not be considered separate transactions. Accordingly, an entity would apply the guidance on debt exchanges in ASC 470-50 on a creditor-by-creditor basis. Note that the mere fact that the old debt is legally extinguished is not sufficient evidence by itself to support a conclusion that the redemption of the old debt and issuance of the new debt are separate transactions.

If a debtor modifies or exchanges an outstanding debt instrument with the same creditor in a transaction that is not a TDR (see Chapter 11), the accounting depends on whether the original and new debt terms are substantially different. The guidance that applies to modifications and exchanges is the same because they have the same economic effect, and in both cases, the debtor continues to have debt outstanding with the same creditor on revised terms.

Under ASC 470-50, debt terms are considered substantially different in each of the following circumstances:

• The 10 percent cash flow test is passed (see Section 10.3.3).
• The fair value of an embedded conversion option changes by at least 10 percent of the carrying amount of the original debt instrument (see Section 10.3.4.2).
• A substantive conversion option is added to, or eliminated from, the debt terms (see Section 10.3.4.3).

If the new debt terms are substantially different from the original debt terms, the original debt is accounted for as being extinguished and a new debt instrument is recognized (see Section 10.4.2). If the new debt terms are not substantially different from the original debt terms, the transaction is accounted for as a modification of the original debt terms (see Section 10.4.3).

If the terms of a modification or exchange of debt are substantially different, the transaction is accounted for as the extinguishment of the original debt and the recognition of new debt, which is initially measured at its fair value adjusted for certain third-party costs (see Section 10.4.2). If the terms of a modification or exchange of debt are not substantially different, the new debt is accounted for as a continuation of the original debt. Any fees or other amounts exchanged between the debtor and creditor as part of the modification or exchange adjust the debt’s carrying amount, whereas any third-party costs are expensed as incurred (see Section 10.4.3). Special considerations are necessary if a debtor incurs costs and fees directly related to a contemplated modification or exchange before the modification or exchange is executed (see Section 10.4.4).

The table below provides an overview of the accounting treatment.

Sometimes, debtors involve a third-party intermediary to arrange or facilitate a debt modification or exchange with the entity’s creditors. For example, if a debtor wishes to replace existing debt for new debt, it might engage a bank to seek out holders of the existing debt and offer them the new debt. The accounting analysis of a debt modification or exchange that involves an intermediary depends on whether the intermediary is considered a principal to the transaction or the debtor’s agent. If the issuer concludes that the intermediary is acting as its agent, ASC 470-50 requires the issuer to “look through” the intermediary by treating the intermediary’s actions as its own (i.e., the intermediary’s transactions with other parties would be considered the debtor’s own transactions). If the issuer determines that the intermediary is acting as a principal, the issuer would not look through the intermediary but would instead view the intermediary as a third-party creditor (i.e., the intermediary’s transactions with other parties would be considered transactions among debt holders to which the debtor is not a party; see Section 10.2.8).

The next section addresses how to determine whether an intermediary should be viewed as a principal or an agent under ASC 470-50. Section 10.5.3 discusses the accounting for modifications or exchanges involving an intermediary.

As discussed in Chapter 5, an entity might incur costs and fees to obtain a commitment from a prospective creditor to obtain funds on specified terms and conditions in the future. Such commitments fall into two broad categories: (1) lines of credit and other revolving-debt commitments that permit the entity to borrow, repay amounts borrowed, and reborrow amounts previously repaid, and (2) delayed-draw term loan commitments and other nonrevolving commitments that do not permit the entity to reborrow amounts repaid (see Section 2.3.3). This section discusses the accounting for modifications and exchanges of the following types of arrangements:

• Line-of-credit and other revolving-debt arrangements (see the next section).
• Delayed-draw term loan commitments (see Section 10.6.3).
• Credit facilities that include both drawn and undrawn components (see Section 10.6.4).

If an outstanding term loan is modified or exchanged so that it becomes an amount drawn under a line-of-credit or revolving-debt arrangement with the same creditor, the debtor should apply the guidance on modifications and exchanges of term-debt arrangements (such as the guidance in ASC 470-50-40-10 on the 10 percent cash flow test) to the associated debt (see Sections 10.2 through 10.5). In evaluating whether to account for the original term loan as extinguished, the debtor would treat the amount drawn after the amendment as a term loan with payment terms that are consistent with those of amounts drawn under the new line-of-credit or revolving-debt arrangement.

ASC 470-50-40-21 states that it applies to “[m]odifications to or exchanges of line-of-credit or revolving-debt arrangements resulting in either a new line-of-credit or revolving-debt arrangement or resulting in a traditional term-debt arrangement.” Accordingly, if a line-of-credit or revolving-debt arrangement is modified or exchanged so that it becomes, in whole or in part, a term-debt arrangement or delayed-draw term loan commitment with the same creditor, the debtor should apply the guidance on modifications of line-of-credit or revolving-debt arrangements (see Section 10.6.2). Note that it would apply this guidance even if amounts were drawn under a line-of-credit or revolving-debt arrangement before its modification or exchange. If the borrowing capacity before the amendment exceeds the borrowing capacity after the amendment, a proportionate amount of the current unamortized deferred costs associated with the line-of-credit or revolving-debt arrangement is expensed and the remaining amount is allocated among any continuing line-of-credit or revolving-debt arrangement, delayed-draw term loan commitment, and term loan on a systematic and rational basis (e.g., on the basis of relative borrowing capacity). If the borrowing capacity after the amendment equals or exceeds the borrowing capacity before the amendment, the current amount of unamortized deferred costs associated with the line-of-credit or revolving-debt arrangement is allocated among any continuing line-of-credit or revolving-debt arrangement, delayed-draw term loan commitment, and term loan on a systematic and rational basis (e.g., first to the continuing line-of-credit or revolving-debt arrangement in proportion to the borrowing capacity that remains under that component of the arrangement and then to the new term loan). Any amounts allocated to the new term loan are accounted for as debt issuance costs of that debt (see Section 5.3.3).

If the original credit facility includes both outstanding term debt and a line of credit or revolving debt, it is often appropriate to analyze the modification or exchange separately for each of those components on the basis of the above guidance (e.g., when only one component is modified). Any amount of term debt outstanding before the amendment that is reallocated to an amount drawn under a line-of-credit or revolving-debt arrangement after the amendment would be analyzed under the guidance on modifications and exchanges of term debt. Any amount that was drawn under a line-of-credit or revolving-debt arrangement before the amendment that becomes an amount drawn under a term-debt arrangement after the modification or exchange is analyzed in accordance with the guidance on modifications of line-of-credit or revolving-debt arrangements. In some circumstances, it may be appropriate to analyze the modification or exchange in combination on the basis of the predominant characteristics of the overall credit facility (e.g., amounts are fully drawn and an increase in the interest rate of one component is compensated by a decrease in the interest rate of the other component). An entity should allocate the fees and costs incurred to amend a credit facility to the different components of the facility by using a reasonable and systematic approach that is consistently applied (e.g., relative fair value).

If a credit facility involves multiple lenders, and an individual creditor no longer participates in the credit facility, any term loan with that creditor is accounted for as an extinguishment unless the replacement of an original creditor with a new creditor, in substance, represents a transfer of the existing debt to a new debt holder (see Section 10.2.8). Any deferred costs related to a line-of-credit or revolving-debt arrangement or delayed-draw term loan commitment with a creditor that no longer participates in the credit facility would be written off through current-period earnings. If a new creditor is added to the credit facility, any term loan with that creditor is recognized as a new term loan and any costs attributable to a line-of-credit or revolving-debt arrangement or delayed-draw term loan commitment with that creditor is deferred as an asset, if appropriate.

The table below summarizes the above considerations.