Chapter 11 — Troubled Debt Restructurings

11.3 Determining Whether a Transaction Qualifies as a TDR

11.3.1 General

ASC Master Glossary

Troubled Debt Restructuring

A restructuring of a debt constitutes a troubled debt restructuring if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider.

In accordance with the definition of a TDR, (1) the debtor must be experiencing financial difficulties and (2) the creditor must grant the debtor a concession that it would not have considered in the absence of “economic or legal reasons related to the debtor’s financial difficulties.” In a TDR, a creditor accepts terms that it normally would not consider because it no longer expects to earn the rate of return anticipated at the time of initial investment. In other words, in the absence of the restructuring, the creditor would be paid a higher effective interest rate for the same receivable currently. For a TDR to exist, the debtor’s creditworthiness must have deteriorated after the original issuance of the debt instrument and such deterioration must have compelled the creditor to accept terms that it would not otherwise consider.

ASC 470-60

55-4 No single characteristic or factor, taken alone, is determinative of whether a modification or exchange is a troubled debt restructuring under this Subtopic. That is, the fact that a single characteristic is present in a transaction (such as that described in paragraph 470-60-15-9(c)(3) or 470-60-15-12(d)) should not be considered sufficient to overcome the preponderance of contrary evidence. Determining whether a transaction is within the scope of this Subtopic requires the exercise of judgment. The guidance that follows is not limited to marketable debt instruments.

55-5 The following model should be applied by a debtor when determining whether a modification or an exchange of debt instruments is within the scope of this Subtopic.

ASC 470-60-15-9 (see Section 11.2.1) identifies characteristics or factors that may be present in a TDR, whereas ASC 470-60-15-8 and ASC 470-60-15-12 identify characteristics and factors that, if present, indicate that a debt restructuring is not necessarily a TDR even if the debtor is experiencing financial difficulties (see Section 11.3.2.2). No single characteristic or factor should be considered determinative of whether a debt restructuring is a TDR. The model described in ASC 470-60-55-5 through 55-14 must be applied to determine whether a debt modification or exchange is a TDR (see also Section 11.3.3.4). A debt modification or exchange that does not qualify as a TDR should be evaluated under ASC 470-50 (see Chapter 10).

11.3.2 Criterion 1 — The Debtor Is Experiencing Financial Difficulties

11.3.2.1 Indicators of Financial Difficulties

ASC 470-60

55-7 If the debtor’s creditworthiness (for example, based on its credit rating or equivalent, the effects of the original collateral or credit enhancements in the debt, or its sector risk) has deteriorated since the debt was originally issued, the debtor should evaluate whether it is experiencing financial difficulties. Changes in an investment-grade credit rating are not considered a deterioration in the debtor’s creditworthiness for purposes of this guidance. Conversely, a decline in credit rating from investment grade to noninvestment grade is considered a deterioration in the debtor’s creditworthiness for purposes of this guidance.

55-8 All of the following factors are indicators that the debtor is experiencing financial difficulties:

The debtor is currently in default on any of its debt.
The debtor has declared or is in the process of declaring bankruptcy.
There is significant doubt as to whether the debtor will continue to be a going concern.
Currently, the debtor has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange.
Based on estimates and projections that only encompass the current business capabilities, the debtor forecasts that its entity-specific cash flows will be insufficient to service the debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity.
Absent the current modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a nontroubled debtor.

One of the two conditions in ASC 470-60 for TDR accounting is that the debtor must be experiencing financial difficulties. A debtor is required to evaluate whether it is experiencing financial difficulties if its creditworthiness has deteriorated since the debt was originally issued (i.e., the likelihood that it is unable to meet its debt obligations has increased). ASC 470-60 specifies that a change in credit rating from investment grade to noninvestment grade should be considered a deterioration in creditworthiness. However, a credit rating downgrade is not considered a deterioration in creditworthiness if the new credit rating is investment grade (e.g., the new credit rating is BBB or higher if issued by Standard and Poor’s or Baa or higher if issued by Moody’s). Other factors that may suggest that the debtor’s creditworthiness has deteriorated include:

A decline in the debtor’s financial performance (e.g., recurring losses).
A decline in the value of any collateral.
Adverse changes in business, financial, or economic conditions (e.g., in the debtor’s industry).
Adverse changes in market indicators of the issuer’s creditworthiness (e.g., credit spreads, credit default swap prices, or observable transactions in the debtor’s securities).

The debtor should use judgment in determining whether, on the basis of the preponderance of the evidence, it is experiencing financial difficulties. The following factors are strong indicators that the debtor is experiencing financial difficulties:

The debtor is experiencing current liquidity issues (i.e., insufficient cash flows to service its debt).
The debtor forecasts that it will not have sufficient cash flows to pay the contractual principal and interest payments during the debt’s remaining term.
The debtor is generally unable to pay its debts when due.
The debtor is unable to obtain new debt at terms applicable to nontroubled debtors from sources other than the current creditor.
There is significant doubt related to whether the debtor will continue as a going concern.
The debtor has declared or is it in the process of declaring bankruptcy.
The debtor’s securities cease to meet exchange listing requirements because of financial issues.

Example 11-1

Debtor That Is Experiencing Financial Difficulties

Entity A has defaulted on some its debt and there is doubt related to whether it will be able to meet its debt obligations as they become due over the next 12 months. Entity A concludes that it is experiencing financial difficulties.

If the debtor concludes that it is not experiencing financial difficulties, a debt restructuring is not a TDR. If the debtor is experiencing financial difficulties, it should evaluate whether it has received a concession before deciding whether the debt restructuring is a TDR (see Section 11.3.3).

11.3.2.2 Access to Alternative Funding

ASC 470-60

15-8 In general, a debtor that can obtain funds from sources other than the existing creditor at market interest rates at or near those for nontroubled debt is not involved in a troubled debt restructuring. A debtor in a troubled debt restructuring can obtain funds from sources other than the existing creditor in the troubled debt restructuring, if at all, only at effective interest rates (based on market prices) so high that it cannot afford to pay them.

15-12 A debt restructuring is not necessarily a troubled debt restructuring for purposes of this Subtopic even if the debtor is experiencing some financial difficulties. For example, a troubled debt restructuring is not involved if any of the following circumstances exist: . . .

c. The creditor reduces the effective interest rate on the debt primarily to reflect a decrease in market interest rates in general or a decrease in the risk so as to maintain a relationship with a debtor that can readily obtain funds from other sources at the current market interest rate.

d. The debtor issues in exchange for its debt new marketable debt having an effective interest rate based on its market price that is at or near the current market interest rates of debt with similar maturity dates and stated interest rates issued by nontroubled debtors.

55-9 Notwithstanding the above, the following factors, if both are present, provide determinative evidence that the debtor is not experiencing financial difficulties, and, thus, the modification or exchange is not within the scope of this Subtopic (the presence of either factor individually would be an indicator, but not determinative, that the debtor is not experiencing financial difficulty):

The debtor is currently servicing the old debt and can obtain funds to repay the old prepayable debt from sources other than the existing creditors (without regard to the current modification) at an effective interest rate equal to the current market interest rate for a nontroubled debtor.
The creditors agree to restructure the old debt solely to reflect a decrease in current market interest rates for the debtor or positive changes in the creditworthiness of the debtor since the debt was originally issued.

A debtor that has access to alternative sources of funding from other creditors at a rate that is at or near the rates for nontroubled debt would not necessarily be experiencing financial difficulties even if its creditworthiness has deteriorated. Under ASC 470-60-55-9, a debtor is deemed not to be experiencing financial difficulties if the following two factors are present:

“The debtor is [both (1)] currently servicing the old debt and [(2) able to] obtain funds to repay the old prepayable debt from sources other than the existing creditors (without regard to the current modification) at an effective interest rate equal to the current market interest rate for a nontroubled debtor.” In evaluating whether this condition is met, the debtor ignores any third-party debt that it was able to issue as a consequence of the debt restructuring. The debtor only considers debt that it would have been able to issue at a nontroubled borrowing rate in the absence of a debt restructuring.
“The creditors agree to restructure the old debt solely to reflect [either (1)] a decrease in current market interest rates for the debtor or [(2)] positive changes in the creditworthiness of the debtor since the debt was originally issued.”

ASC 470-60-15-8 and ASC 470-60-15-12 should be applied in a manner consistent with ASC 470-60-55-5 through 55-14. For example, as noted in ASC 470-60-55-4, the transaction described in ASC 470-60-15-12(d) might be a TDR even if it involves the issuance of debt with an effective interest rate that is at or near the current market rates for nontroubled debt. The debtor should consider the factors in ASC 470-60-55-9 when evaluating such a transaction.

The January 4, 2002, meeting materials for the interpretive guidance in EITF Issue 02-4 (Issue Summary No. 1), which was subsequently codified in ASC 470-60, included two nonauthoritative examples, reproduced below, which illustrate the above guidance. The first example shows that a debt restructuring that involves a reduction in the effective borrowing rate (see Section 11.3.3.4.1) might not be a TDR in a scenario in which the debtor’s creditworthiness has not deteriorated and the debtor has access to alternative sources of funding from external sources at a rate that is at or near the rates for nontroubled debt even if the debtor anticipates some difficulties in meeting future principal and interest payments on the original debt. The second example shows that a debt restructuring that involves a reduction in the effective borrowing rate would be a TDR even if the restructured debt’s effective borrowing rate is based on a market price that is at or near the rates for nontroubled debt in a scenario in which the debtor is experiencing financial difficulties and does not have access to alternative sources of funding at a rate that is at or near the rates for nontroubled debt.

Nonauthoritative EITF Meeting Materials

EITF Issue 02-4, Issue Summary 1 (January 4, 2002)

Example 1

Company A has publicly traded debt (old debt) outstanding. Company A is experiencing financial difficulties caused, in part, by the fact that its sales margins are decreasing while fixed costs have remained level. Based on current forecasts, Company A believes that it will have sufficient cash flows to service the old debt in accordance with its terms over the next six months, but may have difficulty making scheduled principal and interest payments beyond that point. The stated rate on the old debt is significantly higher than current market rates. To reduce costs, Company A renegotiated the terms of the old debt with its creditors and replaced it with new marketable debt (new debt).

Company A considered the following specific facts and circumstances:

Company A initiated the restructuring to reduce the interest rate on its outstanding debt to a level more consistent with current market rates. At the reduced interest rate, Company A forecasts that its cash flows will be more than sufficient to service the debt in accordance with the revised terms, over both the near and longer term.
The old debt’s market price had increased since the date the debt was issued solely as a result of a decrease in general interest rates.
Company A’s credit rating has remained the same since the date it issued the old debt. That is, Company A concluded that the increase in the old debt’s effective market rate was not due to a perceived increase in risk to the creditor.
The new debt has the same payment dates, collateral requirements and covenant requirements as the old debt.
The new debt has a lower principal amount and stated interest rate than the old debt. However, on the date of exchange, the new marketable debt has an effective interest rate based on its market price that is at or near the current market interest rates of debt with similar maturity dates and stated interest rates issued by nontroubled debtors.
Company A was able to and considered borrowing funds from other sources at a lower interest rate than the old debt but decided that its best economic alternative was to renegotiate the debt with its current debt holders provided they agree to restructure the debt in ways more favorable to Company A.
When Company A exchanged the new debt for the old debt with existing creditors, Company A issued an additional 20 percent of the par amount of the new debt at the same terms of the new debt to new investors. However, Company A could not have obtained those additional funds if the existing creditors did not agree to the terms of the restructuring.

Based on the above, even though there was a principal reduction in the old debt, Company A appropriately concluded sufficient persuasive evidence exists to support its assertion that economic and legal considerations related to its financial difficulty were not the primary reasons that compelled the creditors to restructure the marketable debt in ways more favorable to Company A. That is, the restructuring was not within the scope of [ASC 470-60].

While the following factors were also present, Company A did not consider them relevant to its conclusion:

The market value of the old debt prior to the announcement of the terms of the restructuring was greater than the market value of the new debt.
Eighty percent of the existing creditors at the date of the restructuring purchased the old debt within the past week, 10 percent purchased the old debt within the past month, while the remaining 10 percent were the original purchasers of the old debt.

Example 2

Company B has publicly traded debt (old debt) outstanding. Company B is experiencing financial difficulties caused, in part, by the fact that its sales margins are decreasing while fixed costs have remained level. Based on current forecasts, Company B believes that it will not have sufficient cash flows to service the old debt in accordance with its terms in the near or long term. The stated rate on the old debt is significantly higher than current market rates. To reduce future cash flows, Company B renegotiated the terms of the old debt with its creditors and replaced it with new marketable debt (new debt).

Company B considered the following specific facts and circumstances:

Company B’s financial difficulties, which render it unable to service the debt over the near and long term, were the primary reason for its decision to renegotiate the terms of its debt in a manner that reduces both principal and interest.
The old debt’s market price had decreased since the date the debt was issued even though there was a decrease in general interest rates.
Company B’s credit rating has fallen below investment grade since the date it issued the old debt. That is, Company B concluded that the decrease in the old debt’s market price was primarily due to a perceived increase in risk to the creditor.
The new debt has the same payment dates, collateral requirements, and covenant requirements as the old debt.
The new debt has a lower principal amount and stated interest rate than the old debt; however, on the date of exchange, the new marketable debt has an effective interest rate based on its market price that is at or near the current market interest rates of debt with similar maturity dates and stated interest rates issued by nontroubled debtors.
Company B was not able to borrow funds from other sources at an effective interest rate that it could afford to pay. That is, Company B must rely on the current creditors to agree to restructure the old debt in ways more favorable to Company B in order for Company B to sustain operations.
When Company B exchanged the new debt for the old debt with existing creditors, Company B issued an additional 20 percent of the par amount of the new debt at the same terms of the new debt to new investors. However, Company B could not have obtained those additional funds if the existing creditors did not agree to the terms of the restructuring.

Based on the above, even though the new debt has an effective interest rate based on its market price that is at or near the current market interest rates of debt with similar maturity dates and stated interest rates issued by nontroubled debtors, Company B appropriately concluded sufficient persuasive evidence exists to support its assertion that economic and legal considerations related to its financial difficulty were the primary reasons that compelled the creditors to restructure the marketable debt in ways more favorable to Company B. That is, the restructuring was within the scope of [ASC 470-60].

While the following factors were also present, Company B did not consider them relevant to its conclusion:

The market value of the old debt prior to the announcement of the restructuring was equal to the market value of the new debt. That is, theoretically, Company B could have purchased the old debt from the existing creditors in the marketplace for an amount equal to the market value of the new debt.
Eighty percent of the existing creditors at the date of the restructuring purchased the old debt within the past week, 10 percent purchased the old debt within the past month, while the remaining 10 percent were the original purchasers of the old debt.

11.3.3 Criterion 2 — The Creditor Has Granted a Concession

11.3.3.1 General

ASC 470-60

15-5 A restructuring of a debt constitutes a troubled debt restructuring for purposes of this Subtopic if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider.

15-6 That concession is granted by the creditor in an attempt to protect as much of its investment as possible. That concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court; for example, either of the following circumstances might occur:

A creditor may restructure the terms of a debt to alleviate the burden of the debtor’s near-term cash requirements, and many troubled debt restructurings involve modifying terms to reduce or defer cash payments required of the debtor in the near future to help the debtor attempt to improve its financial condition and eventually be able to pay the creditor.
The creditor may accept cash, other assets, or an equity interest in the debtor in satisfaction of the debt though the value received is less than the amount of the debt because the creditor concludes that step will maximize recovery of its investment. . . .

15-7 Whatever the form of concession granted by the creditor to the debtor in a troubled debt restructuring, the creditor’s objective is to make the best of a difficult situation. That is, the creditor expects to obtain more cash or other value from the debtor, or to increase the probability of receipt, by granting the concession than by not granting it.

The second of the two conditions in ASC 470-60 for TDR accounting is that the creditor must have granted a concession. Such a concession might involve a reduction of the interest rate, forgiveness of principal or accrued interest, or a payment delay or deferral, and it could result from an agreement between the debtor and the creditor or be imposed by law or a court.

Although a concession involves making terms more favorable to the debtor, a creditor may have an economic incentive to grant a concession when a debtor is experiencing financial difficulties. For example, a concession may be in the creditor’s economic best interest if it enables the debtor to avoid bankruptcy or other consequences of a default that could (1) have an adverse impact on the creditor’s prospects of recovering amounts due from the debtor or (2) result in additional costs to the creditor (e.g., the legal costs of a foreclosure or bankruptcy proceeding). A creditor grants a concession when it no longer believes that its investment in the receivable will earn the rate of return expected at the time of the investment because of anticipated credit losses in the absence of a restructuring.

While the definition of a TDR suggests that the creditor must have granted a concession that it would not have considered if not for the debtor’s financial difficulties, a debtor is not required to specifically evaluate whether the debtor’s financial difficulties were the reason for the concession or whether the creditor would have granted the concession even if the debtor had not experienced financial difficulties.

11.3.3.2 Level of Aggregation

If a debtor has outstanding debt with multiple creditors, it should separately determine for each creditor whether a concession has been granted. If a debt arrangement involving multiple lenders is structured as a loan participation, the debtor has only one creditor (see Section 10.3.2.4).

If one creditor (or multiple creditors within a consolidated group or otherwise under common control) holds multiple debt instruments issued by the same debtor, the debtor should consider its total relationship with the creditor in determining whether a concession has been granted. For example, in assessing whether the effective borrowing rate on the restructured debt is below the effective borrowing rate immediately before the restructuring (see Section 11.3.3.4), the debtor would calculate and use a composite effective interest rate for any debt instruments that are evaluated on an aggregated basis.

11.3.3.3 Transfers of Assets or Issuances of Equity Interests

ASC 470-60

b. The fair value of cash, other assets, or an equity interest transferred by a debtor to a creditor in full settlement of its payable at least equals the debtor’s carrying amount of the payable. . . .

If a debt restructuring involves a transfer of assets or the issuance of an equity interest in full satisfaction of a debt obligation, the debtor should consider whether the fair value of those assets or equity interests equals or exceeds the debt’s carrying amount. The debtor has not received a concession if the fair value of those assets or equity interests equals or exceeds the debt’s carrying amount. Conversely, the debtor has received a concession if the debt’s carrying amount exceeds the fair value of such assets or equity interests.

The transferred assets’ carrying amount before the debt restructuring is not relevant in the determination of whether a concession has been granted. If a debtor transfers an asset that has a carrying amount of $100 to settle debt with a carrying amount of $100, the creditor would be viewed as having granted a concession if the asset’s fair value at the time of the debt restructuring is less than $100 (see also Section 11.4.2).

ASC 470-60 contains special accounting guidance for TDRs that involve a transfer of assets (see Section 11.4.2), a grant of equity interests (see Section 11.4.3), and a combination of the characteristics in ASC 470-60-15-9(a)–(c) (see Section 11.4.5).

11.3.3.4 Debt Modifications and Exchanges

11.3.3.4.1 Effective Borrowing Rate Test

ASC 470-60

55-10 A creditor is deemed to have granted a concession if the debtor’s effective borrowing rate on the restructured debt is less than the effective borrowing rate of the old debt immediately before the restructuring. The effective borrowing rate of the restructured debt (after giving effect to all the terms of the restructured debt including any new or revised options or warrants, any new or revised guarantees or letters of credit, and so forth) should be calculated by projecting all the cash flows under the new terms and solving for the discount rate that equates the present value of the cash flows under the new terms to the debtor’s current carrying amount of the old debt.

55-11 The carrying amount for purposes of this test would not include any hedging effects (including basis adjustments to the old debt) but would include any unamortized premium, discount, issuance costs, accrued interest payable, and so forth.

55-12 When determining the effect of any new or revised sweeteners (options, warrants, guarantees, letters of credit, and so forth), the current fair value of the new sweetener or change in fair value of the revised sweetener would be included in day-one cash flows. If such sweeteners are not exercisable for a period of time, that delay is typically considered within the estimation of the initial fair value as of the debt’s modification date.

If existing debt is modified or exchanged for new debt, the debtor is deemed to have received a concession if the effective borrowing rate on the restructured debt is less than the effective borrowing rate immediately before the restructuring. However, a reduction in the effective borrowing rate is not considered a concession if there is persuasive evidence that it is due solely to a factor that is not reflected in the calculation of the effective borrowing rate (see Section 11.3.3.4.2).

A debtor calculates the effective borrowing rate on the modified debt by solving for the discount rate that equates the future cash flows of the modified debt to the current carrying amount of the original debt. In this calculation, the carrying amount excludes any hedge accounting adjustments (e.g., if the debt was designated as a hedged item in a fair value hedge under ASC 815; see Section 14.2.1.2) but reflects any remaining unamortized premium or discount (see Chapter 6) as well as any accrued interest payable.

All terms of the restructured debt must be considered in the determination of the cash flows of the restructured debt. If the debt restructuring includes any new “sweetener” (e.g., warrant, option, guarantee, or letter of credit) issued by the debtor, its fair value is treated as an immediate cash outflow as of the time of the debt restructuring (i.e., as a “day 1 cash outflow”). Similarly, the change in fair value of any amended sweeteners as a result of the modification (i.e., the fair value of the sweetener immediately before the debt restructuring compared with its fair value immediately after the modification) is treated as a day 1 cash flow. However, in evaluating whether a concession has been made, the debtor does not compare the fair value of the restructured debt with the fair value of the original debt at the time of the debt restructuring.

ASC 470-60-15-9 contains special accounting guidance for TDRs that involve a debt modification or exchange (see Section 11.4.4) or a combination of the characteristics specified in that guidance (see Section 11.4.5).

Example 11-2

Increase in Interest Rate Does Not Involve a Concession

Entity B is in violation of its debt covenants. Although B’s revolver has been amended several times in the past year, resulting in an increase of 100 basis points in the interest rate, the amendments have not provided for either a reduction or forgiveness of the outstanding obligation (principal and interest). The amendments include “stand-still” agreements, which generally state that the banks will not force B into bankruptcy as long as it makes monthly interest payments and periodic principal payments despite its failure to meet the debt covenants. In the absence of the stand-still agreements, the debt would have become currently due.

The amendments to B’s debt do not constitute a TDR but rather an increase in interest rates, and they have not resulted in a reduced principal or accrued interest balance. In addition, B has not granted an equity interest to its creditors nor has it transferred title to any of its assets to its creditors in satisfaction of any of the outstanding debt. Therefore, the creditor has not granted B a concession, and the amendments to B’s debt do not result in a TDR.

Example 11-3

Amendment to Debt Covenant Ratio Does Not Involve a Concession

Entity C has been experiencing financial difficulties and announced that it would be unable to make the required interest payment to Lender H for the month of December. The terms of the debt agreement provide for a 30-day grace period for paying the interest. In December, C amended its credit agreement with H and reduced the fixed-charge coverage ratio requirement from 1.25 to 1.05 for its fourth-quarter debt covenant calculation. Entity C paid $1.3 million to H to obtain this waiver. In January, C was able to refinance the debt with a different creditor on substantially similar terms and made the required interest payments within the 30-day grace period.

In these circumstances, the amendment to the debt covenant ratio does not represent a concession on the part of H. As a result of the cash payment required on the date of the fixed-charge ratio waiver, H has increased its effective interest rate. In addition, C was able to obtain new financing after year-end on substantially similar terms. ASC 470-50-40-18 addresses the treatment of fees paid to third parties in the event of a modification or exchange of a debt instrument in a nontroubled debt situation.

Example 11-4

Change in Effective Rate on Debt — Concession Has Been Granted

On December 31, 20X0, Entity D issues five-year debt for net proceeds of $245,000. The face amount is $250,000. The stated interest rate is 5 percent per annum payable annually in arrears. The effective interest rate is 5.47 percent per annum. The original amortization schedule is shown below.

On December 31, 20X1, D is experiencing financial difficulties and negotiates a debt restructuring with its creditor. The new stated interest rate is 7 percent per annum (i.e., the stated rate has increased), and the new face amount is $210,000 (i.e., the creditor has forgiven $40,000 of principal). In addition, D issues a warrant with a fair value of $10,000 to the creditor.

To determine whether the creditor has granted a concession, D computes the new effective borrowing rate. It treats the fair value of the warrants issued as an immediate cash outflow to pay down a portion of the outstanding balance (i.e., as an immediate reduction in the carrying amount). Because the new effective borrowing rate (3.63 percent per annum) is lower than the original effective borrowing rate, D is deemed to have received a concession and applies TDR accounting to the debt restructuring.

Example 11-5

Change in Effective Borrowing Rate — Concession Has Been Granted

On December 31, 20X0, Entity E issues a five-year debt security for net proceeds of $97,000. The principal amount is $100,000, and the stated coupon rate is 8 percent payable annually in arrears. Because the debt security was issued at a discount, its stated interest rate differs from its effective interest rate. By solving for the rate that equates the initial net proceeds to the future contractual interest and principal cash flows, E determines that the annual effective interest rate equals 8.77 percent. The original discount amortization schedule is shown below.

In late 20X2, E is experiencing financial difficulties and negotiates a debt restructuring with the lender. On January 1, 20X3, the lender agrees to forgive $4,000 of principal and reduces the stated coupon rate to 4 percent per annum. In addition, E delivers warrants with a fair value of $5,000 to the holder.

In evaluating whether there is a concession, E should calculate the effective borrowing rate of the restructured debt. Entity E solves for the discount rate that equates the contractual cash flows of the modified debt (including the fair value of the warrant) to the current carrying amount of the original debt ($98,051.38). It treats the fair value of the warrants as an immediate cash outflow. Entity E determines that the revised annual effective borrowing rate is 5.13 percent. Because the original effective borrowing rate exceeds the revised effective borrowing rate, the lender has granted a concession. Since E is experiencing financial difficulties, the debt restructuring is a TDR.

11.3.3.4.2 Decrease in Effective Borrowing Rate Due to Other Factors

ASC 470-60

55-13 Although considered rare, if there is persuasive evidence that the decrease in the effective borrowing rate is due solely to a factor that is not captured in the mathematical calculation (for example, additional collateral), the creditor may not have granted a concession and the modification or exchange should be evaluated based on the substance of the modification.

While a decrease in the debt’s effective borrowing rate generally represents a concession under ASC 470-60 (see Section 11.3.3.4.1), ASC 470-60-55-13 provides an exception for scenarios in which persuasive evidence exists that the reduction is due solely to a factor that is not reflected in the calculation of the effective borrowing rate. For example, a reduction in the effective borrowing rate that results from the posting of additional collateral that justifies the reduction in rate is not treated as a concession. However, ASC 470-60-55-13 notes that it would be rare to conclude that a reduction in the effective borrowing rate is not a concession.

ASC 470-60-15-12 specifies that TDR accounting does not apply when the interest rate on the debt is reduced to reflect a general decrease in market interest rates or an improvement in the debtor’s creditworthiness as long as the debtor is currently servicing the original debt and can obtain funds from other sources at rates at or near those for nontroubled debt (see Section 11.3.2.2). The fact that the debtor can readily obtain funds from other sources at or near the current market interest rates for nontroubled debtors suggests that the debtor should not be viewed as experiencing financial difficulties.

11.3.3.4.3 Consecutive Restructurings

ASC 470-60

55-14 Notwithstanding the guidance in this Section, if an entity has recently restructured the debt and is currently restructuring that debt again, the effective borrowing rate of the restructured debt (after giving effect to all the terms of the restructured debt including any new or revised options or warrants, any new or revised guarantees or letters of credit, and so forth) should be calculated by projecting all the cash flows under the new terms and solving for the discount rate that equates the present value of the cash flows under the new terms to the debtor’s previous carrying amount of the debt immediately preceding the earlier restructuring. In addition, the effective borrowing rate of the restructured debt should be compared with the effective borrowing rate of the debt immediately preceding the earlier restructuring for purposes of determining whether the creditor granted a concession (that is, whether the effective borrowing rate decreased).

If a debtor restructures the same debt multiple times in a short period, those debt restructurings are evaluated on a cumulative basis. That is, the debtor calculates the effective borrowing rate of the restructured debt (see Section 11.3.3.4.1) on the basis of (1) the carrying amount before the first recent modification (rather than the carrying amount after the most recent modification) and (2) the modified cash flows after the most recent modification. In determining whether the creditor has granted a concession, the debtor compares the effective borrowing rate of the debt before the first recent modification with the effective borrowing rate of the restructured debt. ASC 470-60 does not specifically address what would be considered a “recent” modification. Unless the facts and circumstances suggest that a different time frame should apply, a debtor may analogize to the one-year time frame that applies to debt modifications under ASC 470-50 (see Section 10.3.3.4).

11.3.4 Factors That Do Not Affect the Evaluation

ASC 470-60

55-6 The following factors have no relevance in the determination of whether a modification or an exchange is within the scope of this Subtopic:

The amount invested in the old debt by the current creditors
The fair value of the old debt immediately before the modification or exchange compared to the fair value of the new debt at issuance
Transactions among debt holders.

In addition, the length of time the current creditors have held the investment in the old debt is not relevant in the determination of whether a modification or exchange is within the scope of this Subtopic unless all the current creditors recently acquired the debt from the previous debt holders to effect what is in substance a planned refinancing.

In accordance with ASC 470-60, the following factors are not relevant in the evaluation of whether a debt restructuring is a TDR:

The amount that current creditors have invested in the debt. For example, the fact that an investor may have purchased the debt from another investor at a discount to par does not affect the analysis of whether that investor has granted a concession or the debtor is experiencing financial difficulties.
The fair value of the restructured debt relative to the fair value of the original debt at the time of the debt restructuring. Note, however, that the fair value of any consideration transferred (such as assets or equity interests) in full or partial satisfaction of the debt is relevant to the analysis (see Section 11.3.3.3).
Transactions among debt holders to which the debtor is not a party (see Section 10.2.8). For example, the fact that the debt may be purchased at a deep discount to par in market transactions between third parties does not affect whether TDR accounting applies.
The length of time during which creditors have held the debt (unless they acquired it recently for a planned refinancing).

Although transactions among debt holders do not trigger TDR accounting, any debt modification or exchange that involves the debtor or its agent should be evaluated in the determination of whether TDR accounting applies even if the modification is made in connection with a transfer to a new holder (see Section 10.2.8 for analogous guidance).

Example 11-6

Modification After a Creditor’s Sale of Debt

Entity F is experiencing financial difficulties and expects to renegotiate its outstanding loan with Bank A. Bank A would like to end its relationship with F; therefore, A sells its loan receivable to Bank B. Shortly after this sale, F modifies the terms of the loan with B by reducing the principal amount owed. In this example, the debtor is experiencing financial difficulties and a concession has been granted. Therefore, the modification is within the scope of ASC 470-60 even though the modification involves a new creditor.

If the debtor has involved an intermediary (e.g., a bank) to transact with its debt holders, the debtor should evaluate whether the intermediary acts as a principal in its own capacity or as the debtor’s agent (see Section 10.5). Transactions made by an intermediary as the debtor’s agent are treated as transactions made by the debtor itself.

11.3.5 Relationship to Creditor’s Assessment

The creditor’s accounting for restructured debt has no impact on the debtor’s accounting because the accounting requirements for debtors and creditors differ.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.