Chapter 11 — Troubled Debt Restructurings
Chapter 11 — Troubled Debt Restructurings
11.1 Background
ASC 470-60
05-1 This Subtopic addresses
measurement, derecognition, disclosure, and implementation
guidance issues concerning troubled debt restructurings
focused on the debtor’s records. . . .
If a creditor anticipates that a debtor might be unable to pay its outstanding debt
obligations as they become due, the creditor may be willing to grant the debtor a
concession. For example, the creditor might agree to reduced or extended payment
terms or a settlement of some or all of the obligation through the transfer of
assets or equity shares (see Section 11.2). By
granting a concession, the creditor hopes to improve its prospects of recovering as
much as possible of its investment and avoiding a costly legal process (e.g.,
foreclosure, bankruptcy proceedings, or other adverse consequences of an event of
default).
Under ASC 470-60, a debt restructuring qualifies as a TDR if both of the following
two criteria are met: (1) the debtor is experiencing financial difficulties and (2)
the creditor for economic or legal reasons related to such difficulties has granted
the debtor a concession that it would not otherwise consider (see Section 11.3). ASC 470-60 discusses special
accounting, presentation, and disclosure requirements related to TDRs (see Sections 11.4 and 11.5).
11.2 Scope
11.2.1 General
ASC 470-60
15-1 The guidance in this
Subtopic applies to all debtors.
15-2 The guidance in this
Subtopic applies to all troubled debt restructurings by
debtors.
15-4 . . . Payables that may
be involved in troubled debt restructurings commonly
result from borrowing of cash, or purchasing goods or
services on credit. Examples are accounts payable,
notes, debentures and bonds (whether those payables are
secured or unsecured and whether they are convertible or
nonconvertible), and related accrued interest, if any. .
. .
15-4A In this Subtopic, a
receivable or a payable (collectively referred to as
debt) represents a contractual right to receive money or
a contractual obligation to pay money on demand or on
fixed or determinable dates that is already included as
an asset or a liability in the creditor’s or debtor’s
balance sheet at the time of the restructuring.
15-9 A troubled debt
restructuring may include, but is not necessarily
limited to, one or a combination of the following:
- Transfer from the debtor to the creditor of receivables from third parties, real estate, or other assets to satisfy fully or partially a debt (including a transfer resulting from foreclosure or repossession)
- Issuance or other granting of an equity interest to the creditor by the debtor to satisfy fully or partially a debt unless the equity interest is granted pursuant to existing terms for converting the debt into an equity interest
- Modification of terms of a debt, such as one or
a combination of any of the following:
- Reduction (absolute or contingent) of the stated interest rate for the remaining original life of the debt
- Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk
- Reduction (absolute or contingent) of the face amount or maturity amount of the debt as stated in the instrument or other agreement
- Reduction (absolute or contingent) of accrued interest.
15-11 For purposes of this
Subtopic, none of the following are considered troubled
debt restructurings:
- Lease modifications (for guidance, see Topic 842)
- Changes in employment-related agreements, for example, pension plans and deferred compensation contracts
- Unless they involve an
agreement between debtor and creditor to
restructure, neither of the following:
- Debtors’ failures to pay trade accounts according to their terms
- Creditors’ delays in taking legal action to collect overdue amounts of interest and principal.
15-13 For further guidance
on determining whether a modification or exchange is a
troubled debt restructuring, see paragraphs 470-60-55-4
through 55-7. If a debtor concludes that the
modification or exchange is not within the scope of this
Subtopic, the debtor would apply the provisions of
Subtopic 470-50.
If a debtor undertakes any of the following transactions involving its
outstanding debt, it should evaluate whether the transaction qualifies as a TDR
under ASC 470-60 (see Section 11.3):
- A modification of terms — The creditor might agree to extend the terms by deferring the timing of the contractual interest or principal payments due. Alternatively, the creditor might agree to reduce the amounts due by (1) decreasing the contractual interest rate to a below-market interest rate or (2) forgiving a portion of the principal amount or previously accrued interest. Further, the modification might make payment terms contingent on, for example, the debtor’s revenue.
- An exchange of debt instruments — The debtor and creditor might agree to exchange the outstanding debt instrument for a new debt instrument with terms that are more favorable to the debtor.
- Transfer of assets in full or partial satisfaction of the debt — The debtor might transfer cash, trade receivables, real estate, or other assets to the creditor to fully or partially satisfy the debt.
- Grant of equity interest in full or partial satisfaction of the debt — The debtor might transfer an equity interest (such as shares of common or preferred stock or warrants on such shares) to the creditor to satisfy fully or partially the obligation even though the debt was not convertible into such an equity interest under the debt’s original contractual terms.
A restructuring that extends the debt’s maturity date might
qualify as a TDR under ASC 470-60 even if the principal balance and the stated
interest rate remain unchanged. ASC 470-60-15-9(c) states, in part, that a TDR
may include “[e]xtension of the maturity date or dates at a stated interest rate
lower than the current market rate for new debt with similar risk.” If the
stated interest rate on the restructured loan is lower than the current market
rate for a new loan with similar risk that a creditor would be willing to make,
the restructuring might be deemed a concession (see Section 11.3.3).
Further, a debt restructuring might represent a TDR even if the debt is settled
in full. For example, a debtor is required to disclose specific information
about TDRs that have occurred during the period for which financial statements
are presented (see Section 11.5.2).
Unless a modification has been made to the debt terms, the
debtor’s failure to pay amounts when due or the creditor’s delay in taking
action to enforce the payment terms is not within the scope of ASC 470-60.
However, the settlement of debt through a foreclosure or repossession or the
transfer of assets or equity securities should be evaluated under ASC 470-60
even if the contractual terms are not modified (see the next section). Special
considerations are necessary for bankruptcy proceedings and
quasi-reorganizations (see Section 11.2.3).
The following transactions are exempt from the scope of ASC 470-60:
- Lease modifications.
- Changes in employment-related contracts (e.g., pensions or deferred compensation arrangements).
ASC 470-60 does not apply to the creditor’s accounting.
11.2.2 Foreclosures and Repossessions
ASC 470-60
15-6 . . . Although troubled
debt that is fully satisfied by foreclosure,
repossession, or other transfer of assets or by grant of
equity securities by the debtor is, in a technical
sense, not restructured, that kind of event is included
in the term troubled debt restructuring in this
Subtopic.
35-9 A troubled debt
restructuring that is in substance a repossession or
foreclosure by the creditor or other transfer of assets
to the creditor shall be accounted for according to the
provisions of the preceding paragraph and paragraphs
470-60-35-2 through 35-3.
Debt that is satisfied through foreclosure, repossession, other
transfer of the debtor’s assets is not exempt from the scope of ASC 470-60 if it
otherwise meets the criteria for a TDR (see Section 11.3). Further, we understand that
the FASB and SEC believe that ASC 470-60 applies to foreclosures or
repossessions of specified collateral (e.g., mortgaged property) if the creditor
has no recourse to the debtor’s other assets. For example, assume that on
January 1, 20X1, an entity borrows, on a nonrecourse basis, $1 million to
purchase real property that has a fair value of $1.2 million. Since the
borrowing is nonrecourse, the lender only has recourse to the real property
being financed and cannot look to any other assets of the borrower to satisfy
the loan. Further assume that on December 1, 20X3, the property has a fair value
of $700,000 and the amount due on the loan is still $1 million. If the borrower
transfers the real property to the lender in full satisfaction of the loan
(i.e., title to the property reverts to the lender and the borrower has no
further obligation), the settlement of the loan is a TDR. Therefore, the
borrower would recognize a loss on the real property of $500,000. The borrower
would also recognize a gain on the debt restructuring of $300,000, which
represents the excess of the loan balance over the fair value of the property.
(For simplicity, it is assumed that the borrower had not previously treated the
real property as impaired even though such treatment may have been required
earlier.)
11.2.3 Bankruptcy Proceedings and Quasi-Reorganizations
ASC 470-60
15-10 The guidance in this
Subtopic shall be applied to all troubled debt
restructurings including those consummated under
reorganization, arrangement, or other provisions of the
Federal Bankruptcy Act or other federal statutes related
thereto. This Subtopic does not apply, however, if under
provisions of those federal statutes or in a
quasi-reorganization or corporate readjustment (see
Topic 852) with which a troubled debt restructuring
coincides, the debtor restates its liabilities
generally, that is, if such restructurings or
modifications accomplished under purview of the
bankruptcy court encompass most of the amount of the
debtor’s liabilities.
55-1 Entities involved with
Chapter 11 bankruptcy proceedings frequently reduce all
or most of their indebtedness with the approval of their
creditors and the court in order to provide an
opportunity for the entity to have a fresh start. Such
reductions are usually by a stated percentage so that,
for example, the debtor owes only 60 cents on the
dollar. Because the debtor would be restating its
liabilities generally, this Subtopic would not apply to
the debtor’s accounting for such reduction of
liabilities.
55-2
On the other hand, this Subtopic would apply to an
isolated troubled debt restructuring by a debtor
involved in bankruptcy proceedings if such restructuring
did not result in a general restatement of the debtor’s
liabilities.
ASC 470-60 does not apply to debt restructurings in which a debtor makes a
general restatement of its liabilities in a reorganization under federal
bankruptcy law or in conjunction with a quasi-reorganization. A
quasi-reorganization is an accounting procedure by which an entity revalues its
assets and liabilities on a “fresh-start” basis to their current fair value
without undergoing a legal reorganization (see ASC 852). As noted in ASC
852-20-25-5, the “effective date of the readjustment . . . shall be as near as
practicable to the date on which formal consent of the stockholders [to the
reorganization] is given.” For example, a debt restructuring may be considered
to have occurred in conjunction with a quasi-reorganization if each occurs
within 30 days of the other.
If a debtor undergoing Chapter 11 bankruptcy proceedings obtains creditor and
bankruptcy court approval for a reduction of substantially all of its
liabilities, such a debt restructuring would be considered a general restatement
of its liabilities and consequently excluded from the scope of ASC 470-60.
However, ASC 470-60 applies if a company negotiates debt restructurings on only
some if its liabilities and does not generally restate its liabilities.
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
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: . . .
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.
11.4 Accounting for a TDR
11.4.1 General
11.4.1.1 Background
ASC 470-60
10-1 The accounting for
restructured debt is based on the substance of the
modifications — the effect on cash flows — not on
the labels chosen to describe those cash flows. The
substance of all modifications of a debt in a
troubled debt restructuring is essentially the same
whether they involve modifications of any of the
following:
- Timing
- Amounts designated as interest
- Amounts designated as face amounts.
10-2 All of those kinds of
modifications affect future cash receipts or
payments and therefore affect both of the following:
- The creditor’s total return on the receivable, its effective interest rate, or both
- The debtor’s total cost on the payable, its effective interest rate, or both.
35-1 A debtor shall
account for a troubled debt restructuring according
to the type of the restructuring as prescribed in
this Section.
The accounting for a TDR depends on whether it involves a transfer of assets,
the grant of an equity interest, a modification of the debt terms, or a
combination thereof:
-
Transfer of assets (see Sections 11.4.2 and 11.4.5) — The debtor transfers trade receivables, real estate, or other assets to the creditor to fully or partially satisfy outstanding debt.
-
Grant of equity interest (see Sections 11.4.3 and 11.4.5) — The debtor issues an equity interest (e.g., the issuer’s common or preferred stock) to the creditor to fully or partially satisfy outstanding debt.
-
Modification of the debt terms (see Section 11.4.4) — For example:
-
A reduction of the stated interest rate.
-
A reduction of the principal amount of the debt.
-
An extension of maturity dates.
-
A forgiveness or reduction of the amount of accrued interest due.
-
A payment deferral.
-
If a TDR involves a transfer of assets, any difference
between the fair value (under ASC 820) and carrying amount of the
transferred assets at the time of the restructuring is reflected as a gain
or loss in the same manner as if the assets were sold for cash. If a TDR
involves a grant of an equity interest, the equity securities are initially
recognized at fair value in accordance with ASC 820 at the time of the
restructuring. However, if a TDR involves a modification of debt terms, it
is accounted for only prospectively unless the carrying amount exceeds the
undiscounted total amount of future cash payments.
11.4.1.2 Unit of Account
ASC 470-60
15-4 The substance rather
than the form of the payable shall govern. . . .
Typically, each payable is negotiated separately,
but sometimes two or more payables are negotiated
together. For example, a debtor may negotiate with a
group of creditors but sign separate debt
instruments with each creditor. For purposes of this
Subtopic, restructuring of each payable, including
those negotiated and restructured jointly, shall be
accounted for individually.
55-3 To a debtor, a bond
constitutes one payable even though there are many
bondholders.
If an entity determines that a debt restructuring should be
accounted for as a TDR, it applies the TDR accounting requirements in ASC
470-60 separately to each unit of account (see Section 3.3). This means that the TDR
must be accounted for on a creditor-by-creditor basis. However, if one
creditor (or multiple creditors with a consolidated group or otherwise under
common control) holds multiple debt instruments before or after the
restructuring, the debtor should determine whether a restructuring gain may
be recognized by considering the aggregate relationship with such creditor.
If, as a result of the relationship with the individual creditor, one debt
instrument is restructured into multiple debt instruments, or multiple debt
instruments are restructured into one debt instrument, the debtor will need
to allocate the existing carrying amount of the original debt instrument (or
aggregate carrying amount of the original debt instruments) to the
restructured debt instrument or instruments. Performing this allocation may
require judgment. Subsequently, each debt instrument that meets the
definition of a freestanding financial instrument should be accounted for as
a separate unit of account.
Example 11-7
Debt Owned by
Multiple Creditors
Entity G has subordinated debentures
that are held by a significant shareholder, a major
insurance company, and other parties. Entity G is
experiencing financial difficulties and has
negotiated with the shareholder and the major
insurance company to redeem the debentures for
senior indebtedness and a combination of preferred
and common stock of G. In addition, G has offered
the other parties a package of preferred stock and
cash in exchange for their subordinated
debentures.
The TDR accounting requirements of ASC 470-60 should
be applied to each individual transaction (or group
of creditors) rather than in the aggregate because
each group separately negotiated its restructuring.
In substance, there are three creditor groups. If a
company presents a restructuring plan to holders of
debt securities and a portion of the debt holders
accept the plan, the company should account for the
bonds as TDRs to the extent of the participation in
the exchange offer. Accordingly, the TDR accounting
requirements of ASC 470-60 should be applied only to
the portion of the bonds that are actually
restructured. The accounting for the bonds owned by
bondholders that do not participate in the
restructuring is not affected.
11.4.1.3 Time of Restructuring
ASC Master Glossary
Time of Restructuring
Troubled debt restructurings may occur before, at, or
after the stated maturity of debt, and time may
elapse between the agreement, court order, and so
forth, and the transfer of assets or equity
interest, the effective date of new terms, or the
occurrence of another event that constitutes
consummation of the restructuring. The date of
consummation is the time of the restructuring.
A TDR should be recognized in the period in which it occurs
(i.e., at the time of the debt restructuring). The time of the restructuring
is the date of its consummation (e.g., the date on which any assets or
equity interests are transferred in settlement of the debt, or new debt
terms become legally binding). A debtor should not recognize a gain on
restructuring before consummation of the restructuring.
If an entity restructures debt after its balance sheet date
but before issuing its financial statements, that restructuring is a
nonrecognized subsequent event under ASC 855. However, the debtor is
required to consider whether the restructuring is of such a nature that it
must be disclosed to keep the financial statements from being misleading
(see ASC 855-10-50-2).
Example 11-8
Debt
Modification That Is Consummated After the Balance
Sheet Date
Entity H has $120 million of notes
outstanding. On October 31, 20X1, H defaulted on an
interest payment due under the debt and entered into
negotiations with the noteholders to restructure the
debt. On December 1, 20X1, the noteholders agreed to
exchange their existing notes for new notes through
an exchange offer to be completed before February
28, 20X2. The noteholders had a choice of receiving
new notes or a combination of new notes and cash.
The agreement stipulated certain steps that H was to
take before the exchange offer could take place
(e.g., renewal of a line of credit, sale of a
division for cash). On December 31, 20X1, no legal
documentation had been finalized for the
restructuring; the agreement was therefore not
binding. On February 8, 20X2, the choices of all
noteholders had been received and the exchange offer
document was finalized.
Because the actual debt restructuring occurred after
December 31, 20X1, and was not legally binding on
December 31, 20X1, the transaction should be treated
as a nonrecognized subsequent event and recognized
in the first quarter of 20X2. Accordingly, interest
should be accrued as of December 31, 20X1, on the
basis of the terms of the original debt
agreements.
11.4.1.4 Costs and Fees
ASC 470-60
35-12 Legal fees and other
direct costs that a debtor incurs in granting an
equity interest to a creditor in a troubled debt
restructuring shall reduce the amount otherwise
recorded for that equity interest according to
paragraphs 470-60-35-4 and 470-60-35-8. All other
direct costs that a debtor incurs to effect a
troubled debt restructuring shall be deducted in
measuring gain on restructuring of payables or shall
be included in expense for the period if no gain on
restructuring is recognized.
The accounting for any costs and fees incurred in connection with a TDR
depends on whether they are attributable to an equity interest granted.
Legal fees and other direct costs of issuing an equity interest (e.g.,
common or preferred stock) reduce the initial carrying amount of the equity
interest issued. Other costs incurred in a TDR (e.g., a TDR that involves
the transfer of assets or a debt modification or exchange) reduce any
restructuring gain recognized (see Section
11.4.4) or, if there is no gain, are expensed in the period
incurred. If the TDR represents a combination of the characteristics in ASC
470-60-15-9(a)–(c), a debtor should use a reasonable method to allocate fees
and costs between equity interests granted and the restructuring gain or
expenses (e.g., by specifically identifying such costs). Costs incurred
related to a potential restructuring that has not been completed as of the
balance sheet date may not be deferred and recognized as an asset.
ASC 470-60-35-12 does not apply to any remaining unamortized
debt issuance costs at the time of the restructuring; such costs are part of
the debt’s carrying amount immediately before the restructuring.
Accordingly, if the total amount of future undiscounted cash flows of the
restructured debt exceeds the carrying amount, such costs continue to be
amortized after the TDR (see Section 11.4.4.2). Alternatively, if
the TDR involves the recognition of a restructuring gain, any remaining
unamortized debt issuance costs reduce the amount of the gain that would
otherwise have been recognized (see Section 11.4.4.3).
11.4.1.5 Related-Party Transactions
ASC 470-60 applies to all debt restructurings (i.e., there
is no scope exception for transactions with related parties). However, if
the creditor is a related party (e.g., a significant shareholder), any
restructuring gain would be recognized in equity in accordance with ASC
470-50-40-2 (see Section
9.3.7.2). Since the evaluation of whether the creditor is a
related party of the debtor under ASC 850 is performed immediately before
the restructuring, any equity interests granted as part of the restructuring
would not affect the determination of whether a restructuring gain should be
recognized as a capital contribution.
Example 11-9
TDR Involving a
Related Party
To meet future needs for debt
service, operations support, and capital outlay,
Entity J negotiated a restructuring with its
preferred stockholders, subordinated debt holders,
and bank debt holders. As part of the restructuring,
the aggregated outstanding principal amount of the
subordinated debt was converted into shares of
common stock. The value provided to the debt holders
in the form of the common stock was substantially
less than the carrying amount of the subordinated
debt before the exchange. The subordinated debt
holders also had significant investments in
preferred stock of J.
By analogy to ASC 470-50-40-2 (see
Section 9.3.7.2), forgiveness of the
amounts owed to a significant shareholder should be
accounted for as a capital contribution to the
debtor to the extent that the carrying amount of the
payable on the date of the restructuring exceeds
either (1) the total future cash payments that will
be made to the shareholder under the new terms or
(2) the fair value of the assets transferred or the
equity interest granted. Accordingly, J should
recognize the “restructuring gain” realized from the
forgiveness of amounts owed as an equity capital
contribution.
11.4.2 Accounting for Transfer of Assets in Full Settlement of Troubled Debt
ASC 470-60
35-2 A debtor that transfers
its receivables from third parties, real estate, or
other assets to a creditor to settle fully a payable
shall recognize a gain on restructuring of payables. The
gain shall be measured by the excess of the carrying
amount of the payable over the fair value of the assets
transferred to the creditor. However, while the guidance
in this Subtopic indicates that the fair value of assets
transferred or the fair value of an equity interest
granted shall be used in accounting for a settlement of
a payable in a troubled debt restructuring, that
guidance is not intended to preclude using the fair
value of the payable settled if more clearly evident
than the fair value of the assets transferred or of the
equity interest granted in a full settlement of a
payable. However, in a partial settlement of a payable,
the fair value of the assets transferred or of the
equity interest granted shall be used in all cases to
avoid the need to allocate the fair value of the payable
between the part settled and the part still
outstanding.
35-3 A difference between the
fair value and the carrying amount of assets transferred
to a creditor to settle a payable is a gain or loss on
transfer of assets. The carrying amount of a receivable
encompasses not only unamortized premium, discount,
acquisition costs, and the like but also an allowance
for uncollectible amounts and other valuation accounts,
if any. The debtor shall include that gain or loss in
measuring net income for the period of transfer,
reported as provided in Topic 220. A loss on
transferring receivables to creditors may therefore have
been wholly or partially recognized in measuring net
income before the transfer and be wholly or partly a
reduction of a valuation account rather than a gain or
loss in measuring net income for the period of the
transfer.
If a debtor pays cash to settle troubled debt in full, it
recognizes a restructuring gain to the extent that the carrying amount exceeds
the amount of cash paid. ASC 470-60 requires a debtor to apply a “two-step”
approach in accounting for a TDR involving a transfer of noncash assets
(including a repossession or foreclosure of assets; see Section 11.2.2). That is,
when a debtor transfers a noncash asset in full settlement of a debt, any
resulting gain or loss consists of two separate components:
- The difference, if any, between the fair value and carrying amount of the asset transferred is recognized as a gain or loss upon derecognition of the asset transferred. (If an issuer transfers assets in full settlement of a payable, ASC 470-60-35-2 does not preclude the debtor from calculating this gain or loss on the basis of the fair value of the payable settled instead of the fair value of the assets transferred if the fair value of the payable settled is more clearly evident.)
- The difference, if any, between that fair value and the carrying amount of the debt is recognized as a restructuring gain on the debt that is settled.
A “one-step” approach is not appropriate. Under such a method, a restructuring
gain or loss would be recognized for the net difference between the carrying
amount of the asset transferred and the carrying amount of the payable
settled.
For TDRs that occurred during a reporting period, ASC
470-60-50-1 requires separate disclosure, either on the face of the financial
statements or in the accompanying notes, of (1) the aggregate net gain or loss
on asset transfers recognized during the period and (2) the aggregate gain on
restructuring of payables (see Section 11.5.2).
Example 11-10
Accounting for a
Transfer of Financial Assets in Full Settlement of a
Payable
Entity K is experiencing financial
difficulties and agrees to settle its $125 million of
debt to Creditor C in full by transferring fixed-rate
loan receivables that have a carrying amount of $130
million. Entity K estimates the current fair value of
the receivables to be $110 million.
Even though the carrying amount of the
assets transferred exceeds the carrying amount of the
debt settled, K would recognize a restructuring gain of
$15 million to reflect the difference between the fair
value of the assets transferred to settle the debt and
the carrying amount of the debt settled. Further, it
would recognize a loss on the asset transfer of $20
million.
Example 11-11
Accounting for a Transfer of Nonfinancial Assets in
Full Settlement of a Payable
Entity L is experiencing financial
difficulties and will not be able to make the scheduled
payments on its outstanding note to Entity T. Entity L
has reached an agreement with T under which L will
transfer land to T to fully settle the outstanding
obligation. The land has a book value of $90,000 and a
fair value of $100,000. The outstanding note has a
principal balance of $100,000 and related accrued
interest of $5,000. Entity L would record the following
entry related to the settlement:
Example 11-12
Accounting for a
Foreclosure of Collateral in Full Settlement of a
Payable
Entity M, whose fiscal year ends on
December 31, owns a mall that is subject to nonrecourse
debt. The fair value of the mall is significantly less
than the amount of related debt (due November 1, 20X4)
and the carrying amount of the mall. Although M is
currently negotiating with the lender, M believes that
it will most likely allow the bank to foreclose on the
property, in which case it will realize a gain on
extinguishment of debt. Consequently, M believes that it
will not be able to recover the carrying amount of the
asset and that it should therefore recognize a loss on
impairment. Entity M would prefer not to record an
impairment loss on the property in its third quarter but
rather recognize a gain on extinguishment of debt in its
fourth quarter.
Entity M cannot defer recognition of the
impairment loss until its fourth quarter and net the
loss with the anticipated gain on the extinguishment of
debt. ASC 360-10-35-15 through 35-49 require an entity
to measure an impairment loss for a long-lived asset,
including an asset that is subject to nonrecourse debt,
as the amount by which the carrying amount of the asset
(asset group) exceeds its fair value. The recognition of
an impairment loss and the recognition of a gain on the
extinguishment of debt are separate events, and each
event should be recognized in the period in which it
occurs. The recognition of an impairment loss should be
based on the measurement of the asset at its fair value;
the existence of nonrecourse debt should not influence
that measurement.
11.4.3 Accounting for Grant of Equity Interest in Full Settlement of Troubled Debt
ASC 470-60
35-4 A debtor that issues or
otherwise grants an equity interest to a creditor to
settle fully a payable shall account for the equity
interest at its fair value. The difference between the
fair value of the equity interest granted and the
carrying amount of the payable settled shall be
recognized as a gain on restructuring of payables.
35-12 Legal fees and other
direct costs that a debtor incurs in granting an equity
interest to a creditor in a troubled debt restructuring
shall reduce the amount otherwise recorded for that
equity interest according to paragraphs 470-60-35-4 and
470-60-35-8. . . .
When a debtor grants an equity interest (e.g., common or preferred stock or
warrants that qualify for classification in equity) in full settlement of debt
in a TDR, multiple financial statement accounts are affected:
-
The debtor recognizes an increase in shareholders’ equity for the fair value of the equity interests issued less legal fees and other direct issuance costs (see Section 11.4.1.4). (If an issuer grants equity interests in full settlement of a payable, it is permitted to elect to measure the equity interests issued on the basis of the fair value of the payable settled instead of the fair value of the equity interests issued if the fair value of the payable settled is more clearly evident; see ASC 470-60-35-2.)
-
The difference, if any, between that fair value and the carrying amount of the debt is recognized as a restructuring gain on the debt that is settled.
The FASB has rejected approaches that would have involved
including the restructuring gain in equity or increasing equity for the carrying
amount of the payable settled with no gain recognized.
Example 11-13
Accounting for a
Transfer of Equity Shares in Full Settlement of a
Payable
Entity N is experiencing financial
difficulties. It agrees with creditors to settle
outstanding nonconvertible debt with a carrying amount
of $45 million in full by issuing 10 million shares of
common stock, which have an aggregate fair value of $25
million at the time of the restructuring (i.e., $2.50
per share). Accordingly, N recognizes a restructuring
gain of $20 million.
If a debtor issues a mandatorily redeemable financial instrument
in the form of a share that must be classified as a liability under ASC
480-10-25-4, the issuer should not account for it as a grant of an equity
interest under ASC 470-60 but as a troubled debt modification or exchange (see
Section
11.4.4).
Example 11-14
Accounting for a
Transfer of Liability-Classified Shares in Full
Settlement of a Payable
Entity O has restructured its debt
because of its inability to service its existing debt
load. As part of the restructuring, O’s creditor
exchanged O’s debt for a new note and shares of
mandatorily redeemable preferred stock classified as a
liability under ASC 480-10-25-4.
The issuance of liability-classified
mandatorily redeemable preferred stock should not be
viewed as the granting of an equity interest under ASC
470-60-35-4 or ASC 470-60-35-8. The substance of the
exchange of liability-classified mandatorily redeemable
equity securities for debt represents a continuation of
monetary payments under new terms. Therefore, such a
transaction should be accounted for as a modification of
the debt terms in accordance with ASC 470-60-35-5
through 35-7. A gain would be recognized only to the
extent that the carrying amount of the existing debt
exceeds all future payments (including dividends and
contingent dividends) to be made on the new note and
redeemable equity securities.
By contrast, if O had issued a new note
and redeemable preferred stock that qualified for equity
classification under ASC 480 (e.g., mandatorily
redeemable preferred stock that is convertible into
common stock or nonmandatorily redeemable preferred
stock), the transaction would be accounted for as a
partial settlement in accordance with paragraph ASC
470-60-35-8.
11.4.4 Accounting for a Troubled Debt Modification or Exchange
11.4.4.1 Background
If a modification of debt terms qualifies as a TDR, the
debtor accounts for the effect of the modification to the debt terms
prospectively as an adjustment to the effective interest rate except that
the rate cannot be reduced below zero. Although a TDR involves a concession,
the debtor does not recognize a restructuring gain (or corresponding
adjustment to the carrying amount) unless the carrying amount exceeds the
total undiscounted future principal and interest payments of the
restructured debt.
Accordingly, as of the time of the restructuring, the debtor
should compare the total amount of undiscounted future cash payments
required by the modified terms (excluding contingently payable amounts) with
the debt’s carrying amount. Different considerations are necessary if the
future cash payments exceed the debt’s carrying amount (see Section 11.4.4.2) or
if the debt’s carrying amount exceeds the future cash payments (see Section 11.4.4.3).
Other special considerations are necessary related to restructured debt with
contingent payments (see Section 11.4.4.4); put, call, or prepayment features (see
Section
11.4.4.5); and variable-rate debt (see Section 11.4.4.6).
Section
11.4.4.7 compares the accounting for a troubled debt
modification or exchange with that for a nontroubled debt modification or
exchange.
Since a TDR involves a concession made by the creditor, a
TDR typically cannot result in the recognition of a restructuring loss by
the debtor.
11.4.4.2 Future Cash Payments Exceed Carrying Amount
ASC 470-60
35-5 A debtor in a troubled
debt restructuring involving only modification of
terms of a payable — that is, not involving a
transfer of assets or grant of an equity interest —
shall account for the effects of the restructuring
prospectively from the time of restructuring, and
shall not change the carrying amount of the payable
at the time of the restructuring unless the carrying
amount exceeds the total future cash payments
specified by the new terms. Total future cash
payments includes related accrued interest, if any,
at the time of the restructuring that continues to
be payable under the new terms. That is, the effects
of changes in the amounts or timing (or both) of
future cash payments designated as either interest
or face amount shall be reflected in future periods.
Interest expense shall be computed in a way such
that a constant effective interest rate is applied
to the carrying amount of the payable at the
beginning of each period between restructuring and
maturity (in substance the interest method
prescribed by paragraphs 835-30-35-2 and 835-30-35-4
through 35-5). The new effective interest rate shall
be the discount rate that equates the present value
of the future cash payments specified by the new
terms (excluding amounts contingently payable) with
the carrying amount of the payable.
If the total amount of future undiscounted cash payments
required by the modified terms (excluding contingently payable amounts)
exceeds the debt’s carrying amount, a restructuring gain is not recognized
and the effective interest rate is adjusted to reflect the modified terms.
The adjusted effective interest rate is the discount rate that equates the
future cash payments required by the modified agreement, excluding amounts
contingently payable, with the debt’s carrying amount at the time of the
restructuring. After the TDR, interest expense is recognized by using the
adjusted effective interest rate.
Example 11-15
Accounting for
an Extension of the Maturity Date of a
Payable
Entity P has an outstanding note
payable that will yield total interest of $4
million. The note matures on September 30, 20X3, on
which date the creditor becomes fully entitled to
payment of all principal and interest. Entity P is
experiencing financial difficulties and will be
unable to make the scheduled principal and interest
payments on the original due date.
On September 1, 20X3, P negotiated
an extension of the maturity date to December 31,
20X3. The extension has not changed the amount of
principal or interest to be paid by P. The creditor
agreed to extend the maturity date to increase its
ability to recover its investment. As of September
1, 20X3, $3.5 million had been accrued by P as
interest expense.
The extension of the maturity date
represents a TDR (see ASC 470-60-15-9(c)(2)). Since
the creditor did not obtain any additional
entitlement to principal or interest in exchange for
the extension, P effectively extended the maturity
of its debt at a zero percent interest rate. Entity
P’s remaining unrecognized interest expense
($500,000) on September 1, 20X3, should be accrued
by P over the remaining maturity in accordance with
ASC 470-60-35-5 (i.e., constant effective interest
rate) so that the full amount of interest expense of
$4 million will be recognized by December 31,
20X3.
Example 11-16
Accounting for a
Reduction in the Interest Rate on a
Payable
As of January 1, 20X1, Entity Q has
a note payable to Entity S with a principal balance
of $95,000, accrued interest of $5,000, an interest
rate of 5 percent, and a remaining life of five
years. Interest is payable on December 31 each year.
Because of Q’s financial difficulties, S has agreed
to forgive all of the accrued interest and lower the
stated interest rate to 4 percent.
In this example, the future cash
payments exceed the carrying value of the liability
(see calculation below). Therefore, in accordance
with ASC 470-60-35-5, the carrying amount of the
note is not adjusted.
The effects of changes in the amount and timing of
future cash payments should be accounted for
prospectively. A new effective interest rate should
be calculated so that the present value of the
future payments equals the carrying amount of the
liability ($100,000).
Interest Amortization Schedule
The following entries would be
recorded by the debtor to reflect the terms of the
modified agreement (note that no entry is required
on January 1, 20X1 — the date of the
modification):
Example 11-17
Accounting for a
Reduction in the Interest Rate on a
Payable
On December 31, 20X0, Entity R
issues five-year debt for net proceeds of $260,000.
The principal amount is $250,000, and the stated
interest rate is 5.50 percent payable annually in
arrears. Because the debt was issued at net premium,
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, R determines that
the annual effective interest rate is 4.59 percent
(see Section 6.2).
The full discount amortization schedule is shown
below.
Entity R is experiencing financial
difficulties and negotiates a debt restructuring
with the debt holder. On January 1, 20X3, the holder
agrees to reduce the stated coupon rate to 2
percent.
In evaluating whether the holder has
granted a concession, R calculates the effective
borrowing rate of the restructured debt (see
Section 11.3.3.4.1). Entity R solves
for the discount rate that equates the future cash
flows of the modified debt to the current carrying
amount of the original debt ($256,266.79) and
determines that the revised annual effective
borrowing rate is 1.15 percent. Because the original
effective borrowing rate exceeds the revised
effective borrowing rate, the holder has granted a
concession. Since R is experiencing financial
difficulties, the debt restructuring qualifies as a
TDR.
The sum of the undiscounted future
contractual interest and principal cash flows
($265,000) exceeds the current carrying amount of
the debt ($256,266.79). Therefore, R does not
recognize a restructuring gain; instead, it adjusts
the effective interest rate to reflect the modified
cash flows.
The revised amortization schedule is
shown below.
11.4.4.3 Carrying Amount Exceeds Future Cash Payments
ASC 470-60
35-6 If, however, the total
future cash payments specified by the new terms of a
payable, including both payments designated as
interest and those designated as face amount, are
less than the carrying amount of the payable, the
debtor shall reduce the carrying amount to an amount
equal to the total future cash payments specified by
the new terms and shall recognize a gain on
restructuring of payables equal to the amount of the
reduction. If the carrying amount of the payable
comprises several accounts (for example, face
amount, accrued interest, and unamortized premium,
discount, finance charges, and issue costs) that are
to be continued after the restructuring, some
possibly being combined, the reduction in carrying
amount may need to be allocated among the remaining
accounts in proportion to the previous balances.
Thereafter, all cash payments under the terms of the
payable shall be accounted for as reductions of the
carrying amount of the payable, and no interest
expense shall be recognized on the payable for any
period between the restructuring and maturity of the
payable. The only exception is to recognize interest
expense according to paragraph 470-60-35-10.
However, the debtor may choose to carry the amount
designated as face amount by the new terms in a
separate account and adjust another account
accordingly.
If the debt’s carrying amount exceeds the total amount of
future undiscounted cash payments required by the modified terms (excluding
contingently payable amounts), the effective interest rate is reset to zero.
Thereafter, the debtor accounts for any cash paid (including amounts
designated as interest) as a reduction of the carrying amount and no
interest expense is recognized. As of the time of the restructuring, the
debtor should also evaluate whether the modified terms specify any
contingently payable or otherwise currently indeterminate amounts (e.g.,
additional amounts become payable if the debtor’s financial situation
improves or the stated interest rate is indexed to a market interest
rate).
If the modified terms do not specify any contingently
payable or otherwise currently indeterminate amounts, the debtor recognizes
a debt restructuring gain at the time of the restructuring equal to the
excess of the debt’s carrying amount over the total amount of undiscounted
future cash payments. However, if the modified terms do specify such
amounts, the debtor recognizes a debt restructuring gain only if the debt’s
carrying amount exceeds the maximum potential amount of total undiscounted
future cash payments that the debtor might be required to pay (irrespective
of the likelihood that the debtor would be required to pay them; see
Section
11.4.4.4).
Example 11-18
Calculation of
Gain on Modification Involving Forgiveness of
Principal and Accrued Interest and a Reduction of
the Interest Rate on a Payable
As of January 1, 20X1, Entity S has
a note payable to Entity X with a principal balance
of $100,000, accrued interest of $10,000, an
interest rate of 5 percent, and a remaining life of
five years. Because of S’s financial difficulties, S
agrees to modify the note by reducing the principal
amount to $80,000, lowering the stated interest rate
to 4 percent, and forgiving all accrued interest.
Interest is payable on December 31 each year.
In this example, the future cash
payments are less than the carrying value of the
liability (see calculation below). Therefore, in
accordance with ASC 470-60-35-6, the carrying value
of the note should be adjusted. Furthermore, all
future cash payments under the terms of the modified
agreement should reduce the carrying amount of the
note. No interest expense should be recognized on
the note payable between the restructuring and the
maturity of the note.
The calculation of the S’s gain on
restructuring is as follows:
Example 11-19
Calculation of
Gain on Modification Involving a Forgiveness of
Principal and a Reduction of the Interest Rate on
a Payable
On December 31, 20X0, Entity T
issues five-year debt for net proceeds of $120,000.
The principal amount is $125,000, and the stated
interest rate is 6 percent payable annually in
arrears. Because the debt was issued at a net
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, T
determines that the annual effective interest rate
is 6.97 percent (see Section 6.2).
The full discount amortization schedule is shown
below.
Entity T is experiencing financial
difficulties and negotiates a debt restructuring
with the debt holder. On January 1, 20X3, the holder
agrees to forgive $15,000 of principal and to reduce
the stated interest rate to 2 percent. There are no
contingently payable or otherwise currently
indeterminate amounts payable on the restructured
debt.
In evaluating whether the holder has
granted a concession, T calculates the effective
borrowing rate of the restructured debt (see
Section 11.3.3.4.1). Entity T solves
for the discount rate that equates the future cash
flows of the modified debt to the current carrying
amount of the original debt ($121,800.45) and
determines that the revised annual effective
borrowing rate is negative. Because the original
effective borrowing rate exceeds the revised
effective borrowing rate, the holder is deemed to
have granted a concession. Since T is experiencing
financial difficulties, the debt restructuring
qualifies as a TDR.
The sum of the undiscounted future
contractual interest and principal cash flows
($116,600) is less than the current carrying amount
of the debt ($121,800.45). Further, there are no
contingently payable or otherwise indeterminate
amounts. Therefore, T recognizes a restructuring
gain for the amount by which the current carrying
amount exceeds the total amount of undiscounted
future cash payments; that is, it recognizes a gain
of $5,200.45. Further, T adjusts the effective
interest rate to zero. The revised amortization
schedule is shown below.
11.4.4.4 Contingent Payment Terms
11.4.4.4.1 Limit on the Recognition of Restructuring Gains
ASC 470-60
35-7 A debtor shall not
recognize a gain on a restructured payable
involving indeterminate future cash payments as
long as the maximum total future cash payments may
exceed the carrying amount of the payable. Amounts
designated either as interest or as face amount by
the new terms may be payable contingent on a
specified event or circumstance (for example, the
debtor may be required to pay specified amounts if
its financial condition improves to a specified
degree within a specified period). To determine
whether the debtor shall recognize a gain
according to the provisions of the preceding two
paragraphs, those contingent amounts shall be
included in the total future cash payments
specified by the new terms to the extent necessary
to prevent recognizing a gain at the time of
restructuring that may be offset by future
interest expense. Thus, the debtor shall apply
paragraphs 450-30-25-1 and 450-30-50-1 in which
probability of occurrence of a gain contingency is
not a factor, and shall assume that contingent
future payments will have to be paid. The same
principle applies to amounts of future cash
payments that must sometimes be estimated to apply
the provisions of the preceding two paragraphs.
For example, if the number of future interest
payments is flexible because the face amount and
accrued interest is payable on demand or becomes
payable on demand, estimates of total future cash
payments shall be based on the maximum number of
periods possible under the restructured terms.
Sometimes, the terms of restructured debt specify
contingently payable amounts. For example, the debtor might be required
to pay additional amounts of principal or interest if its financial
condition or financial performance improves. To prevent offsetting by
future interest expense, ASC 470-60 precludes the recognition of a
restructuring gain if the restructured debt specifies contingent
payments and the maximum total possible amount of contingent and
noncontingent payments equals or exceeds the carrying amount of the
debt. The likelihood that contingent payments might need to be paid is
not a factor. In determining the amount of any restructuring gain, the
debtor must assume that it will have to pay the maximum amount possible
under any contingent payment terms. Therefore, the debtor should reduce
the amount of any restructuring gain that would otherwise have been
recognized up to the maximum total undiscounted amount of any contingent
payments.
As noted above, the purpose of the guidance is to
prevent the debtor from recognizing a restructuring gain that might be
offset by future losses under contingent payment terms. This means that
the debtor should first compare (1) the debt’s carrying amount
immediately before the modification with (2) the total amount of
undiscounted future cash payments required by the modified debt terms
(excluding contingently payable amounts):
-
If the total amount of undiscounted future cash payments (excluding contingently payable amounts) exceeds the carrying amount immediately before the debt restructuring, the debtor adjusts the effective interest rate prospectively to reflect the modified cash flows (see Section 11.4.4.2). In this circumstance, there is no restructuring gain, the carrying amount is not adjusted, and no portion of the carrying amount is attributable to contingently payable amounts at the time of the restructuring.
-
If the carrying amount immediately before the debt restructuring exceeds the amount of undiscounted future cash payments (excluding contingently payable amounts), the effective interest rate is reset to zero (see Section 11.4.4.3). Further, in this circumstance, the debtor should compare the carrying amount immediately before the modification with the total amount of undiscounted future cash payments required by the modified terms (including contingently payable amounts):
-
If the carrying amount immediately before the debt restructuring exceeds the total amount of undiscounted future cash payments required by the modified terms (including contingently payable amounts), the debtor recognizes a debt restructuring gain and a corresponding decrease in the carrying amount for the difference at the time of the restructuring. In this circumstance, any or all contingently payable amounts are included in the carrying amount as if they were not contingent.
-
If the total amount of undiscounted future cash payments required by the modified terms (including contingently payable amounts) exceeds the carrying amount immediately before the debt restructuring, there is no restructuring gain and the carrying amount is not adjusted. In this circumstance, a portion of contingently payable amounts are included in the carrying amount at the time of the restructuring but only to the extent that they offset the contingent gain that would otherwise have been recognized.
-
Contingently payable amounts include cash as well as
other contingently payable amounts (e.g., equity shares).
Example 11-20
Accounting
for a Modification Involving Contingently Payable
Amounts
Entity U has outstanding debt
with a carrying amount of $1.5 million, an
effective interest rate of 10 percent per annum,
and a remaining term of eight years. On January 1,
20X1, U is experiencing financial difficulties and
negotiates a debt restructuring with its creditor.
Under the terms of the restructured debt, the
creditor reduces the principal amount to $750,000
(i.e., it forgives $750,000). The stated rate of
the restructured debt is 10 percent per annum
payable annually in arrears. The maturity date is
not modified. In conjunction with the
modification, U agrees that if it is acquired by a
third party at any time before the final maturity
of the debt, it will make an additional payment to
the creditor in an amount equal to the forgiven
principal amount.
On the basis of the carrying
amount and the modified cash flows, excluding the
contingent payment that will be made if U is
acquired, U determines that the undiscounted
future cash flows of $1,350,000, or $750,000 +
($750,000 × .10 × 8) are less than the existing
carrying amount of the debt (i.e., $1,500,000).
Because U is experiencing financial difficulties
and a concession has been granted, TDR accounting
applies. The maximum total possible amount of
principal and interest payments is $2.1 million.
Consequently, there should be no change to the
carrying amount of the debt and no interest
expense recognized prospectively provided that an
acquisition of U is not expected. Any remaining
carrying amount of the debt at maturity would be
recognized by U as a gain as long as an
acquisition of A did not occur.
11.4.4.4.2 Subsequent Accounting
ASC 470-60
35-10 If a troubled debt
restructuring involves amounts contingently
payable, those contingent amounts shall be
recognized as a payable and as interest expense in
future periods in accordance with paragraph
450-20-25-2. Thus, in general, interest expense
for contingent payments shall be recognized in
each period in which both of the following
conditions exist:
- It is probable that a liability has been incurred.
- The amount of that liability can be reasonably estimated.
Before recognizing a payable and interest expense
for amounts contingently payable, however, accrual
or payment of those amounts shall be deducted from
the carrying amount of the restructured payable to
the extent that contingent payments included in
total future cash payments specified by the new
terms prevented recognition of a gain at the time
of restructuring (see paragraph 470-60-35-7).
The accounting for probable and actual losses under
contingent payment terms after the debt restructuring depends on whether
those losses were included in the carrying amount at the time of the
restructuring. To the extent that potential losses under contingent
payment terms prevented the recognition of a restructuring gain at the
time of the restructuring (i.e., they are included in the debt’s
carrying amount), the realization of such losses after the debt
restructuring are accounted for as a direct reduction of the debt’s
carrying amount (e.g., as debit to debt and a credit to cash). When the
debt’s carrying amount includes an accrual for such losses at the time
of the restructuring, it would be inappropriate to recognize an
additional payable for the losses without a corresponding reduction in
the carrying amount (i.e., the same losses would be counted twice).
The terms of restructured debt might specify that a
contingent payment obligation expires if a specified event does not
occur by a stated date before the debt matures. If the contingent
payment obligation precluded the recognition of a restructuring gain on
the date of the debt restructuring and the amount of the contingent
payment obligation was therefore included in the carrying amount of the
restructured debt, the expiration of the contingent payment obligation
is accounted for as a partial extinguishment of the restructured debt
(see Section
9.3). Special considerations apply to variable-rate debt
(see Section
11.4.4.6).
Unless the contingent payment feature is bifurcated as a
derivative instrument under ASC 815-15, the debtor should apply a loss
contingency approach in a manner similar to that in ASC 450-20 to accrue
for any estimated losses under contingent payment terms that exceed the
amount of contingently payable amounts that were included in the
carrying amount at the time of the restructuring. That is, the debtor
would recognize interest expense with a corresponding increase to the
carrying amount of the debt (or a separate payable) if such incremental
losses are probable and can be reasonably estimated.
A debtor is required to disclose the extent to which inclusion of
contingent future cash payments prevented the recognition of a
restructuring gain under ASC 470-60-35-7 (see Section 11.5.2).
Connecting the Dots
Although interest payments that vary on the
basis of a variable interest rate are similar to contingent
payments in that their amount is uncertain at the time of the
restructuring, they are accounted for differently from
contingent payments (see Section 11.4.4.6).
11.4.4.5 Put, Call, or Prepayment Features
Sometimes, restructured debt includes put, call, or
prepayment features. For example, as part of the restructuring of a debt
instrument, a call option may be added to the debt or the terms of a
previous call option may be amended. In determining whether to recognize a
restructuring gain, the debtor generally analyzes a call, put, or prepayment
feature that could accelerate the repayment of the restructured debt in a
manner similar to how it analyzes a contingent payment term. That is, the
debtor assumes that it will be required to make the maximum potential amount
of principal and interest payments (e.g., the debt will be outstanding for
the maximum number of periods possible).
A debtor should evaluate whether a put, call, or prepayment
feature in a restructured debt instrument must be bifurcated under ASC
815-15. In performing this analysis, the debtor may be required to use
significant judgment and consider the facts and circumstances. For example,
assume that a debt instrument has a $10 million carrying amount, pays
interest at 10 percent per year, and has a remaining term to maturity of
five years. In a restructuring that is accounted for as a TDR, the principal
amount of the debt is reduced from $10 million to $8 million, and the debtor
obtains an option that allows it to repay the debt at any time for $8
million, plus accrued and unpaid interest. In this restructuring, no gain is
recognized by the debtor because the total future undiscounted cash payments
of $12 million (i.e., $8 million principal and five years of interest at
$800,000 per year [i.e., $8 million × 10% × 5 = $4 million]) exceeds the
carrying amount of $10 million as of the date of restructuring.
Nevertheless, the call option added in the restructuring must be evaluated
in accordance with ASC 815-15, under which it would be acceptable to view
the debt instrument as having an initial recorded investment as of the date
of restructuring of $8 million even though the carrying amount remains $10
million as of such date. If, instead of forgiving the principal amount by $2
million, the creditor reduced the annual interest payable from 10 percent to
5 percent, it would be acceptable for the debtor, in evaluating the call
option under ASC 815-15, to calculate an initial recorded investment as of
the date of restructuring on the basis of the net present value of total
future cash flows after the restructuring. However, in all circumstances,
the hybrid debt instrument (including any embedded feature) must be
accounted for in accordance with the TDR guidance in ASC 470-60.
Because ASC 470-60 requires a debtor to assume that it will need to pay the
maximum amount possible to prevent the recognition of a gain that may not be
realized, contingent payments may be included in the carrying amount of a
debt instrument after a TDR. In this situation, it may be acceptable for the
debtor to assume that any contingent payments (other than embedded
redemption features) that form part of the carrying amount after the
application of TDR accounting do not have to be bifurcated under ASC 815-15
if such bifurcation would alter the TDR accounting. However, the debtor may
need to bifurcate under ASC 815-15 any contingent payments that are not part
of the carrying amount of the debt instrument after TDR accounting is
applied.
11.4.4.6 Variable-Rate Debt
ASC 470-60
35-11 If amounts of future
cash payments must be estimated to apply the
provisions of paragraphs 470-60-35-5 through 35-7
because future interest payments are expected to
fluctuate — for example, the restructured terms may
specify the stated interest rate to be the prime
interest rate increased by a specified amount or
proportion — estimates of maximum total future
payments shall be based on the interest rate in
effect at the time of the restructuring.
Fluctuations in the effective interest rate after
the restructuring from changes in the prime rate or
other causes shall be accounted for as changes in
estimates in the periods in which the changes occur.
However, the accounting for those fluctuations shall
not result in recognizing a gain on restructuring
that may be offset by future cash payments (see the
preceding paragraph and paragraph 470-60-35-7).
Rather, the carrying amount of the restructured
payable shall remain unchanged, and future cash
payments shall reduce the carrying amount until the
time that any gain recognized cannot be offset by
future cash payments.
If interest payments on restructured debt are variable
(e.g., indexed to the prime rate or SOFR), the debtor must estimate the
total amount of undiscounted future variable interest payments. To estimate
that amount, the debtor uses the current variable interest rate in effect at
the time of the restructuring (or the “TDR rate”). For example, if the
restructured debt’s interest payments are indexed to the prime rate, the
debtor estimates future interest payments on the basis of the assumption
that the prime rate will not change in future periods.
The debtor determines whether it should recognize a restructuring gain at the
time of the restructuring as follows:
-
If the carrying amount exceeds the total amount of estimated future undiscounted cash payments (including variable interest payments estimated at the TDR rate and the maximum possible amount of other contingently payable amounts), the debtor recognizes a restructuring gain and a corresponding adjustment to the carrying amount at the time of the restructuring. Unlike the accounting for other contingently payable amounts discussed in Section 11.4.4.4.1, a restructuring gain may be recognized at the time of the debt restructuring even if it is possible that it will be offset by future interest expense should actual payments exceed estimated payments because of an increase in variable interest rates.
-
If the total amount of estimated future undiscounted cash payments (including variable cash payments estimated at the TDR rate and the maximum possible amount of other contingently payable amounts) exceeds the debt’s carrying amount at the time of the restructuring, the debtor does not recognize a restructuring gain.
The debtor’s accounting for the variable-rate debt
instrument after the TDR will depend on the particular facts and
circumstances. Some matters to consider are as follows:
- No gain is recognized on the TDR, and there are no contingently
payable amounts — If the total amount of estimated future
undiscounted cash payments (including variable interest payments
estimated at the TDR rate) exceeds the debt’s carrying amount at the
time of the restructuring (i.e., there was no restructuring gain),
the debtor should recognize interest expense over the life of the
restructured debt for the difference between the carrying amount and
the total amount of undiscounted future principal and estimated
interest payments. This will require the debtor to calculate a new
effective interest rate on the restructured debt on the date of the
restructuring. The effective interest rate on that date will reflect
the rate that equates the present value of the future cash flows
specified by the restructured terms (using the TDR rate as the
variable interest rate) to the carrying amount of the debt on the
restructuring date (which will be the same carrying amount as before
the TDR since no gain was recognized). After the restructuring date,
the debtor accounts for changes in the variable interest rate as a
change in accounting estimate (see ASC 470-60-35-11) and amortizes
any implicit premium that results from the restructuring. In other
words, the restructured debt is subsequently accounted for in the
same manner as any other variable-rate debt instrument that is
issued at a premium. Therefore, the debtor will recognize interest
expense in each subsequent financial reporting period at an amount
equal to (1) interest at the then-current variable rate applicable
to the financial reporting period less (2) the amortization of the
implicit premium (if any) on the debt instrument that resulted from
the restructuring. The debtor can apply either of the following
methods discussed in ASC 320-10-35-18 to calculate the amortization
of any implicit premium on the debt instrument that resulted from
the restructuring:
- The variable rate in effect on the date of the restructuring — Under this approach, the amount of amortization in each financial reporting period is fixed as of the date of the TDR and does not change as the variable interest rate changes. This approach is illustrated in ASC 320-10-55-41.
- The variable rate as it changes over the life of the restructured debt — Under this approach, the amount of amortization in each financial reporting period depends on the variable interest rate, which is subject to change. In each period in which the variable interest rate changes, a new amortization rate is applied prospectively. This approach is illustrated in ASC 320-10-55-43.
The accounting discussed above is consistent with the guidance in ASC 470-60-35-7 provided that the combined effect of accounting for the change in variable interest rates as a change in accounting estimate and amortizing the implicit premium by using one of the above two methods does not result in the recognition of negative interest expense or a gain. For an illustration of this accounting, see Example 11-21.
- Gain is recognized on the TDR, and there are no contingently
payable amounts — If the total amount of estimated future
undiscounted cash payments (including variable interest payments
estimated at the TDR rate) is less than the debt’s carrying amount
at the time of the restructuring, a restructuring gain is recognized
and no future interest expense is recognized on the restructured
debt provided that the TDR rate does not increase. However, because
the variable interest rate will generally change after the date of
the restructuring, the debtor will need to account for such changes.
There are two acceptable methods of accounting for changes in the
variable interest rate after the date of restructuring:
- Cumulative method — Under this approach, interest expense is recognized in a financial reporting period only if the cumulative amount of interest calculated in accordance with the variable rate specified in the terms of the restructured debt exceeds the cumulative amount of estimated interest calculated at the TDR rate. Otherwise, each variable interest payment calculated in accordance with the terms of restructured debt after the date of the restructuring is recognized as a reduction of the carrying amount of the restructured debt. In addition, under this approach, the debtor can reverse previously recognized interest expense to the extent that doing so is necessary to reflect cumulative interest expense (if any) that equals the actual amount of interest in accordance with the variable rate specified in the terms of the restructured debt less the estimated interest amounts calculated at the TDR rate. However, the reported carrying amount of the restructured debt on any financial reporting date cannot be less than the amortized balance of the restructured debt calculated in accordance with the TDR rate. This ensures that negative interest expense is not recognized and that a gain is not recognized before the maturity of the debt. For an illustration of this method, see Example 11-22.
- Period-by-period method — Under this approach, the debtor recognizes interest expense in each financial reporting period in which the variable rate specified in the terms of the restructured debt exceeds the TDR rate regardless of whether the TDR rate exceeded the variable rate specified in the terms of the restructured debt in a prior financial reporting period. The amount of interest expense recognized is equal to the principal amount of the restructured debt multiplied by the excess of the actual variable rate over the TDR rate. In periods in which the TDR rate exceeds the variable rate specified in the terms of the restructured debt, no interest expense is recognized, the carrying amount of the debt is reduced for the actual interest amount calculated at that variable rate, and the debtor is precluded from recognizing a gain or negative interest expense for any excess of the TDR rate over the variable rate. Any such gain would be recognized only on the maturity date of the debt instrument. For an illustration of this method, see Example 11-22.
- Restructured debt includes contingently payable amounts — The accounting for restructured debt with contingently payable amounts will depend on the particular circumstances, including whether there was a gain recognized on the restructuring. In all situations, the debtor should expense any estimated losses under contingent payment terms that exceed the amount included in the carrying amount at the time of the restructuring (see Section 11.4.4.4.2).
In any instance in which the TDR rate exceeds the variable
rate in a subsequent period (i.e., interest rates have decreased since the
date of restructuring), ASC 470-60 precludes the debtor from recognizing a
gain in earnings for the difference between actual and estimated payments
before the debt’s extinguishment (see Section 9.2). The debtor recognizes
any such gain only when no obligations remain (i.e., when the debt is
extinguished).
Example 11-21
Accounting for a TDR — Interest Rate Changes From
Fixed Rate to Variable Rate, and No Gain Is
Recognized on Restructuring
Entity V has a fixed-rate loan with a principal
amount of $325 million and a carrying amount of $333
million, which includes the principal amount plus $8
million of accrued interest. The stated interest
rate on the loan is 12 percent per annum payable
quarterly in arrears. The loan has a remaining term
of five years.
Because of V’s financial
difficulties, the lender agrees on June 1, 20X1, to
restructure the loan as follows:
- The $8 million of accrued interest is forgiven.
- The interest rate is changed to the three-month U.S. Treasury rate payable quarterly in arrears.
On the date of restructuring, the three-month U.S.
Treasury rate is 5.50 percent. There are no
contingently payable amounts on the restructured
loan. The principal amount of the loan is due in a
single payment on the loan’s maturity date.
Entity V estimates the future principal and interest
cash flows on the restructured debt by using the
three-month U.S. Treasury rate on the date of the
restructuring (the TDR rate) and calculates the
total future cash flows on the restructured debt as
follows:
On the basis of the loan’s carrying
amount ($333,000,000) and the future cash flows of
the restructured loan ($414,375,000), V determines
that the effective interest rate on the restructured
loan is 4.94 percent per annum. Because the
principal amount of the original loan was equal to
its carrying amount, the effective interest rate on
the original loan was equal to its stated interest
rate of 12 percent per annum. Since the effective
interest rate of the modified loan is lower than
that of the original loan, the lender has granted a
concession. Because V is experiencing financial
difficulties, the restructuring is a TDR.
Notwithstanding the TDR, in accordance with ASC
470-60, V does not recognize a restructuring gain
because the carrying amount of the loan
($333,000,000) is less than the total amount of
undiscounted future principal and interest cash
payments specified by the new terms
($414,375,000).
After the date of the TDR, V will
recognize interest expense on the restructured loan
at 4.94 percent per annum if there are no changes in
the three-month U.S. Treasury rate. As a result, the
carrying amount of the restructured loan will equal
the $325 million principal payment due on the loan’s
maturity date. However, because three-month U.S.
Treasury rates fluctuate, V will need to account for
changes in the variable interest rate.
Entity V should recognize interest on the loan after
the date of the restructuring at an amount equal to
the applicable three-month U.S. Treasury rate less
the amortization of the implicit $8 million premium
in the carrying amount on the date of restructuring
(i.e., $333 million carrying amount – $325 million
principal amount).This premium must be amortized
over the remaining five-year term of the loan in
accordance with the interest method. Entity V can
elect to use either of the following methods to
amortize the premium:
- The variable rate in effect on the date of the restructuring — Under this approach, the amount of amortization in each financial reporting period is fixed on the date of the restructuring and does not change as the three-month U.S. Treasury rate changes. The fixed amount of the premium amortization is 0.56 percent per annual period (i.e., 5.50 percent TDR rate – 4.94 percent effective rate calculated on the date of restructuring).
- The variable rate as it changes over the life of the restructured debt — Under this approach, the amount of amortization in each financial reporting period will vary depending on the three-month U.S. Treasury rate. In each period in which the three-month U.S. Treasury rate changes, a new amortization rate is applied prospectively.
As a result of the recognition of the periodic
interest on the restructured loan as described
above, the carrying amount of the restructured loan
will equal the principal amount due at maturity.
Example 11-22
Accounting for a
TDR — Interest Rate Changes From Fixed Rate to
Variable Rate, and a Gain Is Recognized on
Restructuring
Entity W has a fixed-rate loan with
a principal amount and carrying amount of $325
million. The stated interest rate on the loan is 12
percent per annum payable quarterly in arrears. The
loan has a remaining term of five years.
Because of W’s financial
difficulties, the lender agrees on January 1, 20X1,
to restructure the loan as follows:
- The $75 million in principal amount is forgiven.
- The interest rate is changed to the three-month U.S. Treasury rate payable quarterly in arrears.
On the date of restructuring, the
three-month U.S. Treasury rate is 5.50 percent.
There are no contingently payable amounts on the
restructured loan. The principal amount of the loan
is due in a single payment on the loan’s maturity
date.
Entity W estimates the future
principal and interest cash flows on the
restructured debt by using the three-month U.S.
Treasury rate on the date of the restructuring (the
TDR rate) and calculates the total future cash flows
on the restructured loan as follows:
On the basis of the loan’s carrying
amount ($325,000,000) and the future cash flows of
the restructured loan ($318,750,000), W determines
that the effective interest rate on the restructured
loan is negative. Because the principal amount of
the original loan was equal to its carrying amount,
the effective interest rate on the original loan was
equal to its stated interest rate of 12 percent per
annum. Since the effective interest rate of the
modified loan is lower than that of the original
loan, the lender has granted a concession. Because W
is experiencing financial difficulties, the
restructuring is a TDR.
In accordance with ASC 470-60, W
recognizes a restructuring gain of $6,250,000 on the
TDR, which equals the amount by which the carrying
amount of the original loan ($325,000,000) exceeds
the total amount of undiscounted future principal
and interest cash payments specified by the new
terms ($318,750,000). The journal entry recognized
to reflect the restructuring gain is as follows:
After recognition of this
restructuring gain, the carrying amount of the loan
is equal to the total undiscounted principal and
interest cash flows on the loan, calculated on the
basis of the TDR rate. Therefore, if the three-month
U.S. Treasury rate did not change during the
remaining life of the loan, all payments made on the
loan would be reflected as a reduction of the loan’s
carrying amount and no interest expense would be
recognized. However, since the three-month U.S.
Treasury rate is expected to change during the
remaining life of the loan, cumulatively, W will
recognize either interest expense on the loan or a
gain on extinguishment of the loan. Although the
total income statement effect will be the same, the
method that W uses to subsequently account for
changes in the U.S. Treasury rate could affect the
classification of the income statement amounts
recognized during the remaining life of the
loan.
As discussed above, there are two
acceptable methods of accounting for changes in the
variable interest rate after the date of
restructuring: the cumulative method and the
period-by-period method. The application of these
two methods is discussed below and is based on the
following assumptions regarding the three-month U.S.
Treasury rate, which for simplicity purposes is
shown only on an annual basis even though the
variable interest is paid quarterly on the loan in
arrears:
Cumulative
Method
Under this approach, variable
interest payments calculated in accordance with the
terms of the restructured loan are recognized in
each period as a reduction of the carrying amount of
the restructured loan except to the extent that the
cumulative variable interest payments exceed the
cumulative estimated interest payments calculated at
the TDR rate. Therefore, interest expense is
recognized only if the interest rates have increased
over the TDR rate on a cumulative basis, in which
case such expense is recognized for the excess of
the cumulative actual interest payments over the
cumulative estimated interest payments calculated at
the TDR rate. However, the reported carrying amount
of the restructured loan on any financial reporting
date cannot be less than the amortized balance of
the restructured loan calculated in accordance with
the TDR rate.
Using this approach, W would
subsequently account for the loan after the
restructuring date as follows:
Period-by-Period Method
Under this approach, variable
interest payments after the date of restructuring
are recognized as a reduction of the carrying amount
of the restructured loan except to the extent that
the variable interest rate in any financial
reporting period exceeds the TDR rate. In any
financial reporting period in which the variable
interest rate exceeds the TDR rate, the debtor
recognizes interest expense for the excess
regardless of whether the TDR rate exceeded the
variable rate in a prior financial reporting period.
The amount of interest expense recognized is equal
to the principal amount of the restructured debt
multiplied by the excess of the variable rate
specified in the terms of the restructured debt over
the TDR rate. The debtor is precluded from
recognizing a gain, or negative interest expense, in
any financial reporting period in which the TDR rate
exceeds the variable rate. A gain on extinguishment
may only be recognized on the maturity date of the
debt instrument.
Using this approach, W would
subsequently account for the loan after the
restructuring date as follows:
11.4.4.7 Comparison of ASC 470-50 and ASC 470-60
A debt modification or exchange that qualifies as a TDR
should be accounted for as a modification of the debt terms under ASC 470-60
irrespective of whether the original and new terms are substantially
different. This is unlike the analysis of a debt modification or exchange
that does not qualify as a TDR under ASC 470-50, which should be accounted
for as a debt modification or an extinguishment depending on whether the
terms are substantially different (see Chapter 10). The table below depicts
key differences between the accounting for a debt modification or exchange
depending on whether the transaction qualifies as a TDR.
|
TDR (ASC 470-60)
|
Not a TDR (ASC 470-50)
| ||
|---|---|---|---|
|
Future Undiscounted Cash Flows
Exceed Original Carrying Amount
|
Original Carrying Amount Exceeds
Future Undiscounted Cash Flows
| ||
|
Terms substantially different
|
|
|
|
|
Terms not substantially different
|
|
|
|
The example below discusses a debt modification that
qualifies as a TDR.
Example 11-23
Debtor’s Analysis of a Debt Modification That
Qualifies as a TDR
Entity X issues debt on which it
must make interest payments of $100 at the end of
each year for five more years and repay the $1,000
face amount at the end of those five years. The
stated interest rate is 10 percent, compounded
annually. The debt’s initial and current carrying
amount is $1,000, and the annual effective interest
rate implicit in the debt is also 10 percent. If all
contractual amounts are paid, the debtor’s total
interest expense will be $500 — the difference
between the total amount to be paid ($1,500) and the
debt’s carrying amount ($1,000). The effective
interest rate on the $1,000 carrying amount will be
10 percent.
Entity X and the creditor are
considering whether to modify the debt in one of the
following four ways:
-
Timing of interest only — Terms modified to defer payment of interest until the debt matures (a single collection of $500 at the end of five years is substituted for five annual collections at $100).
-
Amount of interest only — Terms modified to leave unchanged the timing of interest and the timing and amount of principal payment but to reduce the annual interest from $100 to $60.
-
Amount of principal only — Terms modified to leave unchanged the amounts and timing of interest but to reduce the principal amount to $800 due at the end of five years.
-
Both timing of interest and principal amount — Terms modified to defer collection of interest until the debt matures and to reduce the principal amount to $800 (modifications 1 and 3 combined).
The contractual cash payments before
the modification and in the above four modification
scenarios are as follows:
If X and the creditor modified the
debt terms in accordance with one of the above four
scenarios and the modification qualifies as a TDR
under ASC 470-60, X would reduce the effective
interest rate used to calculate interest expense on
the debt prospectively in each of the four
modification scenarios above in accordance with ASC
470-60-35-5 (see Section
11.4.4.2). The revised effective interest
rate would be the discount rate that equates the
future cash payments specified by the new terms with
the debt’s carrying amount (see row (d) in the table
below). Because the modified remaining cash payments
would exceed the carrying amount, the carrying
amount would not be adjusted, and there would be no
restructuring gain in any scenario in accordance
with ASC 470-60.
The following table illustrates the
analysis under ASC 470-60 of each of these
scenarios:
If the debt modification was not a
TDR, the accounting analysis for the same set of
facts would be different. Because the present value
of the modified cash payments discounted at the
original effective interest rate would be more than
10 percent different from the carrying amount (i.e.,
the present value of the original cash payments
discounted at the original effective interest rate)
in scenarios 2, 3, and 4, the original debt would be
accounted for as an extinguishment under ASC 470-50
(see Section 10.4.2).
Therefore, the new debt would be recognized at its
fair value as of the modification date, an
extinguishment gain or loss would be recognized for
the difference between the carrying amount and the
current fair value, and a new effective interest
rate would be calculated on the basis of the initial
carrying amount of the modified debt.
In scenario 1, the present value of
the modified cash payments discounted at the
original effective interest rate is less than 10
percent different from the carrying amount.
Therefore, the debt would not qualify for
extinguishment accounting under ASC 470-50 (see
Section 10.4.3). Instead, X would
calculate a revised effective interest rate in
accordance with ASC 470-50-40-14 (see row (l)
below). The table below illustrates the analysis
under ASC 470-50 of each of the above modification
scenarios in situations in which the modification
does not qualify as a TDR. It is assumed in the
scenarios that the applicable current market
interest rate for the debt is 5.5 percent.
11.4.5 Accounting for a Combination of TDR Characteristics
ASC 470-60
35-8 A troubled debt
restructuring may involve partial settlement of a
payable by the debtor’s transferring assets or granting
an equity interest (or both) to the creditor and
modification of terms of the remaining payable. Even if
the stated terms of the remaining payable, for example,
the stated interest rate and the maturity date or dates,
are not changed in connection with the transfer of
assets or grant of an equity interest, the restructuring
shall be accounted for as prescribed by this guidance. A
debtor shall account for a troubled debt restructuring
involving a partial settlement and a modification of
terms as prescribed in paragraphs 470-60-35-5 through
35-7 except that, first, assets transferred or an equity
interest granted in that partial settlement shall be
measured as prescribed in paragraphs 470-60-35-2 and
470-60-35-4, respectively, and the carrying amount of
the payable shall be reduced by the total fair value of
those assets or equity interest. If cash is paid in a
partial settlement of a payable in a troubled debt
restructuring, the carrying amount of the payable shall
be reduced by the amount of cash paid. A difference
between the fair value and the carrying amount of assets
transferred to the creditor shall be recognized as a
gain or loss on transfer of assets. No gain on
restructuring of payables shall be recognized unless the
remaining carrying amount of the payable exceeds the
total future cash payments (including amounts
contingently payable) specified by the terms of the debt
remaining unsettled after the restructuring. Future
interest expense, if any, shall be determined according
to the provisions of paragraphs 470-60-35-5 through
35-7.
Some TDRs involve a partial settlement of the debt through a transfer of cash or
other assets or the issuance of equity instruments. The terms of the remaining
debt might also be modified. When a TDR involves a combination of the
characteristics in ASC 470-60-15-9(a)–(c), the accounting is as follows:
-
The debt’s carrying amount is reduced by the amount of any cash paid to the creditor.
-
The debtor recognizes a gain or loss on any noncash assets transferred that is equal to the difference between their carrying amount and fair value and reduces the debt’s carrying amount by that fair value.
-
The debtor recognizes the issuance of any equity instruments at fair value and reduces the carrying amount of the debt by that fair value.
-
Once the carrying amount has been reduced for the amount of cash and the fair value of any assets transferred or equity interests granted, the debtor applies the accounting requirements for troubled debt modifications and exchanges (see Section 11.4.4) to the remaining debt on the basis of the reduced carrying amount.
The guidance in ASC 470-60-35-8 applies to a TDR with a
combination of the characteristics specified in ASC 470-60-15-9(a)–(c) even if
such TDR does not involve a partial settlement of the debt (e.g., an asset
transfer and debt modification that does not involve a reduction of the debt’s
principal amount). Also, note that the fair value of the assets transferred or
equity instruments issued may be different from any reduction in the debt’s
carrying amount agreed to by the debtor and creditor.
Example 11-24
Accounting for a
Modification Involving a Reduction of Interest Rate
on a Payable in Exchange for an Issuance of Common
Stock
Entity Y issues common stock to
fixed-rate debt holders in exchange for delaying
interest payments on the outstanding debt. The
transaction qualifies as a TDR. Although none of the
debt has been settled as a result of this transaction,
this arrangement is analogous to a TDR with a
combination of the characteristics described in ASC
470-60-15-6(a)–(c).
Entity Y should reduce the carrying
amount of the debt by the fair value of the common stock
issued, and it would not record a gain because the
adjusted carrying amount of the debt does not exceed the
total future cash payments required by the new terms
(only the timing of the payments was affected). The
reduction of the carrying amount effectively creates a
discount on the debt, which will result in increased
interest expense prospectively over the remaining term
of the debt, as described in ASC 470-60-35-5 through
35-7.
11.5 Presentation and Disclosure
11.5.1 Current Versus Noncurrent Classification
ASC 470-60
45-1 All or a portion of the
carrying amount of the payable at the time of the
restructuring may need to be reclassified in the balance
sheet because of changes in the terms, for example, a
change in the amount of the payable due within one year
after the date of the debtor’s balance sheet.
45-2 A troubled debt
restructuring of a short-term obligation after the date
of a debtor’s balance sheet but before that balance
sheet is issued or is available to be issued (as
discussed in Section 855-10-25) may affect the
classification of that obligation in accordance with
Subtopic 470-10.
Like a credit-related covenant violation that takes place after
the balance sheet date, a TDR that occurs after the balance sheet date may
affect the classification of the related debt as current or noncurrent (see
Section
13.5).
11.5.2 Disclosure
ASC 470-60
50-1 A debtor shall
disclose, either in the body of the financial statements
or in the accompanying notes, all of the following
information about troubled debt restructurings that have
occurred during a period for which financial statements
are presented:
- For each restructuring, a description of the principal changes in terms, the major features of settlement, or both; separate restructurings within a fiscal period for the same category of payables (for example, accounts payable or subordinated debentures) may be grouped for disclosure purposes
- Aggregate gain on restructuring of payables
- Aggregate net gain or loss on transfers of assets recognized during the period (see paragraphs 470-60-35-3 and 470-60-35-8)
- Per-share amount of the aggregate gain on restructuring of payables.
Pending Content (Transition
Guidance: ASC 220-40-65-1)
50-1 A debtor shall disclose, either
in the body of the financial statements or in the
accompanying notes, all of the following
information about troubled debt restructurings
that have occurred during a period for which
financial statements are presented:
-
For each restructuring, a description of the principal changes in terms, the major features of settlement, or both; separate restructurings within a fiscal period for the same category of payables (for example, accounts payable or subordinated debentures) may be grouped for disclosure purposes
-
Aggregate gain on restructuring of payables
-
Aggregate net gain or loss on transfers of assets recognized during the period (see paragraphs 470-60-35-3 and 470-60-35-8)
-
Per-share amount of the aggregate gain on restructuring of payables.
See paragraphs 220-40-50-21 through 50-25
for additional disclosure
requirements.
50-2 A debtor shall disclose
in financial statements for periods after a troubled
debt restructuring the extent to which amounts
contingently payable are included in the carrying amount
of restructured payables pursuant to the provisions of
paragraph 470-60-35-7. If required by paragraphs
450-20-50-1 through 50-6 and 450-20-50-9 through 50-10,
a debtor shall also disclose in those financial
statements total amounts that are contingently payable
on restructured payables and the conditions under which
those amounts would become payable or would be
forgiven.
ASC 470-60-50-1 and 50-2 specify the disclosure requirements for
a TDR that has occurred during a financial reporting period. Such disclosures
are required even if the debt is no longer outstanding.