Chapter 5 — Accounting for Debt Issuance Costs and Fees

5.3 Costs and Fees Associated With Nonrevolving Debt

5.3.1 Background

Before nonrevolving debt is issued, qualifying costs and fees associated with the contemplated issuance are deferred as an asset (see Section 5.3.2), including any loan commitment fees paid to the creditor (see Section 5.3.3). Upon the debt’s issuance, the costs to issue it are presented as a deduction from the debt’s net carrying amount in a manner similar to a debt discount (see Section 4.3.6). Fees paid to the creditor are treated as a reduction of the debt proceeds received, not as a debt issuance cost (see Section 5.3.3.2). Debt issuance costs associated with nonrevolving debt are amortized to interest expense over the life of the related debt in a manner similar to a debt discount (see Chapter 6).

The guidance in this section does not apply to debt for which the issuer has elected the fair value option in ASC 815-15 (see Section 8.5.6) or ASC 825-10 (see Section 4.4). If a transaction involves multiple units of account, the issuer should allocate the related issuance costs among those units of account (see Section 3.5).

5.3.2 Accounting for Costs and Fees Incurred Before Debt Issuance

5.3.2.1 General

Entities often incur fees and costs in connection with a debt issuance before the recognition of the debt liability (e.g., document preparation costs, legal fees, and commitment fees). ASC 835-30 does not address the balance sheet presentation of such fees and costs. In developing ASU 2015-03, the FASB considered but ultimately decided against providing guidance on the accounting for costs incurred before the receipt of debt proceeds. Paragraph BC4 of ASU 2015-03 states, in part:

The Board acknowledges that costs may be incurred before an associated debt liability is recorded in the financial statements (for example, the costs are incurred before the proceeds are received on a debt liability or costs incurred in association with undrawn line of credit). However, the Board did not consider providing explicit guidance in circumstances in which the proceeds have not yet been received because it observed that in practice entities defer issuance costs and apply them against the proceeds when they are received. For example, the accounting treatment for issuance costs associated with equity instruments is that the costs generally are deferred and charged against the gross proceeds of the offering (paragraph 340-10-S99-1).

Entities should present specific incremental costs and fees that are directly attributable to a contemplated issuance of debt as a deferred charge (i.e., an asset) before the issuance of the debt. This treatment applies to eligible costs and fees paid to the creditor and third parties even though amounts paid to the creditor ultimately represent a reduction of proceeds as opposed to debt issuance costs. It would be inappropriate to record a contra-liability when there is no associated liability. On the date on which the issued debt is recognized as a liability, the carrying amount of the deferred charge is reclassified as a reduction of the initial carrying amount of the debt unless those costs and fees are attributable to a line-of-credit or revolving-debt arrangement (see Section 5.4). Costs and fees paid to third parties are treated as debt issuance costs (see Section 5.3.3.1), whereas costs and fees paid to the creditor are treated as a direct deduction from the proceeds (see Section 5.3.3.2).

If an entity incurs fees and costs in connection with a contemplated debt issuance and it becomes probable that the debt will not be issued, the entity should immediately expense any related costs and fees, including any previously deferred costs, in a manner consistent with the guidance on loss contingences in ASC 450-20-25-2 (see Deloitte’s Roadmap Contingencies, Loss Recoveries, and Guarantees). Similarly, any previously deferred costs and fees should be expensed if a contemplated debt offering is aborted (including an anticipated debt offering that is postponed for more than 90 days; see Section 5.2).

5.3.2.2 Nonrevolving Loan Commitment Fees

An entity may incur costs and fees to obtain a nonrevolving loan commitment. Such expenses are sometimes paid in a form other than cash. For instance, start-up and emerging companies that have limited cash resources often issue contracts on their own equity in exchange for commitments to obtain debt financing (e.g., warrants that vest on the basis of debt draws).

As discussed in Section 2.3.3, a commitment to obtain debt financing usually is exempt from derivative accounting requirements in accordance with the scope exception in ASC 815-10-15-69. It is generally appropriate for an entity to defer fees and costs it has paid for a commitment to obtain nonrevolving debt as an asset until the related debt is drawn. The potential debtor’s deferral of loan commitment costs and fees as an asset is analogous to the creditor’s treatment of fees received for a loan commitment under ASC 310-20-25-11, which generally requires commitment fees to be deferred.

Example 5-1

Warrant Issued in Exchange for Delayed-Draw Term Loan Commitment

Company A executes a delayed-draw term loan agreement with Bank B, which permits, but does not require, A to draw up to $125 million of term loans in five separate tranches of $25 million each on specified future dates. Company A determines that its commitment to obtain term loans from B should not be accounted for as a derivative under ASC 815. Instead, the loan commitment represents an asset. In exchange for the commitment, A agrees to issue a warrant that allows B to purchase shares of A’s common stock. The warrant is issuable and only exercisable by B if A elects to obtain term loan funding from B. The number of shares that A will deliver to B upon exercise of the warrant is indexed to the principal amount of term loans issued under the agreement. Company A has determined that the warrant issued to B is a single freestanding financial instrument (see Chapter 3).

Under ASC 815-40, the warrant is outstanding for accounting purposes even though it is contingent on debt draws and is not legally issued until such debt draws occur (see Section 2.8 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity). Company A determines that the warrant is not within the scope of ASC 480 since it does not embody an obligation of A (see Section 2.2.1.3 of Deloitte’s Roadmap Distinguishing Liabilities From Equity); that is, A is under no obligation to draw debt and the warrant does not become issued or exercisable unless A issues debt under the agreement. However, because the amount of debt draws is not an input into the pricing of a fixed-for-fixed option on A’s own equity, the warrant does not qualify as equity under ASC 815-40-15 (see Section 4.3.3 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity) but must be recognized by A as a liability initially and subsequently at its fair value (see Section 6.2 of Deloitte’s Roadmap Contracts on an Entity’s Own Equity). Company A determines that the initial fair value of the warrants is $1.5 million. Accordingly, A makes the following accounting entry to recognize its loan commitment asset (it is assumed in this entry that the initial fair value of the warrant equals the initial value of the loan commitment asset):

Note that in this example, the warrant is considered a freestanding financial instrument, which is generally the case for these types of arrangements. If, however, the warrant was considered embedded in the loan commitment, the warrant would be bifurcated from the loan commitment host contract and recognized as a derivative liability unless it did not meet the definition of a derivative. An entity would not be able to apply the loan commitment scope exception to the warrant because this scope exception could only be applied to the host contract.

If all or a portion of the total commitment amount is funded, a proportionate amount of the commitment asset reduces the initial net carrying amount of the funded debt. This accounting treatment is different from that for revolving loan commitment fees, which are deferred and amortized as an asset over the term of the revolving debt (see Section 5.4).

Example 5-2

Funding of Delayed-Draw Term Loan Commitment

After obtaining the delayed-draw term loan commitment described in Example 5-1, Company A requests and obtains $25 million of term loan funding from Bank B. Company A continues to have a right to obtain funding of $100 million from B in accordance with the terms of the commitment. Accordingly, A reclassifies as debt discount a portion of the amount originally deferred as a loan commitment asset. The amount reclassified corresponds to the proportion of the amount of term loan funding obtained compared with the total amount of funding that was originally available under the loan commitment, or $1,500,000 × ($25,000,000 ÷ $125,000,000). Company A recognizes the debt discount as follows:

Since the warrant represents a unit of account that is separate from the loan commitment, it continues to be accounted for under ASC 815-40. If the warrant represents a single unit of account, it will continue to be accounted for in its entirety as a liability at fair value, with changes in fair value recognized in earnings. Such accounting is not affected by the reclassification of a portion of the loan commitment asset as debt discount.

Note that this example does not specifically address A’s evaluation of whether any portion of the loan commitment asset becomes impaired because A does not expect to fund term loans under the debt agreement.

If a term loan commitment is canceled or terminates, the related commitment costs and fees are immediately expensed. Expense recognition is also required if it becomes probable that (1) the debtor will not meet all of the conditions that it must satisfy to draw down on a commitment or (2) the creditor will not be financially capable of honoring the commitment.

5.3.2.3 Shelf Registration Costs and Fees

Nonauthoritative AICPA Guidance

Technical Q&As Section 4110, “Issuance of Capital Stock”

.10 Costs Incurred in Shelf Registration

Inquiry — A public company incurs legal and other fees in connection with an SEC filing for a stock issue it plans to offer under a shelf registration. How should the company account for these costs?

Reply — The costs should be capitalized as a prepaid expense. When securities are taken off the shelf and sold, a portion of the costs attributable to the securities sold should be charged against paid in capital. Any subsequent costs incurred to keep the filing “alive” should be charged to expense as incurred. If the filing is withdrawn, the related capitalized costs should be charged to expense.

A shelf registration permits a company to issue securities in one or more separate future offerings, with the size and price determined at the time of sale. AICPA Technical Q&As Section 4110.10 addresses the accounting for “legal and other fees in connection with an SEC filing for a stock issue [a public company] plans to offer under a shelf registration.” It is appropriate to apply this guidance by analogy to the costs and fees incurred by an entity to set up a shelf registration of debt securities. Under the AICPA’s guidance, the initial shelf registration costs are capitalized as a prepaid expense (i.e., deferred as an asset). When the entity issues securities under the shelf, an appropriate portion of the deferred costs is reclassified as a debt issuance cost of the issued debt. For example, deferred costs might be allocated to current and future debt offerings on the basis of estimates of the amount of debt the entity might issue under the shelf over its expected life. Any subsequent costs to maintain the shelf registration (i.e., to keep it “alive”) are charged to expense as incurred. If the filing is withdrawn or expires, any remaining capitalized costs should be immediately expensed. If an entity incurs costs and fees in connection with a shelf registration but it becomes probable that the entity will not use it, the entity should immediately expense any related costs and fees, including any previously deferred costs, in a manner consistent with the guidance on loss contingences in ASC 450-20-25-2 (see Deloitte’s Roadmap Contingencies, Loss Recoveries, and Guarantees).

5.3.2.4 Secondary Offering Costs

Contracts governing the sale of debt securities that are sold in a private placement offering (a “primary offering”) often require the issuer to register the securities with the SEC within a specified period. It is common for these contracts to specify a penalty, such as a higher interest rate for debt securities, for failure to complete the registration. Registration of the securities is usually accomplished through a secondary offering, which does not yield any proceeds.

The appropriate accounting for the specific incremental costs directly attributable to the secondary offering (e.g., underwriting fees, attorneys’ fees, and accountants’ fees) depends on the circumstances. Informal discussions with the SEC staff have indicated that the acceptable method of accounting for the secondary offering costs depends on whether the terms of the primary offering contractually require the issuer to effect a secondary offering.

5.3.2.4.1 Contractual Obligation Is Present in Primary Offering

If, as of the date of the primary offering, the issuer is contractually obligated to enter into a secondary offering (e.g., a registration rights agreement), the obligation constitutes a liability for future third-party registration costs that should be recognized as of the date of the primary offering as an additional cost of the offering. The issuer should estimate and defer as a debt issuance cost the specific incremental costs of the secondary offering upon completion of the primary offering (assuming that completion of the registration is deemed to be probable within a reasonable period), as applicable.

This guidance is supported by the fact that the costs of the secondary offering meet the definition of a liability upon completion of the primary offering. Furthermore, recognition of the secondary offering costs as an expense as of the date of the primary offering, or as incurred, appears inconsistent with analogous guidance in ASC 825-20. In accordance with ASC 825-20-30-4, “[i]f the transfer of consideration under a registration payment arrangement is probable and can be reasonably estimated at inception, the contingent liability under the registration payment arrangement shall be included in the allocation of proceeds from the related financing transaction” and not recorded as an expense.

5.3.2.4.2 Contractual Obligation Is Not Present in Primary Offering

If there is no contractual obligation to enter into a secondary offering as of the date of the primary offering, the two offerings are disassociated and the costs of the secondary offering should be expensed as incurred. This approach is supported analogously in SAB Topic 5.A, which states, in part:

Specific incremental costs directly attributable to a proposed or actual offering of [equity] securities may properly be deferred and charged against the gross proceeds of the offering. However, management salaries or other general and administrative expenses may not be allocated as costs of the offering and deferred costs of an aborted offering may not be deferred and charged against proceeds of a subsequent offering. A short postponement (up to 90 days) does not represent an aborted offering. [Emphasis added]

In essence, SAB Topic 5.A requires consideration of whether transaction costs have been incurred as part of a single, combined offering or as the result of a separate, subsequent offering. If there is no contractual obligation to have a secondary offering, entities should treat the secondary offering as a separate subsequent offering. Because the separate secondary offering does not result in additional proceeds (i.e., no additional capital raising), the costs associated with the secondary offering should be expensed as incurred. That is, the secondary offering is the economic equivalent of an aborted offering.

5.3.3 Accounting for Costs and Fees Upon Debt Issuance

5.3.3.1 Debt Issuance Costs

ASC 835-30

45-1A [D]ebt issuance costs related to a note shall be reported in the balance sheet as a direct deduction from the face amount of that note. [D]ebt issuance costs shall not be classified as a deferred charge . . . .

Debt issuance costs must be presented as a direct deduction from the carrying amount of a debt liability once the debt is issued. Therefore, such costs are treated in the same manner as a debt discount (see Section 4.3.6).

Example 5-3

Initial Recognition of Debt Issuance Costs

Entity D issues long-term debt at par for cash proceeds of $100 million. It incurs $1 million of debt issuance costs. Therefore, D makes the following entry:

Entities are not permitted to present debt issuance costs as deferred charges (i.e., assets) unless the debt has not yet been issued (see Section 5.3.2) or the costs are related to line-of-credit or revolving-debt arrangements (see Section 5.4).

After the issuance of the debt, debt issuance costs are amortized as additional interest expense over the life of the debt in a manner similar to a debt discount (see Section 6.2) unless the issuer has elected the fair value option in ASC 815-15 or ASC 825-10 for the debt, in which case any up-front costs and fees are expensed as incurred (see Section 5.5).

5.3.3.2 Fees and Other Amounts Paid to the Creditor

Issuance costs are limited to incremental and direct costs incurred with parties other than the investor (creditor). Although amounts paid to both the creditor and third parties in connection with a debt issuance reduce the debt’s initial net carrying amount, the distinction between amounts paid to the creditor and amounts paid to third parties is relevant in certain situations. For example, an entity treats amounts paid to the creditor differently from amounts paid to a third party when it evaluates whether a put or call option embedded in a debt host contract should be bifurcated as a derivative (see Section 8.4.4). That evaluation includes an assessment of whether a significant discount or premium exists. Whereas creditor fees affect the size of any discount or premium, third-party costs do not. Further, entities treat creditor fees and third-party costs differently when evaluating and accounting for debt modifications and extinguishments under ASC 470-50 (see Section 10.3.3.2.4). Therefore, a debtor may need to distinguish and separately track the amount of debt discounts and debt issuance costs.

Amounts paid to the creditor upon issuance represent a reduction in the proceeds received. Accordingly, such amounts are treated as an increase to a debt discount or a reduction in a debt premium and not as an issuance cost. Examples of such amounts include origination fees, commitment fees, reimbursement of the creditor’s expenses, and other amounts paid to the creditor in connection with the issuance of the debt. Depending on the relationship between the debtor and creditor, amounts paid to the creditor could represent a dividend or other equity distribution (see Section 3.3.3.4). An entity should use judgment and consider the particular facts and circumstances when determining what these amounts represent.

In some situations, an amount paid to a creditor may represent compensation for services associated with the issuance of the debt to parties other than the creditor. Such amounts may be appropriately characterized as debt issuance costs. For example, some portion of the total fees paid to a lead financial institution in a syndicated loan with multiple lenders (see Section 10.3.2.4) may represent arrangement fees associated with the placement of debt to other participating lenders (such amounts represent debt issuance costs). Issuers of debt will need to use judgment on the basis of the particular facts and circumstances to determine whether a portion of fees paid to a lead bank should be treated as debt issuance costs and, if so, how that amount is determined. In making this determination, entities should be mindful that a lead bank may pass on fees it receives to participating banks in a syndication. Such fees would not represent debt issuance costs since the lead bank is merely functioning as an agent to pass on fees to other lenders in the arrangement.

As another example, in some debt offerings the proceeds received are reduced by an amount described as an “initial purchasers’ discount,” which is payable to a bank that has helped arrange the offering. If the related amount serves to compensate the bank for underwriting fees and the bank immediately transfers the debt to third-party investors that pay the stated principal amount without deduction for the initial purchasers’ discount, the related amount represents a debt issuance cost. However, if the bank continues to hold some or all of the debt or the ultimate investors receive some or all of the discount through a reduction in the price they pay for the debt, some or all of the amount represents a debt discount.

5.3.4 Accounting After Debt Issuance

ASC 835-30

45-3 Amortization of discount or premium shall be reported as interest expense in the case of liabilities or as interest income in the case of assets. Amortization of debt issuance costs also shall be reported as interest expense.

Unless a debt instrument is subsequently measured at fair value on a recurring basis (see Section 5.5), any debt issuance costs reduce the instrument’s initial net carrying amount in a manner similar to a debt discount (see Section 4.3.6). Under ASC 835-30-45-3, both debt discount and debt issuance costs must be amortized and reported as interest expense. Further, ASC 470-50-40-18(a), which addresses the accounting for modifications and exchanges of debt instruments (see Chapter 10), implies that debt issuance costs should be amortized by using the interest method. It states, in part:

[C]osts [incurred with third parties] shall be associated with the new debt instrument and amortized over the term of the new debt instrument using the interest method in a manner similar to debt issue costs.

Accordingly, entities should reflect eligible debt issuance costs as an adjustment to the initial proceeds received in the calculation of the debt’s original effective interest rate (see Section 6.2.3).

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