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:
Costs 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).