PDF - A guide to accounting for debt modifications and restructurings

A GUIDE TO ACCOUNTING FOR DEBT MODIFICATIONS

AND RESTRUCTURINGS

June 2023

A GUIDE TO ACCOUNTING

FOR DEBT MODIFICATIONS

AND RESTRUCTURINGS

June 2023

A GUIDE TO ACCOUNTING FOR DEBT MODIFICATIONS

AND RESTRUCTURINGS

is edition of A Guide to Accounting for Debt Modiﬁcations and Restructurings has been produced

by the National Professional Standards Group of RSM US LLP.

We would like to acknowledge the eﬀorts of the contributors to the June 2023 edition of this publication:

• Brian Marshall, Partner

• RoAnna Pascher, Senior Director

We would also like to acknowledge the contributions of Patricia Baldowski, Partner, and Alpesh Shah, Senior Manager.

June 2023

e FASB material is copyrighted by the Financial Accounting Foundation, 801 Main Avenue, Norwalk, CT 06851,

and is used with permission.

 
 
 
 
 
 
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TABLE OF CONTENTS 
Introduction ..................................................................................................................... 1 
1  Determining whether the same lender is involved before and after changes are made to the 
debt .................................................................................................................................................... 3 
2  Convertible debt ............................................................................................................................... 4 
3  Effective interest method ................................................................................................................. 4 
Relevant literature and general concepts ..................................................................... 6 
1  Liability derecognition ..................................................................................................................... 6 
1.1  Liability derecognition threshold ........................................................................................... 6 
1.2  Continuing term loans with the same lender ........................................................................ 7 
2  TDR accounting ................................................................................................................................ 7 
2.1  Nature, scope and unit of account ....................................................................................... 7 
2.2  Determining whether a TDR exists ...................................................................................... 9 
2.3  Series of restructurings on same debt ............................................................................... 14 
2.4  TDR accounting model ....................................................................................................... 14 
2.5  Direct costs incurred with third parties in a TDR ................................................................ 23 
2.6  Lender fees incurred in the restructuring ........................................................................... 24 
2.7  Preexisting unamortized debt discount .............................................................................. 24 
2.8  Classification considerations .............................................................................................. 24 
2.9  Disclosures ......................................................................................................................... 25 
3  Extinguishment and modification accounting models for term loans ...................................... 25 
3.1  Scope ................................................................................................................................. 25 
3.2  Which model applies? ........................................................................................................ 27 
3.3  Extinguishment accounting model ..................................................................................... 36 
3.4  Modification accounting model ........................................................................................... 38 
3.5  Accounting for fees and costs incurred .............................................................................. 39 
3.6  Fees between borrower and lender trigger accounting assessment ................................. 41 
3.7  Loan participations and syndications ................................................................................. 42 
3.8  Third-party intermediaries .................................................................................................. 42 
3.9  Transactions between lenders ........................................................................................... 43 
4  Modification of a line-of-credit arrangement ............................................................................... 43 
4.1 Modifications of undrawn delayed-draw term loan commitments ........................................... 44 
5  Changing from term loan to line-of-credit and vice versa .......................................................... 44 
6  Debt disclosures ............................................................................................................................. 45 
Examples ........................................................................................................................46 
1  Liability derecognition threshold .................................................................................................. 46 
2  TDR with modification of terms in which no gain is recognized ............................................... 47 
3  TDR with modification of terms in which a gain is recognized ................................................. 50 
4  TDR with transfer of assets and modification of terms .............................................................. 52 
5  Changes to prepayable debt that result in modification accounting ........................................ 55 
6  Changes to prepayable debt including incremental borrowings .............................................. 58 
7  Changes to prepayable delayed-draw term loan (DDTL) ............................................................ 62 
8  Changes to prepayable debt with partial repayment of principal ............................................. 65 
9  Changes to debt that result in extinguishment accounting ....................................................... 69 
10  Changes to prepayable loans in a syndication ........................................................................... 71 

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3.11 Multiple changes to prepayable debt within a one-year period ................................................. 77

3.12 Multiple changes to prepayable debt with a prepayment fee based on a percentage of

principal within a one-year period ................................................................................................ 80

3.13 Line-of-credit modification with decrease in borrowing capacity ............................................. 84

3.14 Line-of-credit arrangement modification with increase in borrowing capacity ....................... 85

Appendix A: Acronyms, literature and technical accounting guide and whitepaper

references ..........................................................................................................87

Appendix B: Definitions .........................................................................................................89

Appendix C: U.S. GAAP vs. IFRS Comparison .....................................................................93

Appendix D: Summary of significant changes .....................................................................97

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1 Introduction

Borrowers may seek to renegotiate the terms of existing loans because they are not able to meet current

loan covenants or cash flow requirements under their loans, or because they want to increase the amount

borrowed or obtain lower interest rates. Lenders may be willing to renegotiate the terms of existing loans

because they realize that it may be in their best interests to reconsider the terms of a loan instead of: (a)

losing the borrower to a competitor that is willing to provide a reduced interest rate because of an

improvement in the borrower’s credit quality or a reduction in market interest rates, (b) forcing the

borrower to find another lender or file for bankruptcy or (c) foreclosing on any collateralized assets. As a

result of the renegotiations, the borrower and lender may agree to modify or restructure an existing loan

or exchange one loan for another. The degree of change introduced by the modification, restructuring or

exchange (collectively referred to as changes) depends on any number of factors, first and foremost

being the financial condition and prospects of the borrower.

Naturally, there are accounting implications when the borrower and lender agree to modify or restructure

an existing loan or exchange one loan for another. The accounting implications differ depending on

whether the borrower’s or lender’s accounting is being considered. This guide deals solely with the

borrower’s accounting for changes made to its loans. Depending on the facts and circumstances, different

accounting outcomes could result for the borrower. For example, the borrower may be required to

recognize a gain or loss in the period of the changes, or the borrower may be required to recognize the

effects of the changes in future periods through an adjustment to the effective interest rate. A thorough

analysis of the borrower’s facts and circumstances and the relevant authoritative accounting literature is

required to ultimately determine how the borrower should account for changes to its loans. In some

circumstances, a significant amount of professional judgment must be exercised in making this

determination.

To identify the appropriate accounting model to apply to changes to a loan, the borrower must first

determine whether it has met the threshold to remove a liability from its books (i.e., derecognize the

liability and apply the extinguishment accounting model). Typically, this liability derecognition threshold is

met when the changes involve an old loan being paid off with proceeds from a new loan with a new

lender (i.e., an unrelated party that was not considered a lender with respect to the old loan), provided

there is no continuing debt with the old lender. In contrast, this threshold is not met just because the

borrower and the same lender exchange cash to satisfy an existing loan and issue a new loan. For

additional information about determining whether the same lender is involved in the loan before and after

changes are made, see Section 1.1. For additional information about determining whether the liability

derecognition threshold has been met, see Section 2.1.

If the liability derecognition threshold has not been met, then the borrower must determine whether it

should apply the accounting model for a troubled debt restructuring (TDR), which is discussed in detail in

Section 2.2. In some cases, a TDR results from the full settlement of debt through the transfer of cash,

noncash assets or equity (i.e., the debt is derecognized in the TDR). While the net effect on the income

statement is the same regardless of whether the extinguishment or TDR accounting model is applied in

these cases, there are additional accounting and disclosure requirements for a TDR. As such,

consideration should be given to whether the derecognition of debt meets the conditions present in a

TDR.

If the liability derecognition threshold has not been met and the TDR accounting model does not apply,

then for term loans the borrower must determine whether it should apply the accounting model for a debt

modification or extinguishment, discussed in detail in Section 2.3. The accounting for changes to a line-of-

credit arrangement (which also encompasses a revolving debt or revolver arrangement when used

throughout this guide) that is not a TDR is discussed in detail in Section 2.4. Changes to a delayed-draw

term loan (DDTL) that is not a TDR will either be accounted for under the term loan or the line-of-credit

accounting model as discussed in detail in Section 2.3.1.2.

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The following flowchart illustrates these considerations and the order in which they should occur:

Changes are made to the terms of the borrower s debt that affect the debt s cash

flows

Apply the extinguishment accounting

model (see Section 2.3.3)

Apply the modification accounting

model (see Section 2.3.4)

Is the new or changed debt substantially different from the old debt (see

Section 2.3.2)?

Yes

Did any of the following happen in conjunction with the changes being

made to the debt (see Sections 1.1 and 2.1)?

• Borrower has been legally released as the primary obligor either

judicially or by the lender and there is no other continuing debt with the

same lender.

• Borrower repaid the debt (and has been relieved of the related

obligation) using proceeds from debt with a new lender and there is no

other continuing debt with the old lender.

• Borrower repaid the debt (and has been relieved of the related

obligation) without entering into new debt with the old lender and there

is no other continuing debt with the old lender.

The liability derecognition

threshold has been met (see

Section 2.1.1).

Borrower applies extinguishment

accounting and considers whether

the accounting and disclosure

requirements applicable to a TDR

apply (see Sections 2.1.1 and

2.2.9).

Yes

The liability derecognition threshold is not met because there continues to be debt

with the old lender after the changes to the borrower s debt.

Borrower next considers whether the changes to its debt should be accounted for as

a TDR (see Section 2.2), and if not, whether the changes should be accounted for as

an extinguishment or modification (see Section 2.3).

Is the borrower

experiencing financial

difficulties (see Section

2.2.2.1)?

Has the lender granted a

concession (see Section

2.2.2.2)?

Apply the TDR accounting model

(see Section 2.2.4)

Yes Yes

Is the old debt a term loan or a line-of-credit arrangement (see Section 2.5)?

Apply the borrowing capacity model

(see Section 2.4)

Term debt

Line-of-credit

arrangement

No No

Note 1: Many of the terms used in this flowchart (e.g., financial difficulties, concessions, substantially

different) have specific meanings and related implementation guidance. This guide explains and

illustrates those meanings and guidance.

Note 2: As noted earlier in this section, changes to a DDTL that is not a TDR will either be accounted

for under the term loan or the line-of-credit accounting model.

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The conclusions reached by a borrower in determining the appropriate accounting for changes made to a

loan could significantly affect its financial statements. Depending on the facts and circumstances, one or

more of the following may be required of the borrower:

• Adjust the carrying amount of the loan

• Derecognize the loan and recognize a new loan

• Change the amount of interest expense recognized in the income statement on a going-forward

basis or recognize a gain or loss in the income statement in the period the changes were made to

the loan

• Expense some of the costs incurred to execute the changes and (or) defer and amortize other

costs

The borrower must also consider classification questions related to the old loan and the new or changed

loan. Classification of debt is discussed in detail in our debt classification whitepaper.

As mentioned earlier, this guide deals solely with the borrower’s accounting for changes to its loans.

Guidance applicable to the lender, which differs, is discussed in Chapter 5 of our financial assets guide.

The relevant accounting literature on accounting for the changes made to loans by the borrower

(including term loans and line-of-credit arrangements) is primarily included in the following sections of the

Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC):

• ASC 405-20, Liabilities – Extinguishments of Liabilities

• ASC 470-50, Debt – Modifications and Extinguishments

• ASC 470-60, Debt – Troubled Debt Restructurings by Debtors

The remainder of Chapter 1, Introduction, discusses pervasive issues relevant to the accounting for

changes a borrower makes to its debt. The relevant guidance in ASC 405-20, 470-50 and 470-60 is

explained in Chapter 2, Relevant literature and general concepts. Several detailed examples of how to

apply this guidance are included in Chapter 3, Examples.

1.1 Determining whether the same lender is involved before and after changes are

made to the debt

Commentary: The two key parties to a loan are the borrower and its lender. Reading and understanding

the terms of the agreements that underlie a loan and any related changes to the loan should clearly

identify these and other relevant parties. Identifying the relevant parties factors into determining the

accounting model that should be applied in a particular situation. For example, if an old term loan is paid

off with proceeds from a new term loan with a new lender (i.e., an unrelated party that was not considered

a lender with respect to the old loan), then there are two separate accounting events for the borrower

(provided there are no other term loans with the old lender):

a) derecognition of the old term loan (which would be accounted for as an extinguishment) and

b) entering into the new term loan with a new lender (which would be accounted for as any other

issuance of new debt).

On the other hand, if the old term loan is paid off with proceeds from a new term loan that is with the

same lender, then consideration must be given to whether the borrower should account for the exchange

of the term loans using the TDR, modification or extinguishment accounting model. (Further discussion of

identifying the unit of account in a TDR or modification or extinguishment is included in Section 2.2.1.1

and Section 2.3.1.1.) If the loan in this example was a line-of-credit, and the old line-of-credit was paid off

with the proceeds from a new line-of-credit with the same lender, then consideration must be given to

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whether the borrower should account for the exchange of the lines-of-credit using the TDR or borrowing

capacity accounting model.

Typically, determining whether the same lender is involved in a loan before and after any changes are

made to the loan is a straightforward exercise involving looking at the name of the lender and seeing that

the name of the lender is the exact same before and after the changes. However, in other cases, it may

not be as straightforward. For example, if an affiliate of the old lender is the new lender, or if the old

lender and new lender are two subsidiaries or two divisions within the same consolidated entity, making

the determination as to whether the same lender is involved in a loan before and after any changes are

made to it requires additional analysis. To determine whether the same lender is involved in a loan before

and after any changes are made to the loan in these less-than-straightforward situations, such as when

there are multiple funds in a private equity group acting as lenders, requires careful consideration of the

relevant facts and circumstances, including but not limited to addressing the following questions:

• Are the new and old lenders separate legal entities?

• Are the new and old lenders not included in the same consolidated entity?

• Are management of the new and old lenders responsible as fiduciaries to manage the lenders

solely for the benefit of the owners and equity holders of each individual lender?

If the answer to each of these questions is yes, there are indications that the old and new lenders

operated separately and should not be considered the same lender for accounting purposes.

Alternatively, when the new and old lenders are part of the same consolidated group and use the same

representative to negotiate the debt modification with the borrower, there are indications that the old and

new lenders operated together and should be considered the same lender for accounting purposes.

Additional information about identifying the lender(s) in loan participations and loan syndications, as well

as identifying the roles of the parties involved, including third-party intermediaries, is provided in Section

2.3.7 and Section 2.3.8, respectively.

1.2 Convertible debt

This guide covers the guidance in ASC 470-50 related to the modification or exchange of debt with an

embedded conversion option. Chapters 2 and 3 of our debt and equity guide address the following related

to convertible debt:

• conversions in accordance with the terms of the debt,

• induced conversions, and

• modifications and extinguishments when the conversion feature was given separate recognition

as a derivative, a cash conversion feature or a beneficial conversion feature.

1.3 Effective interest method

Relevant guidance: ASC 835-30-35-1 to 35-4

U.S. GAAP requires interest expense on debt to be recognized using the effective interest method. Under

this method, any debt discount (which includes lender fees and third-party costs related to the original

issuance of the debt) is amortized into interest expense using a constant interest rate over the life of the

debt, which is known as the effective interest method. U.S. GAAP permits the use of other methods of

amortization if the results are not materially different than those resulting from the effective interest

method.

In practice, some borrowers amortize the debt discount on a straight-line basis, which is only appropriate

if doing so generates results that are not materially different from the results using the effective interest

method. For purposes of the discussion in this guide, it is assumed that the borrower is recognizing

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interest expense using the effective interest method and that the carrying amount of the debt reflects use

of that method to amortize the debt discount.

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2 Relevant literature and general concepts

2.1 Liability derecognition

Did any of the following happen in conjunction with the changes being

made to the debt (see Sections 1.1 and 2.1)?

• Borrower has been legally released as the primary obligor either

judicially or by the lender and there is no other continuing debt with the

same lender.

• Borrower repaid the debt (and has been relieved of the related

obligation) using proceeds from debt with a new lender and there is no

other continuing debt with the old lender.

• Borrower repaid the debt (and has been relieved of the related

obligation) without entering into new debt with the old lender and there

is no other continuing debt with the old lender.

The liability derecognition

threshold has been met (see

Section 2.1.1).

Borrower applies extinguishment

accounting and considers whether

the accounting and disclosure

requirements applicable to a TDR

apply (see Sections 2.1.1 and

2.2.9).

Yes

The liability derecognition threshold is not met because there continues to be debt

with the old lender after the changes to Borrower s debt.

Borrower next considers whether the changes to its debt should be accounted for as

a TDR (see Section 2.2), and if not, whether the changes should be accounted for as

an extinguishment or modification (see Section 2.3).

2.1.1 Liability derecognition threshold

Relevant guidance: ASC 405-20-40-1 to 40-2 and ASC 470-50-15-4

Extinguishment is the derecognition of a liability. Derecognizing a liability simply means to take the liability

off, or remove the liability from, the borrower’s books. The liability derecognition threshold is met only if:

a) The borrower pays the lender and is relieved of its obligation, or

b) The borrower is legally released as the primary obligor.

Payment to a lender may occur upon the delivery of cash, other financial assets, or goods or services.

Payment may also occur if the borrower reacquires its outstanding debt securities and cancels them or

holds them as treasury bonds. Legal release as the primary obligor may be granted by the lender or may

occur judicially. If the liability derecognition threshold has been met, then the borrower should apply the

extinguishment accounting model (see Section 2.3.3). Refer to the commentary later in this section for

discussion about considering whether the extinguishment resulted from a TDR.

Questions arise regarding whether the following circumstances constitute an extinguishment: (a) the

borrower is legally released by the lender as the primary obligor, (b) a third party agrees to assume the

obligation and (c) the borrower agrees to become secondarily liable for the obligation. While the

occurrence of all these circumstances extinguishes the borrower’s original obligation, it also creates a

new obligation. This new obligation is a guarantee and must be accounted for as such (i.e., initially

recognized and measured at fair value in accordance with ASC 460-10-30-2).

Commentary: As discussed further in Section 2.2.4 some TDRs may result in debt being fully settled

either through the transfer of cash, noncash assets, equity or a combination thereof. For these TDRs, the

liability derecognition threshold has been met. While the net effect on the income statement is the same

regardless of whether the extinguishment accounting model or TDR accounting model is applied in these

situations, there are additional accounting (related to settlement of the debt by transferring noncash

assets or equity [see Section 2.2.4.1 and Section 2.2.4.2, respectively]) and disclosure requirements for a

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TDR. As such, when the changes to debt meet the liability derecognition threshold, consideration should

also be given to whether those changes meet the definition of a TDR.

If the borrower and lender agree to change the terms of debt to allow the borrower to settle the debt by

transferring equity-linked instruments to the lender, the borrower must determine whether those

instruments should be classified as equity or a liability for accounting purposes (see our debt and equity

guide). When the equity-linked instruments should be classified as equity, the discussion in the preceding

paragraph applies. However, when the equity-linked instruments should be classified as a liability, the

borrower has exchanged debt for a different liability with the same lender and additional considerations

apply (see Section 2.1.2).

See Example 3.1 for application of this guidance.

2.1.2 Continuing term loans with the same lender

Commentary: There may be continuing term loans with the same lender either because the old loan was

modified or exchanged with the same lender, or because there are other term loans with the same lender.

(See Section 1.1 for discussion regarding whether two lenders should be considered the same lender for

accounting purposes.) When there are continuing term loans with the same lender, the borrower has not

met the substance of the liability derecognition threshold and should next consider whether the changes

made to the borrower’s loans should be accounted for as a TDR. In other words, the mere fact that the

borrower and lender concurrently exchange cash to satisfy an existing term loan (cash from borrower to

lender) and issue a new term loan (cash from the same lender to borrower) should not lead the borrower

to automatically conclude that the liability derecognition threshold has been met and the extinguishment

accounting model should be applied. The borrower may need to account for this exchange of cash and

term loans using the TDR accounting model for situations in which there has been a change to the loan’s

terms (with or without partial settlement of that debt) or the modification accounting model instead of the

extinguishment accounting model. In addition, when the borrower has more than one term loan with the

same lender and settles one or more (but less than all) of those term loans, the borrower may not have

met the substance of the liability derecognition threshold (see Section 2.2.1.1).

Further, when a borrower has a term loan with multiple lenders (e.g., a syndicated loan), the borrower

could meet the threshold for liability derecognition with a lender leaving the syndicate but not with the

remaining lenders (see Section 2.3.7).

2.2 TDR accounting

Is the borrower

experiencing financial

difficulties (see Section

2.2.2.1)?

Has the lender granted a

concession (see Section

2.2.2.2)?

Apply the TDR accounting model

(see Section 2.2.4)

Yes Yes

2.2.1 Nature, scope and unit of account

Relevant guidance: ASC 470-60-10-1 to 10-2, ASC 470-60-15-4 to 15-7, ASC 470-60-15-9 to 15-11

and ASC 470-60-55-1 to 55-3

As noted in Appendix B, the Master Glossary of the Codification defines a TDR as follows: “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.” The concession granted by the lender will affect both the borrower’s and lender’s

cash flows related to the debt. The cash flows may be affected by changing: (a) the amount or timing of

cash flows paid by the borrower, (b) how much of the cash flows will be designated as interest and (c)

how much of the cash flows will be designated as principal, which will affect the lender’s total return and

its effective interest rate as well as the borrower’s total cost and effective interest rate.

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A TDR may involve debt, bonds, notes or accounts payable relating to purchasing goods or services on

credit. It is not limited solely to loans or debt.

For liabilities other than bonds payable, the evaluation of whether a TDR has occurred should take place

on a lender-by-lender basis, even in cases where the restructuring of a group of similar liabilities is

negotiated at the same time across a number of lenders (see Section 2.2.1.1 regarding situations in

which there are multiple term loans with the same lender). For bonds payable that are part of a TDR, the

bond constitutes one payable (and unit of account) even though there are many bondholders.

A lender’s incentive in agreeing to a TDR rests on the theory that it is better to get something instead of

nothing. In other words, if the only way a lender will get any payments from a borrower is if they agree to

a concession, then they may be incented to agree to the TDR to get at least some of the amount owed to

them. Of course, the lender is only motivated to grant a concession that protects as much of its

investment as possible. Any of the following could take place in a TDR:

• The lender agrees to settle the debt for less cash than the outstanding balance of the debt.

• The lender agrees to settle the debt by accepting assets (other than cash) whose fair value is

less than the carrying amount of the debt. The assets could be accounts receivable from routine

sales made by the borrower, real estate or other assets. These assets may come to the lender as

a result of foreclosure, repossession or other transfers.

• The lender agrees to settle the debt by accepting a grant of equity securities issued by the

borrower, provided the grant is not occurring in accordance with preexisting terms that would

have permitted conversion of the debt to an equity interest.

• The borrower and lender agree to modify the terms of the debt and not transfer any assets or

equity. The cash requirements under the debt may be reduced as a result of one or more of the

following types of changes: (a) a reduction in the stated interest rate on the debt, (b) an extension

of the maturity dates when the stated interest rate is lower than the market rate for comparable

new debt, (c) a reduction in the face amount of the debt or, (d) a reduction in accrued interest

owed on the debt.

• The borrower and lender agree to extend the maturity date of the debt and defer required interest

payments until that date.

• The borrower and lender agree to: (a) the partial settlement of the debt through the transfer of

noncash assets or equity and (b) the modification of terms for the debt that remains.

The borrower and lender may initiate the discussions that lead to a TDR or those discussions may be

forced by law or by a court. As such, a TDR may exist for accounting purposes if it was carried out under

various provisions of the Federal Bankruptcy Act (e.g., reorganization) or other related federal statutes.

When the borrower in a TDR is undergoing bankruptcy proceedings, a quasi-reorganization or corporate

readjustment at the same time as the TDR, it is important to understand whether such activities will result

in a general restatement of the borrower’s liabilities. If so, a TDR does not exist for accounting purposes.

Our bankruptcy whitepaper includes an overview of bankruptcy proceedings under Chapter 11, and

guidance and examples related to financial reporting while in Chapter 11 bankruptcy and fresh start

accounting upon emergence from bankruptcy.

The following situations are not in the scope of the TDR guidance:

• Lease modifications under ASC 842. Refer to our lessee guide for information about the

accounting for lease modifications.

• Changes in employment-related agreements (e.g., pension plans, deferred compensation

contracts)

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• Failure by the borrower to pay its trade accounts according to their terms without reaching an

agreement with its creditors to change the terms

• Deferral of legal action by the lender to collect past due amounts of interest and principal from the

borrower without reaching an agreement with the borrower

• Application of bankruptcy accounting by the borrower and a general restatement of its liabilities

(see our bankruptcy whitepaper)

2.2.1.1 Unit of account when there are multiple term loans with the same lender

Commentary: When there are multiple term loans with the same lender (see Section 1.1) and changes

are made to one or more of those loans, we believe the changes should be evaluated for TDR purposes

as if they were a single term loan with the lender. Not taking this approach could result in the borrower

accounting for changes to one term loan as a TDR (and potentially recognizing a gain) when such

changes might not be considered a TDR (or not result in gain recognition under the TDR accounting

model) if those changes were evaluated in the context of all the term loans with that specific lender.

2.2.2 Determining whether a TDR exists

Relevant guidance: ASC 470-60-15-13 and ASC 470-60-55-4 to 55-5

Determining whether the accounting for a TDR applies in a particular situation is a matter of professional

judgment. An analysis of all the facts and circumstances must be performed and no one fact or

circumstance should itself be considered determinative in the face of a preponderance of contrary

evidence. The accounting literature provides guidelines that should be used in this analysis. These

guidelines focus on the definition of a TDR (see Section 2.2.1). Based on that definition, the following two

questions must be answered to determine whether the accounting model for a TDR applies in a particular

situation:

1. Is the borrower experiencing financial difficulties? (see Section 2.2.2.1)

2. Is the lender granting a concession? (see Section 2.2.2.2)

If the answer to both questions is yes, then the changes to the debt should be accounted for as a TDR. If

the answer to either of these questions is no, then the changes to the debt should not be treated as a

TDR for accounting purposes. In the latter situation, the borrower must determine whether the

modification or extinguishment accounting model is appropriate (see Section 2.3).

For efficiency purposes, the borrower should first evaluate the question above that is easiest to answer,

because a “no” response to either question means that the changes to the debt should not be treated as

a TDR by the borrower for accounting purposes. We believe that for most borrowers, the question of

whether the borrower is experiencing financial difficulties is easiest to answer and should be answered

first. Thus, a borrower’s conclusion that they are not experiencing financial difficulties would obviate the

need to determine whether the lender is granting a concession.

2.2.2.1 Is the borrower experiencing financial difficulties?

Relevant guidance: ASC 470-60-15-8, ASC 470-60-55-4 and ASC 470-60-55-7 to 55-8

The following flowchart captures how a borrower should assess whether it is experiencing financial

difficulties as that term is used in ASC 470-60:

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Has the lender agreed to restructure debt only to

reflect: (a) decreases in current market interest rates

at which the borrower could obtain funds or (b)

improvements in the borrower s creditworthiness

since original issuance of the loan?

Has the borrower been servicing the debt and

can it obtain debt from other lenders at market

rates offered on comparable debt to nontroubled

borrowers?

Has the borrower s creditworthiness

deteriorated? ?

Does an in-depth qualitative analysis

indicate that the borrower is experiencing

financial difficulties?

Financial difficulties exist

No financial difficulties,

therefore no TDR

Yes

The top two questions in the flowchart are focused on why the debt was changed. So, if the debt was

changed just to reflect decreases in current market interest rates at which the borrower could obtain funds

or improvements in the borrower’s creditworthiness since the original issuance of the debt, and the

borrower has been servicing the debt and can obtain debt from other lenders at market rates offered on

comparable debt to nontroubled borrowers, there is determinative evidence that the changes to the debt

were not made because the borrower was experiencing financial difficulties. When these are not the

reasons the debt was changed, further analysis is required to determine whether the borrower is

experiencing financial difficulties. This further analysis involves the borrower determining whether there

has been a deterioration in its creditworthiness since it originally issued the debt. For purposes of

assessing whether the borrower’s creditworthiness has deteriorated:

• If the borrower’s credit rating changes but remains an investment-grade credit rating (e.g.,

Standard & Poor’s credit rating on the borrower drops from an A to a BBB), then its

creditworthiness has not deteriorated.

• If the borrower’s credit rating declines from investment grade to noninvestment grade (e.g.,

Standard & Poor’s credit rating on the borrower drops from a BBB to a BB), then its

creditworthiness has deteriorated.

In many cases, a borrower’s creditworthiness has not been evaluated by a nationally recognized rating

agency. This is particularly true of many privately held companies. Assessing whether a borrower’s

creditworthiness has deteriorated in these cases requires the consideration of other factors in the context

of the borrower’s specific facts and circumstances. Examples of other questions that should be

considered in determining whether the borrower’s creditworthiness has deteriorated when the borrower’s

credit has not been evaluated by a nationally recognized rating agency include the following:

• If the borrower’s debt is collateralized, has there been a significant decrease in the value of that

collateral?

• If the borrower has a guarantee issued by a related party or third party (or other credit

enhancement) on its debt, has there been a significant decrease in the value of that guarantee or

other credit enhancement? For example, if the borrower has a guarantee on its debt from a third

party, has there been a decline in the financial standing of the third party that has led to a

significant decrease in the value of the guarantee?

• Is the borrower part of an industry whose sector risk has deteriorated?

JUNE 2023

• Is the borrower unable to obtain new debt at reasonable terms?

• Is the borrower unable to meet the debt covenants in its existing loan agreements?

• Is the borrower experiencing liquidity issues? For example, has its working capital ratio

worsened?

• Has there been a general decline in the borrower’s financial performance? For example, has the

borrower recently experienced recurring net losses?

Answering yes to any of these questions is an indicator that the borrower’s creditworthiness has

deteriorated. The final assessment as to whether the borrower’s creditworthiness has deteriorated should

take into consideration the responses to all of these questions, as well as other relevant facts and

circumstances specific to the borrower.

If the borrower’s creditworthiness has not deteriorated, then the borrower is not experiencing financial

difficulties. Conversely, if the borrower’s creditworthiness has deteriorated, then additional factors must

be considered. Answering yes to any of the following questions is an indicator that the borrower is

experiencing financial difficulties:

• Is the borrower currently in default on any of its debt?

• Has the borrower declared bankruptcy or is the borrower in the process of declaring bankruptcy?

• Is there doubt about the borrower’s ability to continue as a going concern?

• Have any of the borrower’s securities been delisted from an exchange?

• Are any of the borrower’s securities in the process of being delisted from an exchange?

• Does the threat exist for any of the borrower’s securities to be delisted from an exchange?

• Are the borrower’s projected cash flows (based on current business capabilities) insufficient to

cover payments required on the debt through maturity?

• Is the borrower unable to obtain debt from other lenders in which the effective interest rate

charged by the lender is equal to the current market interest rate charged on comparable debt

issued to a nontroubled borrower?

The final assessment as to whether the borrower is experiencing financial difficulties should take into

consideration the responses to all of these questions, as well as other relevant facts and circumstances

specific to the borrower. Refer also to Section 2.2.2.3, which discusses the significance of certain factors

to the overall analysis as to whether a TDR exists.

From a practical perspective, when a borrower’s debt is not formally rated by a nationally recognized

rating agency and there is not determinative evidence that the borrower is not experiencing financial

difficulties, the borrower may perform the qualitative analyses related to whether there has been a

deterioration in the borrower’s creditworthiness and whether the borrower is experiencing financial

difficulties at the same time given the interrelated nature of the analyses. Refer also to Section 2.2.2.3,

which discusses the significance of certain factors to the overall analysis as to whether a TDR exists.

JUNE 2023

2.2.2.2 Is the lender granting a concession?

Relevant guidance: ASC 470-60-55-10 to 55-13

A concession has been granted by the lender if the debt’s effective (not stated) interest rate after changes

are made to it is less than the debt’s effective (not stated) interest rate prior to those changes being

made.

However, there may be rare situations in which a decrease in the effective interest rate is attributable to a

factor not reflected in the mathematical calculation of the effective interest rate. Adding more collateral to

the debt may give rise to this situation. Provided there is persuasive evidence in support of these rare

situations, a concession may not have occurred even though there has been a decrease in the borrower’s

effective interest rate. The accounting in such a situation should reflect the substance of the changes

made to the debt.

The effective interest rate after changes are made to the debt should give effect to all of the terms of the

changed debt, which should include any new or revised options, warrants, guarantees and letters of

credit. The following steps should be taken when calculating the effective interest rate after the changes

are made to the debt:

• Project all cash flows required under the changed debt

• Solve for the discount rate that makes the present value of the projected cash flows equal to the

carrying amount of the borrower’s debt before it was changed

Reflected in the carrying amount of the borrower’s debt should be any unamortized premium, discount or

issuance costs, and any accrued interest payable. However, hedging effects related to the debt should

not be included in its carrying amount. For example, the borrower may have previously elected fair-value

hedge accounting for an interest rate derivative (such as an interest rate swap) related to the debt.

Adjustments to the carrying amount of the debt to record changes in fair value associated with the

hedging relationship should be excluded from the carrying amount of the debt when calculating the

changed debt’s effective interest rate.

Reflected in the projected cash flows required under the changed debt should be any future principal and

interest payments, as well as any fees paid or payable by the borrower to the lender. In addition, the

projected cash flows required under the changed debt should include the effects of any new or revised

enhancements (i.e., sweeteners) included in the debt. Examples of sweeteners include options, warrants,

Effective

interest rate

BEFORE

changes are

made to the

debt

Effective

interest rate

AFTER

changes are

made to the

debt

Concession

Present value

of projected

cash flows

required under

the changed

debt

Carrying

amount of debt

before it was

changed

The effective interest rate

after changes are made to

the debt is the discount rate

used in this present value

calculation that results in

these two amounts equaling

each other.

JUNE 2023

guarantees and letters of credit. One way in which adding a sweetener would directly affect cash flows is

if the borrower added a new financially-sound guarantor to the debt, and as a result, the lender agreed to

reduce the interest rate charged on the debt. Adding, deleting or changing a sweetener may not always

have a direct effect on cash flows. Nonetheless, the FASB believes that adding, deleting or changing a

sweetener should be taken into consideration when determining whether the lender has granted a

concession. As such, the day-one projected cash flows required under the changed debt for purposes of

determining whether a concession has been granted should include a new sweetener’s fair value or the

change in a revised sweetener’s fair value, along with any future principal and interest payments and any

fees paid or payable by the borrower to the lender. The length of time until a sweetener becomes

exercisable should be taken into consideration in estimating its fair value on the date the restructuring

occurs.

2.2.2.3 Overall indicators of whether a TDR exists for accounting purposes

Relevant guidance: ASC 470-60-15-8, ASC 470-60-15-12, ASC 470-60-55-4 and ASC 470-60-55-9

Overall indicators that a TDR does not exist for accounting purposes include the following:

• Other lenders are willing to loan the borrower funds at market interest rates at or near the interest

rates available for debt that is not troubled.

• The fair value of the assets (including cash) or equity interest either:

a) Accepted by the lender in full satisfaction of its receivable is equal to or more than the

lender’s recorded investment (before the adoption of ASC 326), or amortized cost basis (after

the adoption of ASC 326) in the receivable, or

b) Transferred by the borrower in full satisfaction of its debt is equal to or more than the carrying

amount of the borrower’s debt (see Chapter 6 of our financial assets guide for information

about ASC 326).

• To maintain its relationship with the borrower, the lender agrees to reduce the effective interest

rate on the debt solely because the borrower could go elsewhere to obtain funds at a current

market interest rate that is less than the effective interest rate on the debt (such decrease in the

current market interest rate could be due to the occurrence of a general decrease in market

interest rates or a decrease in the risk being taken on by the lender with respect to the borrower).

• The new marketable debt issued by the borrower in exchange for its old debt has an effective

interest rate that is at or near current market interest rates on comparable debt issued by

nontroubled borrowers.

To the extent any of these indicators exist, we believe it would take a preponderance of evidence to the

contrary to conclude that a TDR does, in fact, exist for accounting purposes.

An overall indicator that a TDR exists for accounting purposes is if other lenders are only willing to loan

the borrower funds at effective interest rates that are so high that the borrower would not be able to make

all the required payments under the debt. To the extent this indicator exists, we believe it would take a

preponderance of evidence to the contrary to conclude that a TDR does not, in fact, exist for accounting

purposes.

2.2.2.4 Factors that should not be considered in TDR determination

Relevant guidance: ASC 470-60-55-6

Factors that should not enter into the determination as to whether a TDR exists for accounting purposes

include:

• How much do the current lenders have invested in the debt before the restructuring?

JUNE 2023

• What is the fair value of the debt immediately before and after the changes are made?

• What transactions have occurred among the lenders affected by the changes?

In general, how long the current lenders have held their investment in the debt should also not enter into

the determination as to whether a TDR exists for accounting purposes. However, a TDR could exist for

accounting purposes if the lenders recently came to their current position through what was, in substance,

a planned refinancing.

2.2.3 Series of restructurings on same debt

Relevant guidance: ASC 470-60-55-14

Changes to debt that occur in the same recent time frame should be evaluated on a cumulative basis to

determine whether a TDR occurred. Although GAAP does not define what is considered recent for

purposes of determining whether a TDR has occurred, we generally believe a one-year period should be

considered recent, which is the same period prescribed in GAAP for modifications and exchanges that

are not TDRs (see Section 2.3.2.2).

For purposes of determining whether the lender granted a concession in these situations, the borrower

should solve for the discount rate that makes the present value of the projected cash flows (including

those required as a result the most recently changed debt) equal to the carrying amount of the borrower’s

debt before the first changes were made to the debt in the recent time frame. The borrower should

compare this effective interest rate to the effective interest rate prior to the first changes made to the debt

in the recent timeframe to determine whether the lender granted a concession. Analyzing the changes to

the debt on a cumulative basis prevents the borrower from reaching a different accounting conclusion by

executing the changes in stages.

2.2.4 TDR accounting model

Relevant guidance: ASC 360-10-35, ASC 470-60-35-1 to 35-2, ASC 470-60-35-4 to 35-5 and ASC

470-60-35-8 to 35-9

How a borrower accounts for a TDR depends on whether the borrower: (a) transfers assets in the TDR,

(b) transfers equity in the TDR or, (c) modifies the terms of the debt (e.g., the borrower and lender agree

to modify the cash requirements under the debt on a going-forward basis). The remaining discussion in

this section focuses on the accounting when:

• Full settlement of the debt occurs through the borrower’s transfer of assets (which would include

a repossession or foreclosure by the lender [see commentary later in this section for discussion of

the timing related to the accounting for a TDR and the timing related to recognizing an impairment

(if necessary) on the asset being foreclosed upon]) (see Section 2.2.4.1)

• Full settlement of the debt occurs through the borrower’s transfer of equity (see Section 2.2.4.2)

• Modification of the debt’s terms occurs with no assets or equity transferred in settlement (see

Section 2.2.4.3)

• Partial settlement of the debt occurs through the borrower’s transfer of assets or equity or

modification of terms (see Section 2.2.4.4)

For purposes of this discussion, the carrying amount of the borrower’s debt includes any unamortized

premium, discount, or issuance costs and any accrued interest payable.

Commentary: Foreclosure by the lender may result in full or partial settlement of debt through the

transfer of assets (see Section 2.2.4.1 and Section 2.2.4.4). While the accounting for debt fully or partially

settled through foreclosure does not take place until the foreclosure occurs, the borrower may be required

to recognize an impairment loss on the asset group that includes the asset subject to foreclosure prior to

JUNE 2023

the foreclosure occurring. Consider a situation in which an impairment loss should be recognized in 20X1

on an asset group that includes an asset about to be foreclosed upon, but the foreclosure and recognition

of the related gain on restructuring is not expected to occur until 20X2. A question arises in this situation

about whether the portion of the impairment loss allocated to the asset subject to foreclosure may be

deferred until the gain on restructuring is recognized in 20X2. The answer to that question is no. There is

no link between the timing of when an impairment loss allocated to an asset that may be subject to

foreclosure should be recognized and the timing of when a gain on restructuring related to settling debt

through foreclosing on the asset should be recognized.

2.2.4.1 Full settlement of debt through borrower’s transfer of assets

Relevant guidance: ASC 470-50-40-2, ASC 470-60-35-2 to 35-3 and ASC 470-60-35-9

In a TDR in which the borrower agrees to transfer assets, the assets could be accounts receivable from

routine sales made by the borrower, real estate or other assets (including cash). If the debt is fully settled

by the transfer of assets:

• The borrower recognizes a gain on restructuring for the difference between the carrying amount

of the debt and the more clearly evident fair value of the transferred assets or the settled debt.

The gain on restructuring should be included as a separate line item in the income statement and

should be reduced by the amount of any fees paid or payable to the lender.

• The borrower recognizes a gain or loss on the transfer of assets for any difference between the

carrying amount of the transferred assets and the fair value of the transferred assets. Whether

the gain or loss affects operating income depends on the nature of the assets transferred. For

these purposes, the carrying amount of the transferred assets should reflect any related valuation

allowances (e.g., allowance for doubtful accounts before the adoption of ASC 326 or the

allowance for credit losses after the adoption of ASC 326 [see Chapter 6 of our financial assets

guide for information about ASC 326]) and any related unamortized premium, discount or

acquisition costs.

To illustrate the accounting described above, consider a TDR in which accounts receivable are being

transferred to settle outstanding debt. The carrying amount of the debt being settled is $1.2 million on the

date of the restructuring. Information related to the accounts receivable being transferred on the date of

the restructuring is as follows:

• Gross balance is $1 million,

• Related allowance for doubtful accounts (or credit losses) determined as of the date of transfer is

$100,000, and

• Fair value is $850,000.

If the borrower concludes that this scenario represents a TDR, the borrower would record the following

journal entry on the date the assets are transferred to settle the debt:

Note 1: ($1 million gross balance in accounts receivable − $100,000 allowance for doubtful accounts) − $850,000

fair value of accounts receivable

Note 2: $1.2 million carrying amount of the debt − $850,000 fair value of accounts receivable transferred

Debit

Credit

Debt

$1,200,000

Allowance for doubtful accounts (or credit losses)

100,000

Loss on transfer of assets (Note 1)

50,000

Accounts receivable

$1,000,000

Gain on troubled debt restructuring (Note 2)

350,000

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In this example, the gain on restructuring should be included as a separate line item in the income

statement. The loss on transfer of assets should be included in operating income given that the assets

transferred (i.e., accounts receivable) are operating assets.

Determining the fair value of debt

The fair value of a liability is based on its transfer price. It is not appropriate to assume that the price to

transfer the liability is the same as the price to settle the liability or the same as the carrying amount of

the liability. How a borrower estimates the amount at which it would be able to transfer one of its

liabilities may present unique challenges given the lack of market information on transfer prices for

entity-specific liabilities. Oftentimes, there is little market information available because contractual or

other legal restrictions prevent the transfer of such liabilities. Guidance on measuring the fair value of

liabilities is included in ASC 820-10-35.

2.2.4.2. Full settlement of debt through borrower’s transfer of equity

Relevant guidance: ASC 470-60-35-2, ASC 470-60-35-4 and ASC 470-60-35-12

In a TDR in which the borrower agrees to transfer equity to fully settle the debt, the borrower recognizes a

gain for the difference between the carrying amount of the debt and the more clearly evident fair value of

the transferred equity or the settled debt. See Section 2.2.4.1 for information about determining the fair

value of debt. Any fees paid or payable to the lender and any direct costs incurred with third parties

related to the issuance of equity to settle the debt reduce the amount recorded in equity. All other fees

and direct costs incurred unrelated to the issuance of equity either: (a) are included in expense for the

period, if no gain on restructuring is recognized, or (b) reduce the amount of the gain, if a gain on

restructuring is recognized.

Commentary: For purposes of this discussion, equity includes equity-linked instruments that should be

classified as equity, but not equity-linked instruments that should be classified as liabilities. The

classification of equity-linked instruments is discussed in detail in our debt and equity guide. Settling debt

with equity-linked instruments that should be classified as liabilities results in there being continuing debt

with the same lender, the implications of which are discussed in Section 2.1.2 and Section 2.2.1.1.

2.2.4.3 Borrower and lender only change the debt’s terms

Relevant guidance: ASC 470-60-35-5 to 35-7 and ASC 470-60-35-11

In a TDR in which the borrower and lender agree to change the terms of the debt (and not transfer assets

or equity), the accounting depends on whether the total cash outflows required under the restructured

debt are more or less than the carrying amount of the debt prior to the restructuring. In some cases, total

cash outflows required under the restructured debt may fluctuate (e.g., the interest rate varies over time

depending on changes in the prime rate). In these cases, total cash outflows required under the

restructured debt should be based on the interest rate in effect at the time of the restructuring. Additional

discussion about debt with a variable interest rate is provided later in this section.

To the extent the borrower must pay the lender any fees in conjunction with the restructuring, those fees

should be included in the total projected cash outflows because they are essentially equivalent to

additional principal and interest payments. In other words, the lender could decrease (or increase) the

lender fee and retain the same economics by increasing (or decreasing) the principal or interest

payments.

Total cash outflows required for restructured debt > Carrying amount of debt prior to restructuring

If total cash outflows required under the restructured debt are greater than the carrying amount of the

debt prior to the restructuring, then no gain or loss is recognized and there is no adjustment to the

carrying amount of the debt. The fact that no gain or loss is recognized and no adjustment is made to the

JUNE 2023

carrying amount of the debt does not affect the conclusion that a TDR has occurred. The change in cash

outflows resulting from the restructuring is accounted for on a prospective basis (i.e., the changes are

recognized in future periods) by calculating a new effective interest rate on the restructured debt and

using it to recognize lower interest expense over the restructured debt’s remaining term.

As mentioned earlier, a lender fee that must be paid by the borrower in conjunction with the restructuring

is included in the total cash outflows required under the restructured debt. Those total cash flows are

used to calculate the effective interest rate on the restructured debt. As a result, a lender fee increases

the effective interest rate, which leads to the fee being recognized over the restructured debt’s remaining

term.

The new effective interest rate used to account for the debt on a going-forward basis is the effective

interest rate calculated on the restructured debt for purposes of determining whether the lender granted a

concession to the borrower (see Section 2.2.2.2).

Example 3.2 illustrates the application of this guidance.

Total cash outflows required for restructured debt < Carrying amount of debt prior to restructuring

If total cash outflows required under the restructured debt are less than the carrying amount of the debt

prior to the restructuring, then a gain is generally recognized and there is an adjustment to the carrying

amount of the debt. However, as explained later in this section, gain recognition may not be appropriate

when contingent payments are included in the terms of the restructured debt. In addition, as discussed in

Section 2.2.4.5, incremental considerations arise with respect to gain recognition when the lender is also

an equity holder in the borrower.

When there are no contingent payments, the amount of the recognized gain and the adjustment to the

carrying amount of the debt is determined as follows:

More than one account (e.g., debt and the related debt discount or premium) may be affected by the

adjustment to the carrying amount of the debt. These accounts may either be retained or combined after

the restructuring. If they are retained, the adjustment should be allocated among those accounts that

remain after the restructuring using their previous balances for allocation purposes.

Going forward, all cash payments under the terms of the restructured debt must be accounted for as

reductions of the carrying amount of the debt, and no interest expense should be recognized on the debt

for any period between the restructuring and maturity of the debt. The only exception is to recognize

interest expense according to ASC 470-60-35-10.

Example 3.3 illustrates the application of this guidance.

Contingent payments

Contingent payments, or what are essentially contingent payments, may be included in the terms of the

restructured debt. Examples of such contingent payments include: (a) amounts the borrower is required

to pay if its financial condition improves (based on a specified, measurable metric) by a specific date and

Carrying

amount of debt

prior to

restructuring

Total cash

outflows

required under

terms of

restructured

debt

Amount of

recognized

gain and

adjustment to

carrying

amount of debt

JUNE 2023

(b) indeterminate interest payments the borrower has to make because the restructured debt is due on

demand.

When contingent payments are included in the terms of the restructured debt and the total projected

noncontingent cash outflows required under the restructured debt are less than the carrying amount of

the debt prior to the restructuring, the borrower should not recognize a gain on the restructuring if the

maximum total future cash payments (total projected noncontingent cash outflows plus all contingent

amounts that could become payable) is greater than the carrying amount of the debt prior to the

restructuring. If a gain is not recognized as a result of this guidance, a new effective interest rate must be

calculated for purposes of recognizing interest expense in future periods. In some cases, this new

effective interest rate may be at or near zero. When determining the new effective interest rate, only those

contingent payments necessary to prevent gain recognition are included in the calculation. For example,

assume in a TDR that: (a) the carrying amount of the debt prior to the restructuring is $1 million, (b) the

total projected noncontingent cash outflows required under the restructured debt are $900,000 and (c) the

maximum contingent payments that could be made under the restructured debt are $200,000 (two

payments of $100,000 each). In this example, only $100,000 of the maximum contingent payments is

included in calculating the new effective interest rate because that is the amount that would prevent gain

recognition.

The probable and reasonably estimable thresholds applied to the recognition of other contingent liabilities

should be applied to determine if and when a liability should be recognized for the contingent payments

included in the terms of the restructured debt. If a liability should be recognized, or when the contingent

payments are actually made, consideration must be given to whether those amounts should serve to

reduce the carrying amount of the restructured debt. This would be the case if those amounts were

included in the total projected cash payments under the restructured debt for purposes of preventing the

recognition of a gain at the time of the restructuring.

Variable interest rate

When total cash outflows required under the restructured debt may fluctuate because the interest rate

varies over time (e.g., based on changes in the prime rate), the total maximum cash outflows required

under the restructured debt should be based on the interest rate in effect at the time of the restructuring. If

these cash outflows are less than the carrying amount of the debt prior to the restructuring, a gain is

recognized for the difference, provided there are no contingent payments (other than those related to the

debt’s variable interest rate) that could be required in the future that would reduce the gain.

After the TDR, a debtor should not recognize a gain on the restructured debt that involves indeterminate

future cash payments as long as the maximum cash payments may equal or exceed the carrying amount

of the debt. Fluctuations in the debt’s effective interest rate after the restructuring due to changes in the

underlying benchmark or index (e.g., the prime rate) or other causes are accounted for as changes in

estimates in the periods in which the changes occur. However, the accounting for those fluctuations

should not result in recognizing a gain on restructuring that may be offset by future cash payments.

Rather, the carrying amount of the restructured debt should remain unchanged, and future cash

payments should reduce the carrying amount until the time that any gain recognized cannot be offset by

future cash payments. Based on this guidance, if the debt’s variable interest rate after the TDR increases

to a rate above the rate on the date that the TDR occurred (the TDR variable interest rate), the

incremental interest expense is recognized in the period the increase occurs. Conversely, if the debt’s

variable interest rate decreases below the TDR variable interest rate, all interest accrued offsets the

carrying amount of the debt, and any additional gain is not recognized until the debt is settled.

Commentary: As discussed in the preceding paragraph, when there is a decrease in the debt’s variable

interest rate after a TDR, a gain is not recognized until settlement of the debt, in case there is a

subsequent increase in the variable interest rate that offsets the effects of the previous decrease. If there

JUNE 2023

is such a subsequent increase, we believe the borrower should continue to defer the recognition of any

gain until settlement of the debt and elect one of the following two accounting policies:

(a) Recognize interest expense when the variable interest rate increases above the TDR variable

interest rate where such interest expense would be based on the excess of the increased variable

interest rate over the TDR variable interest rate, or

(b) Recognize the effects of the increase in the variable interest rate as a reduction in the carrying

amount of the debt until the effects of the previous decrease in the variable interest rate has been

offset, at which point the incremental interest is recognized as an expense.

The accounting policy elected by the borrower should be disclosed and consistently applied in similar

facts and circumstances.

To illustrate the accounting discussed above, consider a situation in which the borrower and lender

changed a loan with a carrying amount of $133,000, and it was determined that these changes met the

definition of a TDR. Pertinent information related to the loan after the restructuring included the following:

• Interest is paid annually at a variable interest rate (which is reset at the beginning of each year),

with the first interest payment being due one year after the restructuring.

• Principal amount is $100,000.

• Remaining term is four years.

• Variable interest rate on the date of the restructuring is 7%

• Estimated interest related cash flows are $28,000 ($100,000 principal x 7% variable interest rate

on the date of the TDR x 4-year remaining term)

Borrower recognized a gain on restructuring of $5,000, calculated based on the excess of the carrying

amount of the debt immediately before the restructuring ($133,000) over the total projected cash outflows

required under the terms of the restructured debt ($128,000), which represents the principal amount

repayable of $100,000 plus $28,000 of total estimated interest payments over the term of the restructured

debt.

JUNE 2023

Subsequent to the restructuring:

The variable rate of interest remained at 7% throughout Year 1; however, at the beginning of Year 2, the

debt’s variable interest rate changed to 6% and remained at that rate throughout the year. The following

journal entries were recorded in Year 1 and 2 related to the debt:

Debit

Credit

Interest accrued during Year 1 (Note 1)

Debt (Note 1)

$7,000

Accrued interest

$7,000

Interest paid at the end of Year 1 (Note 1)

Accrued interest

$7,000

Cash

$7,000

Interest accrued during Year 2 (Note 2)

Debt (Notes 1 and 2)

$6,000

Accrued interest

$6,000

Interest paid at the end of Year 2 (Note 2)

Accrued interest

$6,000

Cash

$6,000

Note 1: Entry to recognize interest accrued during Year 1 and then paid at the end of Year 1 is based on a

variable rate of interest of 7%. The offsetting entry to accrued interest is debt, rather than interest

expense, because upon the debt’s restructuring, the carrying amount of the loan was adjusted to equal

the total estimated cash outflows for both the remaining principal and interest payable over the term of the

restructured loan.

Note 2: Entry to recognize interest accrued during Year 2 and then paid at the end of Year 2 is based on a

variable rate of interest of 6%. The offsetting entry to accrued interest is debt, rather than interest

expense, because upon the debt’s restructuring, the carrying amount of the loan was adjusted to equal

the total estimated cash outflows for both the remaining principal and interest payable over the term of the

restructured loan. In accordance with ASC 470-60-35-7, no gain is recognized for the decrease in the

variable interest rate (from 7% to 6%) because the variable interest rate could subsequently increase in

Years 3 or 4 and offset the effects of the decrease in Year 2.

At the beginning of Years 3 and 4 and throughout these years, the debt’s variable interest rate is 9% and

7%, respectively. The borrower’s accounting for the interest due during Years 3 and 4 depends on

whether it elects accounting policy (a) or (b) discussed earlier.

Under accounting policy (a):

• In Year 3, the borrower reduces the carrying amount of the debt by the original estimated annual

interest payment of $7,000 and records interest expense of $2,000 for the excess of the variable

interest payment based on a 9% interest rate over the original estimated annual interest

payment.

• In Year 4, the borrower pays $7,000 of interest and $100,000 of principal and reduces the

carrying amount of the debt to zero and recognizes a $1,000 gain on restructuring.

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Under accounting policy (b):

• In Year 3, the borrower reduces the carrying amount of the debt by the original estimated annual

interest payment of $7,000 plus the shortfall of $1,000 between the interest payment made in the

prior year ($6,000) and the original estimated interest payment for that year ($7,000). Borrower

also records interest expense of $1,000 for the difference between actual interest payment for the

year ($9,000) and the amount for which debt was reduced as noted above ($8,000).

• In Year 4, the borrower pays $7,000 of interest and $100,000 of principal and reduces the

carrying amount of the debt to zero with no gain or loss recorded as the interest paid in year 4

was based on a 7% variable interest rate, which is consistent with the original variable interest

rate.

The following summarizes the journal entries that would be recorded in Years 3 and 4 depending on the

accounting policy elected by the borrower:

Note 1: Entries to record the interest accrued and paid in Year 3 based on the variable interest rate of 9%. Under

this accounting policy, the amount by which the carrying value of a loan with a variable interest rate is

reduced is based on the lesser of the actual interest payable for the period or the amount estimated at the

time of the restructuring. Any actual interest payable for the period in excess of the amount estimated at

the time of the loan restructuring is recognized as interest expense until the debt carrying amount is fully

settled or reduced to zero.

Accounting policy (a)

(Notes 1, 3 and 4)

Accounting policy (b)

(Notes 2, 3, and 4)

Debit

Credit

Debit

Credit

Interest accrued during Year 3

Debt

$7,000

$8,000

Interest expense

2,000

1,000

Accrued interest

$9,000

Interest paid at the end of Year 3

Accrued Interest

$9,000

Cash

$9,000

Interest accrued during Year 4

Debt

$7,000

Accrued interest

$7,000

Interest paid at the end of Year 4

Accrued Interest

$7,000

Cash

$7,000

Principal repaid at maturity

Debt

$101,000

$100,000

Cash

$100,000

Gain on restructuring

$1,000

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Note 2: Entry to record the interest paid in Year 3 based on the variable interest rate of 9%. Under this accounting

policy, the amount by which the carrying value of a loan with a variable interest rate is reduced is the sum

of the interest estimated at the time of the restructuring of $7,000 plus the shortfall of $1,000 between the

accrued interest recorded in the prior year ($6,000) and the original interest estimated at the time of

restructuring for that year ($7,000). Borrower also records interest expense of $1,000 for the difference

between actual interest owed for the year ($9,000) and the amount for which debt was reduced ($8,000).

Note 3: Entries to record the interest accrued and paid in Year 4 based on the variable interest rate of 7%.

Note 4: Entry to record the principal repayment in Year 4 to settle the remaining principal

outstanding on the debt. The related gain upon extinguishment of the restructured debt

under each respective accounting policy is calculated as follows:

Accounting

Policy (a)

Accounting

Policy (b)

Debt carrying value on date of restructuring

$128,000

Less: Changes to debt carrying value relating to interest

adjustments

Year 1

(7,000)

Year 2

(6,000)

Year 3

(7,000)

(8,000)

Year 4

(7,000)

Less: Principal Repayment

(100,000)

Ending debt balance recognized as a gain on extinguishment

$1,000

$ -

2.2.4.4 Partial settlement of debt

Relevant guidance: ASC 470-60-35-2 and ASC 470-60-35-8

The borrower and lender may agree to the partial settlement of debt in conjunction with a restructuring.

For example, a TDR could result from any of the following:

• The borrower agrees to pay some cash to the lender and the borrower and lender agree to

modify some of the remaining terms of the debt.

• The borrower agrees to transfer noncash assets to the lender and the borrower and lender agree

to modify some of the remaining terms of the debt.

• The borrower agrees to transfer equity (including equity-linked instruments classified as equity

[see details in our debt and equity guide]) to the lender and the borrower and lender agree to

modify some of the remaining terms of the debt.

• The borrower agrees to transfer cash, noncash assets or equity (including equity-linked

instruments classified as equity [see details in our debt and equity guide]) to the lender that

partially settles the debt, but the terms of the debt that remain are unchanged.

When the TDR involves a partial settlement, the carrying amount of the debt is reduced by the fair value

of the assets or equity transferred in the partial settlement. Unlike the full settlement of debt through the

borrower’s transfer of assets or equity in which the fair value of the settled debt (if it is more clearly

evident) could be used in place of the fair value of the assets or equity to determine the gain on

restructuring (see Section 2.2.4.1 and Section 2.2.4.2), the fair value of the partially-settled debt cannot

be used to reduce the carrying amount of the debt.

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When noncash assets are involved, a gain or loss on the transfer of the assets is recognized for the

difference between the carrying amount and fair value of the noncash assets transferred. This is similar to

the approach taken when the TDR is a full settlement through the transfer of noncash assets (see Section

2.2.4.1).

After the carrying amount of the debt has been reduced and any gain or loss on the transfer of noncash

assets recognized, the accounting for the restructuring follows the approach taken when the TDR

involves only the modification of terms (see Section 2.2.4.3). When using this approach to account for a

TDR that involves a partial settlement of the debt, the borrower’s analysis should: (a) use the carrying

amount of the debt after reduction for the fair value of any assets or equity transferred, (b) use the terms

of the debt that remains after the partial settlement and (c) include any lender fees not related to the

issuance of equity in the total projected cash outflows required under the restructured debt. Additional

considerations arise with respect to gain recognition when the lender is also an equity holder in the

borrower (see the next section).

Example 3.4 illustrates the application of this guidance.

2.2.4.5 Additional considerations when the lender is also an equity holder in the borrower

Commentary: A common related party relationship involving a borrower and a lender is when the lender

is also an equity holder in the borrower. If the TDR accounting model is applied to changes in a loan with

a lender that is also an equity holder, consideration must be given to whether any gain that results from

applying that accounting model should be reflected in the income statement or in equity (i.e., additional

paid-in capital). A key consideration in this regard is whether the lender is restructuring the loan to protect

its equity investment in the borrower. If so, that would provide a strong indication that any gain recognized

in connection with the restructuring should be reflected in equity.

When determining whether the lender is protecting its equity investment in the borrower, consideration

should be given to the significance of the lender’s equity investment in the borrower. The Master Glossary

of the Codification defines principal owners as those that own more than 10% of the voting interests

(including direct and beneficial interests) of an investee. If the lender’s equity investment in the borrower

would result in the lender being considered a principal owner, we believe the lender’s equity investment in

the borrower is significant, which indicates that the lender entered into the restructuring to protect its

equity investment in the borrower. As a result, any gain on the restructuring should be reflected in equity.

If the lender is not considered a principal owner, other relevant facts and circumstances should be

considered to determine whether the lender entered into the restructuring to protect its equity investment

in the borrower. Among those facts and circumstances are the significance of the lender’s debt and equity

investments in the borrower relative to each other and relative to those held by other investors in the

borrower.

2.2.5 Direct costs incurred with third parties in a TDR

Relevant guidance: ASC 470-60-35-12

The borrower will likely incur direct costs with third parties in connection with executing a TDR. Any of

these costs (including legal fees) that relate to transferring equity from the borrower to the lender in the

TDR should reduce the amount that would otherwise have been recognized in equity. For all other direct

costs with third parties incurred in executing a TDR, they are recognized in the income statement as

incurred. The classification of these costs in the income statement depends on whether a gain on

restructuring is recognized. If so, such costs should reduce the amount that would otherwise be

recognized as a gain. If not, such costs should typically be reflected in a separate line item in the income

statement.

Commentary: The borrower may incur direct costs with third parties (e.g., legal expenses) when working

towards a TDR in one reporting period, but not complete the TDR until the next reporting period. When

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this is the case, the question arises about whether the borrower should defer those direct costs incurred

in the first reporting period until the reporting period in which the TDR is completed. The answer to that

question is no. The borrower should recognize direct costs incurred with third parties in conjunction with a

TDR that are not related to the issuance of equity in the income statement in the period in which those

costs are incurred.

2.2.6 Lender fees incurred in the restructuring

Commentary: Fees paid or payable to the lender in conjunction with the TDR that are not related to the

issuance of equity either decrease the amount of the gain that would have otherwise been recognized

(when there are no contingent payments and total projected cash outflows under the restructured debt is

less than the carrying amount of the debt prior to the restructuring) or are deferred and increase the

effective interest rate used to account for the debt on a going-forward basis (when total projected cash

outflows under the restructured debt are greater than the carrying amount of the debt prior to the

restructuring).

2.2.7 Preexisting unamortized debt discount

Commentary: To the extent there is an unamortized debt discount (which would include unamortized

debt issuance costs) prior to the restructuring when the debt is not fully settled in the restructuring, those

costs should already be included in the net carrying amount of the debt prior to the restructuring. As

discussed earlier in Section 2.2.4.3, if total projected cash outflows required under the restructured debt

are greater than the carrying amount of the debt prior to the restructuring (and, consequently, no gain or

loss is recognized), the carrying amount of the debt is used in determining the new effective interest rate

for the restructured debt. This new effective interest rate is used to calculate interest expense over the

remaining term of the restructured debt. As such, the unamortized debt discount prior to the restructuring

continues to be recognized as interest expense over the remaining term of the restructured debt.

Conversely, in a TDR in which the total projected cash outflows required under the restructured debt

(including any contingent amounts) are less than the carrying amount of the debt prior to the

restructuring, a gain is recognized. The calculation of the gain in this situation is based on the carrying

amount of the debt prior to the restructuring less the total cash outflows required under the terms of the

restructured debt. Because the unamortized debt discount is included in the carrying amount of the debt

prior to the restructuring, it would effectively reduce the amount of gain recognized.

To the extent there is an unamortized debt discount prior to the restructuring when the debt is fully settled

in the restructuring, such unamortized debt discount would reduce any gain recognized on the

restructuring.

Example 3.3 and Example 3.4 provide further detail on the accounting for TDRs.

2.2.8 Classification considerations

Relevant guidance: ASC 470-60-45-1 to 45-2

When debt is restructured, consideration should be given to the current versus noncurrent classification of

the debt that remains. Consideration should also be given to the current versus noncurrent classification

of the debt that remains from a TDR that occurs after the borrower’s balance-sheet date but before the

balance sheet is issued or available to be issued.

Commentary: While the classification of debt may be affected by a TDR that occurs after the borrower’s

balance-sheet date but before the balance sheet is issued or available to be issued, the timing of the

accounting for the TDR is not affected. In other words, any gain recognized in the accounting for the TDR

cannot be pushed back to the balance-sheet date. In addition, any equity grants that were part of the TDR

cannot be pushed back to the balance-sheet date.

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For more information about the current versus noncurrent classification of debt, refer to our debt

classification white paper.

2.2.9 Disclosures

Relevant guidance: ASC 470-60-50-1 to 50-2

The borrower must disclose the following about a TDR that affected any of the financial statements

presented:

• A description of how the terms of the debt changed and the major features of settlement

• The amount of any gain recognized in connection with the restructuring, as well as the gain per

• The amount of any gain or loss recognized on the transfer of assets in connection with the

restructuring

Separate TDR transactions that impact the same type of liability may be aggregated.

To the extent contingent payments are involved in the TDR, the borrower should disclose in periods after

the restructuring the portion of the restructured debt’s carrying amount that reflects contingently payable

amounts. In addition, with respect to the contingent payments, the borrower should also consider whether

it satisfies the general disclosure requirements applicable to contingent liabilities. Depending on the facts

and circumstances, information such as the total amount contingently payable and the terms of the

contingency may need to be disclosed.

2.3 Extinguishment and modification accounting models for term loans

Apply the extinguishment accounting

model (see Section 2.3.3)

Apply the modification accounting

model (see Section 2.3.4)

Is the new or changed debt substantially different from the old debt (see

Section 2.3.2)?

Yes

2.3.1 Scope

Relevant guidance: ASC 470-50-05-1, ASC 470-50-15-2 to 15-3, ASC 470-50-40-5 and ASC 470-50-

55-8 to 55-9

If the borrower concludes that it has not met the liability derecognition threshold or the TDR criteria, then

it must determine whether the modification or exchange should be accounted for using the

extinguishment or modification accounting model. This determination may be necessary when the

borrower and lender agree to exchange loans or modify the terms of an existing loan. The determination

must also be made when the borrower and lender agree to modify a loan to require its redemption at a

future date for a specified amount.

JUNE 2023

The extinguishment and modification guidance discussed in this guide does not apply in any of the

following circumstances:

• Conversions of debt into equity securities of the borrower pursuant to conversion privileges

provided in the terms of the debt at issuance. Additionally, the guidance does not apply to

conversions of convertible debt instruments pursuant to terms that reflect changes made by the

borrower to the conversion privileges provided in the debt at issuance (including changes that

involve the payment of consideration) for the purpose of inducing conversion.

• Transactions between a borrower or a borrower's agent and a third party that is not the lender.

• Debt tendered to exercise detachable warrants that were originally issued with that debt if the

debt is permitted to be tendered towards the exercise price of the warrants under the terms of the

securities at issuance. The tendering of the debt in such a case would be accounted for in the

same manner as a conversion.

• The borrower announces its intention to call a loan at its first call date.

• There is an in-substance defeasance, which occurs when the borrower establishes an irrevocable

trust for the benefit of the lender and deposits in that trust the principal, interest and prepayment

penalties applicable to the loan between the borrower and lender.

• There is an agreement with a lender that a debt instrument issued by the borrower and held by a

different party will be redeemed.

• A loan is converted to the borrower’s equity securities in accordance with conversion privileges

included in the loan at issuance.

• A loan is converted to the borrower’s equity securities in accordance with conversion privileges

included in the loan that have been changed since issuance (including induced conversions).

The accounting for convertible debt, including conversions and modifications (other than modifications of

convertible debt with an embedded conversion option [see Section 1.2]) are discussed in detail in Chapter

2 of our debt and equity guide.

2.3.1.1 Unit of account when there are multiple term loans with the same lender

Commentary: When there are multiple term loans with the same lender (see Section 1.1) and changes

are made to one of those loans, we believe that judgment should be used in determining the unit of

account for purposes of evaluating the changes under ASC 470-50. We believe that one of the primary

considerations when determining the unit of account is whether the changed term loan reflects market

terms at the time the changes were made. If so, that would be an indication that the unit of account for

purposes of evaluating the changes under ASC 470-50 would be the specific term loan that was changed.

Conversely, when the changed term loan does not reflect market terms, that would be an indication that

the unit of account for purposes of evaluating the changes under ASC 470-50 may be a combination of

some or all of the term loans with that lender. Depending on those facts and circumstances, among

others, the unit of account for purposes of evaluating the changes to the term loan under ASC 470-50

may be just the specific term loan that was changed or a combination of some or all of the term loans with

that lender.

Similarly, consider a situation in which a borrower enters into a new term loan with a lender. The borrower

has a preexisting term loan that was entered into more than a year prior to entering into the new term

loan with the same lender (see Section 1.1) that was not changed or otherwise affected by the new term

loan. In this situation, we believe that whether the new term loan should be accounted for as a separate

unit of account (i.e., a new term loan that would not be evaluated under ASC 470-50) or as a combined

unit of account (i.e., a modification of a preexisting term loan for incremental borrowings that would be

evaluated under ASC 470-50) is subject to judgment. Consistent with the discussion in the previous

paragraph, we believe that one of the primary considerations when determining the unit of account is

JUNE 2023

whether the new term loan reflects market terms at the time it was entered. If so, that would be an

indication that the new term loan would be a separate unit of account and accounted for as a new loan. If,

on the other hand, the new term loan does not reflect market terms, that would be an indication that the

unit of account may be a combination of the new term loan and some or all of the preexisting term loans

with that lender and evaluated as a change to the preexisting loan under ASC 470-50.

2.3.1.2 Unit of account for delayed-draw term loans (DDTLs)

Commentary: DDTLs generally represent commitments from lenders for term loan facilities in which the

borrower may draw on these facilities at a future date within a period identified in the loan agreement.

Therefore, these loans may not be funded, or may not be fully funded, on the date that the loan

agreements are executed, but rather will be funded at some future date. This adds complexity to the

models for evaluating debt modifications and restructurings, as these loans have characteristics of term

loans and line-of-credit facilities. As a result, these loans may need to be evaluated under two different

models depending on the facts and circumstances.

Assuming that the transaction does not meet the TDR criteria, we believe that judgment is necessary in

determining the appropriate accounting model to be used when evaluating changes to DDTLs. In general,

we believe that changes to DDTLs that are unfunded and not expected to be funded in the near term

should be evaluated using the line-of credit model, while changes to funded DDTLs and those expected

to be funded in the near term should be evaluated using the term loan model.

Example 3.12 illustrates the application of this guidance.

2.3.2 Which model applies?

Relevant guidance: ASC 470-50-40-6 to 40-12A

If the borrower concludes that an exchange of loans or a modification to the terms of an existing loan do

not meet the liability derecognition threshold or the TDR criteria, then it must determine whether the

modification or exchange should be accounted for using the modification or extinguishment accounting

model (the latter of which could result in the borrower recognizing a gain or loss in its income statement

[see Section 2.3.3]). In making this determination, the mere fact that the borrower and lender concurrently

exchange cash to satisfy an existing loan (cash from borrower to lender) and issue a new loan (cash from

the same lender [see Section 1.1] to borrower) should not automatically lead the borrower to conclude

that the extinguishment accounting model should be applied. In these and other situations in which a loan

is modified, the borrower must determine whether the new loan (the modified loan or the loan received in

the exchange) is substantially different from the old loan (the loan before modification or the loan given up

in the exchange).

The considerations involved in accounting for changes to a loan that are related to reference rate reform

are discussed in Section 2.3.2.4.

JUNE 2023

A flowchart for determining whether a substantial difference exists because of a change in the loan’s cash

flows follows:

Considered substantially

different (i.e., apply the

extinguishment accounting

model – see Section 2.3.3)

Is there at least a 10% difference

between the present value of the

new loan s cash flows and the

present value of the old loan s

remaining cash flows (i.e., the 10%

cash flow test)?

No (less than 10%)

Yes (10%

or more)

Assess whether the addition

of, elimination of or changes to

the embedded conversion

options make the new loan

substantially different from the

old loan? (see separate

flowchart below in this

Section)

Were embedded conversion

options added to, eliminated from

or changed in the loan?

Yes

Not considered substantially different

(i.e., apply the modification accounting

model – see Section 2.3.4)

When calculating the present value of cash flows referred to in the flowchart:

• The cash flows of the new loan should include any amounts exchanged by the borrower and

lender in connection with the exchange or modification, including any fees charged by the lender,

or paid on behalf of the lender (see Section 2.3.5.1), to execute the modification or exchange, any

incremental borrowings received by the borrower, and any repayments of principal by the

borrower.

• The cash flows for loans with floating interest rates should be based on the variable rate in effect

when the exchange or modification occurs.

• When either or both the preexisting or changed loan is callable or puttable, two sets of cash flows

may need to be considered: (1) cash flows assuming the call or put is exercised and (2) cash

flows assuming the call or put is not exercised. The cash flows that should be used in the 10%

cash flow test are those that result in the smaller change between the present value of the new

loan’s cash flows and the present value of the old loan’s remaining cash flows. A loan is callable if

the lender has the right, but not the obligation, to require the borrower to repay the loan’s principal

before its stated maturity date. A loan is puttable if the borrower has the right, but not the

obligation, to repay the loan before maturity on specified dates for a predetermined price. Refer to

Section 2.3.2.1 for discussion about the applicability of this guidance to explicit and implicit

prepayment options.

JUNE 2023

• The discount rate is the preexisting loan’s effective interest rate (as determined for accounting

purposes).

• If one or more less-than-substantially-different exchanges or modifications to the loan occurred

within a year of the current exchange or modification, the changes would be assessed

cumulatively (instead of separately) for purposes of applying the 10% cash flow test (see Section

2.3.2.2 for additional discussion). This requirement is so the borrower does not get a different

accounting answer by executing the exchange or modification in stages.

• The effects of an exchange or modification on an embedded conversion option’s fair value is

assessed separately and is not reflected in the 10% cash flow test (refer to the remaining content

in this section for additional discussion).

• If the borrower modifies or exchanges a freestanding equity-classified written call option (such as

a warrant) held by its lender as part of, or directly related to, a modification or exchange of the

related debt held by that same lender, an increase or a decrease in the fair value of the

freestanding equity-classified written call option held by such lender should be reflected in the

10% cash flow test.

The treatment of a “sweetener” in the 10% cash flow test is discussed in Section 2.3.2.3.

JUNE 2023

Following is a flowchart for determining whether a substantial difference exists because an embedded

conversion option was added, eliminated or changed in the modification or exchange:

Considered substantially

different (i.e., apply the

extinguishment accounting

model – see Section 2.3.3)

Was an embedded conversion option (which

was not accounted for as a derivative) that

was substantive at the date of the exchange

or modification eliminated from the loan?

(Note 1)

Was a substantive embedded conversion

option (which should not be accounted for as

a derivative) added to the loan? (Note 1)

Were the terms of an embedded conversion

option (which was not and should not be

accounted for as a derivative) changed such

that the change in its fair value is 10% or

more of the original loan s carrying amount

right before the exchange or modification?

(Note 2)

Not considered substantially different (i.e., apply the

modification accounting model – see Section 2.3.4)

Less than 10% difference between the present value of the new loan s cash flows and the present

value of the old loan s remaining cash flows and an embedded conversion option was added to,

eliminated from or changed in the loan

Yes

Note 1: For purposes of determining whether a conversion option is substantive, the guidance in ASC

470-20-40-7 to 40-9 should be used. For additional information, refer to Chapter 2 of our debt and

equity guide.

Note 2: To determine the change in the fair value of an embedded conversion option, compare the fair

value of the option right before and right after the exchange or modification.

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As noted in the flowchart, the significance of an exchange or modification on an embedded conversion

option’s fair value is assessed separately and is not reflected in the 10% cash flow test discussed earlier

in this section.

2.3.2.1 Prepayment options

Relevant guidance: ASC 470-50-40-12(c)

For a loan that is callable or puttable, two sets of cash flows may need to be considered for purposes of

applying the 10% cash flow test: (1) cash flows assuming the call or put is exercised and (2) cash flows

assuming the call or put is not exercised. The cash flows that should be used in the 10% cash flow test

for purposes of reaching a decision about the accounting model that should be used are those that result

in the smaller change between the present value of the new loan’s cash flows and the present value of

the original loan’s remaining cash flows.

Commentary: A common form of put option present in a loan is a prepayment option. A prepayment

option may be explicitly stated in the loan agreement, or it may be implied when the loan agreement does

not prohibit prepayment. Such an option allows the borrower to prepay (i.e., put) the debt before it

otherwise matures, often subject to a penalty. If the new loan or old loan is prepayable, the cash flows

used in the 10% cash flow test may need to be calculated assuming both exercise and non-exercise of

the prepayment option because GAAP indicates that the assumption that results in the smaller change in

cash flows is used for purposes of reaching a decision about the accounting model that should be used to

account for the modification or exchange. This is the case regardless of the probability of prepayment and

even if the borrower does not have the financial ability to prepay. Any prepayment penalties are

considered part of the cash flows when assuming the prepayment option is exercised. The practical

effects of applying this guidance are that: (a) the modification accounting model should be applied when

either assumption (i.e., exercise or non-exercise of the prepayment option) produces a change in cash

flows of less than 10% (unless an evaluation of changes involving an embedded conversion option

indicates otherwise) and (b) the extinguishment accounting model should be applied when both

assumptions produce a change in cash flows of more than 10%. These effects are illustrated in the

following flowchart:

Is the change in cash flows less than 10%

when assuming the prepayment option is

exercised?

Is the change in cash flows less than 10%

when assuming the prepayment option is not

exercised?

Apply the extinguishment accounting model (see

Section 2.3.3)

Apply the modification accounting model

(unless an evaluation of changes involving an

embedded conversion option indicate otherwise)

(see Section 2.3.4)

Yes

The 10% cash flow test performed assuming exercise of the prepayment option will typically result in

modification accounting because the factors that cause a change in cash flows when assuming exercise

of the prepayment option (e.g., fees charged by the lender to modify the loan, a change to the

prepayment penalty) would generally not rise to the magnitude necessary to cause a change in cash

flows of more than 10%. However, when the prepayment penalty is expressed as a percentage of the

new principal amount (rather than as a fixed dollar amount) and the principal amount increases

substantially as a result of the amendment, the change in cash flows determined using the 10% cash flow

JUNE 2023

test assuming exercise of the prepayment option could result in a change in cash flows of more than

10%.

From an efficiency perspective, when the borrower has a loan with a prepayment option, we believe it

should start by performing the 10% cash flow test under the assumption that it expects would result in the

smaller change in cash flows (which is typically the assumption that the prepayment option will be

exercised). If the difference is less than 10% under the assumption that the prepayment option will be

exercised, the modification accounting model should be applied, and it would not be necessary to perform

the 10% cash flow test assuming non-exercise of the prepayment option. If the difference is more than

10% under the first assumption, the borrower would have to perform the 10% cash flow test under the

other assumption. This would include considering all factors impacting changes in cash flows, such as

interest payments, as well as reflecting all cash flows on a discounted basis while excluding the

prepayment penalty.

The following examples illustrate the application of this guidance:

• Example 3.5, Changes to prepayable debt that result in modification accounting

• Example 3.6, Changes to prepayable debt including incremental borrowings

• Example 3.7, Changes to prepayable delayed-draw term loan (DDTL)

• Example 3.8, Changes to prepayable debt with partial repayment of principal

2.3.2.2 Assessing multiple changes to the same debt within a one-year period

Relevant guidance: ASC 470-50-40-12(f)

As discussed in Section 2.3.2, if one or more less-than-substantially-different exchanges or modifications

to debt occurred within a year of the current exchange or modification, the changes should be assessed

cumulatively (instead of separately) for purposes of applying the 10% cash flow test. This is required so

the borrower does not get a different accounting answer by executing the exchange or modification in

stages. However, before the borrower applies the 10% cash flow test on a cumulative basis, it should first

determine whether the cumulative changes result in a TDR (see Section 2.2.3).

Commentary: Based on the limited guidance in ASC 470-50-40-12(f) and the guidance in ASC 470-50 in

general, we believe that when there are multiple changes to the same debt within a one-year period, and

the first of those changes was determined to be a modification, the borrower should evaluate the changes

within the one-year period on a cumulative basis. To do so, when assuming the prepayment option is not

exercised, we believe the borrower should perform the 10% cash flow test by comparing the following two

amounts (i.e., A and B below) as of the date the first changes were made to the debt in the one-year

period:

A. The present value of the remaining cash flows of the debt right before the first changes were

made in the one-year period

− Remaining cash flows include principal repayments and interest payable on the outstanding

principal balance from the date right before the first changes were made through the maturity

date

B. The present value of the cash flows for the changed debt on the date the first changes were

made to the debt, which should reflect all the changes made to the debt within the one-year

period (i.e., the first and the subsequent changes made to the debt within the one-year period)

and include:

− Incremental borrowings or principal repayments made (or to be made) from the date of the

first changes in the one-year period through the final maturity date

− Interest payments through the debt’s final maturity date

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− Fees paid or payable to the lender from the date of the first changes in the one-year period

through the final maturity date

The discount rate used for present-value purposes is the effective interest rate of the debt right before the

first changes were made to the debt in the one-year period.

As discussed further in Section 2.3.2.1, when the debt that has been changed is prepayable, the cash

flows used in the 10% cash flow test may need to be calculated assuming both exercise and non-exercise

of the prepayment option because GAAP indicates that the assumption that results in the smaller change

in cash flows is used for purposes of reaching a decision about the accounting model that should be used

to account for the changes made to the debt. For the reasons discussed in Section 2.3.2.1, from an

efficiency perspective, when the borrower has debt with a prepayment option, it should start by

performing the 10% cash flow test under the assumption that it expects would result in the smaller

change in cash flows, which is typically the assumption that the prepayment option will be exercised. To

perform the 10% cash flow test under the assumption that the prepayment option will be exercised when

there are multiple changes to the same debt within a one-year period, we believe that U.S. GAAP

requires calculating: (a) the preexisting debt’s remaining cash flows assuming the debt is prepaid right

before the first changes were made to the debt within the one-year period and (b) the present value of the

changed debt’s cash flows on the date the first changes were made to the debt in the one-year period

assuming the debt is prepaid right after the last changes were made to the debt within the one-year

period.

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The following table provides the inputs that should be used to calculate the preexisting debt’s remaining

cash flows and the changed debt’s cash flows assuming the prepayment option will be exercised:

Inputs to the 10% cash flow test assuming prepayment option is

exercised

Preexisting debt’s

remaining cash flows

Changed debt’s cash flows

Present value of input required

Yes (Note 1)

Principal

Principal amount

outstanding right before

the first change in the one-

year period

Principal repaid or borrowed between

the date of the first change and the

date of the last change in the one-year

period plus the remaining principal

repayment due after the last-change

date

Lender fees

Accrued and unpaid lender

fees due right before the

first change in the one-year

period

Lender fees paid in conjunction with

making the first and any subsequent

changes to the debt in the one-year

period, plus any due and unpaid lender

fees as of the last-change date

Interest

Accrued and unpaid

interest due right before

the first change in the one-

year period

Interest paid after the first change in

the one-year period up to and including

any interest paid in conjunction with the

last change in the one-year period,

plus any accrued and unpaid interest

as of the last-change date

Prepayment penalty or fee

Penalty or fee that would

be paid upon prepayment

based on the debt’s terms

right before the first change

in the one-year period

Penalty or fee that would be paid upon

prepayment based on the debt’s terms

right after the last change in the one-

year period

Note 1: The discount rate used for present valuing purposes is the effective interest rate of the debt right before

the first changes in the one-year period

If the 10% cumulative cash flow test performed assuming prepayment results in a percentage change in

cash flows of less than 10%, the borrower accounts for the last change made to the debt in the one-year

period as a modification (unless an evaluation of changes involving an embedded conversion option

indicate otherwise [see Section 2.3.2]). Conversely, if the cumulative 10% cash flow test performed

assuming prepayment results in a change in cash flows of 10% or more, the borrower should reperform

the 10% cash flow test assuming the debt is not prepaid. In this case, the 10% cash flow test will exclude

the prepayment penalty and must include calculations of the present value of all cash flows over the life of

the debt. If the cumulative 10% cash flow test assuming the debt is not prepaid results in a change in

cash flows of less than 10%, the borrower accounts for the last change made to the debt in the one-year

period as a modification (unless an evaluation of changes involving an embedded conversion option

indicate otherwise). Conversely, if that cumulative 10% cash flow test results in a change in cash flows of

10% or more, the borrower accounts for the last change made to the debt in the one-year period as an

extinguishment.

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Example 3.11 and Example 3.12 provide comprehensive illustrations of this guidance.

2.3.2.3. Treatment of a warrant or other sweetener or enhancement in the 10% cash flow test

Relevant guidance: ASC 470-50-40-12A and ASC 470-50-40-17A

Commentary: In some situations, a sweetener might be added to or removed from a loan agreement as

a result of a modification or exchange of the loan. In other situations, the terms of a sweetener included in

the original terms of the loan agreement might be changed. The question that arises in these situations is

how adding, changing or removing a sweetener affects the conclusion about whether there is a

substantial difference between the old loan and the new loan (and, therefore, whether the extinguishment

or modification accounting model should be applied to account for the modification or exchange of the

loan). While GAAP does not explicitly answer this question for sweeteners as a whole, GAAP does

address the treatment of changes in the fair value of freestanding equity-classified written call options that

are modified together with the related debt, stating that the fair value of those changes should be

reflected in the 10% cash flow test. Further, when determining whether a concession has been granted in

a TDR (see Section 2.2.2.2), GAAP requires the effects of any new, revised or removed sweeteners to be

included in the projected cash flows required under the debt after the changes are made even though

adding, revising or removing a sweetener may not always have a direct effect on cash flows. As such,

when performing the analysis as to whether a concession has been granted, the day-one projected cash

flows required under the debt after the changes are made includes the new sweetener’s fair value or the

change in a revised sweetener’s fair value. Based on this guidance, we believe it would also be

appropriate to take this approach when assessing whether there is a substantial difference between the

old loan and new loan when a modification or exchange occurs. In other words, we believe that it would

be appropriate to include a new sweetener’s fair value in the cash flows of the new loan for purposes of

the 10% cash flow test used to determine whether there is a substantial difference between the old loan

and new loan. In addition, if the terms of a sweetener have changed, we believe it would be appropriate

to include the change in the fair value of the sweetener in the new loan’s cash flows for purposes of the

10% cash flow test.

The accounting for the fair value or the change in fair value of a sweetener (e.g., warrant) that is added,

revised or removed depends on whether the extinguishment or modification accounting model should be

applied to the modification or exchange itself. For example, if a loan agreement is modified to include a

warrant and the fair value of that warrant is $1 million, then $1 million would be included in the new loan’s

cash flows for purposes of the 10% cash flow test. In addition, if the modification accounting model is

applicable, the fair value of the warrant would be recognized as a debt discount. In contrast, if the

extinguishment accounting model is applicable, the fair value of the warrant would be taken into

consideration in determining the gain or loss on extinguishment (i.e., it would increase what would

otherwise be a loss or decrease what would otherwise be a gain). The accounting for any equity-linked

sweetener or enhancement, including whether it should be classified as a liability or equity, is addressed

in our debt and equity guide.

2.3.2.4 Reference rate reform

Relevant guidance: ASC 848-10-05, ASC 848-10-15, ASC 848-10-65, ASC 848-20-05, ASC 848-20-15,

ASC 848-20-35-3 to 35-5, ASC 848-20-35-10 and ASC 848-20-55-1

The publication of the London Interbank Offered Rate (LIBOR), which is referenced in approximately

$350 trillion of contracts, is expected to cease after June 30, 2023. In the U.S., the Secured Overnight

Financing Rate (SOFR) has been identified as the preferred alternative to LIBOR as part of reference rate

reform. Reference rate reform will affect entities that have assets, debt instruments, interest rate swap

agreements or other contracts that reference LIBOR or another rate that is expected to be discontinued.

The FASB issued ASU 2020-04 to provide temporary optional expedients and exceptions to the guidance

in GAAP regarding contract modifications, hedge accounting and other transactions to ease the expected

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burden on financial reporting related to the upcoming reference rate reform. In December 2022, the FASB

issued ASU 2022-06 to extend the temporary optional guidance provided by ASC 848 to December 31,

2024.

One of the temporary optional expedients in ASC 848 may be applied instead of the otherwise applicable

guidance in ASC 470-50 in certain circumstances involving changes to debt to replace LIBOR (or another

reference rate that is expected to be discontinued). If appropriately elected, this optional accounting

expedient allows a borrower to continue its existing accounting for the contract with no reassessment of

whether the changes should be accounted for as a debt modification or extinguishment. Additionally, the

impact of any change in interest rates would be accounted for prospectively through an adjustment to the

effective interest rate.

The details of this temporary optional expedient and the practical expedient available for other contract

modifications are provided in our LIBOR whitepaper.

2.3.3 Extinguishment accounting model

Relevant guidance: ASC 470-50-40-1 to 40-2 and ASC 470-50-40-13

The essence of extinguishment accounting is to remove the settled loan from the borrower’s books.

However, extinguishment accounting might also apply when a loan is modified or exchanged (see Section

2.3.3.3). For the modification or exchange of a loan that qualifies for extinguishment accounting, a loan

remains on the borrower’s books after the modification or exchange. In these cases, the old loan (i.e., the

loan being modified or given up in the exchange) is effectively derecognized and a new loan (i.e., the

modified loan or loan received in the exchange) is recognized. The remainder of this section discusses

extinguishment accounting (both when debt is and is not accounted for at fair value) and the special

consideration involved when extinguishment accounting is applied to the modification or exchange of a

loan.

Prior to accounting for a loan extinguishment, the borrower should identify all of the rights and privileges

being exchanged between the borrower and lender as part of the extinguishment. If more than just the

extinguishment of a loan is occurring between the parties, then separate accounting recognition for any

activities above and beyond the extinguishment would be required. In doing so, a portion of the

consideration exchanged by the parties would need to be allocated to these additional activities.

Example 3.9 provides an illustration of this guidance.

2.3.3.1. Considerations when debt is not accounted for at fair value

Relevant guidance: ASC 470-50-40-1 to 40-2, ASC 470-50-40-3 and ASC 470-50-40-13

Depending on the facts and circumstances surrounding the extinguishment of a loan, the borrower may

be required to separately recognize a gain or loss in the period of the extinguishment (i.e., recognition of

a gain or loss upon a loan extinguishment is not deferred to future periods). The gain or loss is calculated

as the difference between the loan’s reacquisition price (as defined below) and its net carrying amount.

The loan’s reacquisition price is the amount paid to extinguish (settle) the loan, which includes any call

premium or costs of reacquisition. If the loan is extinguished through the direct exchange of a new loan

(i.e., the borrower replaces its existing loan for a new loan with the same lender), the old loan’s

reacquisition price is the present value of the new loan’s cash flows. When there are incremental

borrowings in the new loan, the reacquisition price of the old loan should be equivalent to the new loan’s

fair value less the fair value of those incremental borrowings. If a loan is extinguished early through the

borrower’s issuance of common or preferred stock to the lender, the more clearly evident of the issued

stock’s fair value or the loan’s fair value should be used as the reacquisition price.

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The loan’s net carrying amount is: (a) the amount due at maturity (including any accrued but unpaid

interest), (b) plus (minus) any related unamortized debt premium (discount) and (c) minus any related

unamortized debt issuance costs.

The gain or loss on extinguishment of debt should be reported as a separate line item in the income

statement.

If a loan is extinguished at maturity under the terms and conditions agreed to at issuance (i.e., no early

extinguishment, no modification of terms, etc.) and all accrued interest has been paid, the reacquisition

price of the loan would typically be the amount of the principal repayment. In addition, a gain or loss on

extinguishment would normally not exist in this situation because the principal repayment and the net

carrying amount of the loan would be the same.

To the extent the borrower and lender are related parties, consideration should be given to whether the

extinguishment of a loan is effectively a capital transaction between the parties.

Commentary: A common related-party relationship involving a borrower and a lender is when the lender

is also an equity holder in the borrower. If extinguishment accounting is applied to changes in a loan with

a lender that is also an equity holder, consideration must be given to whether any gain or loss that results

from applying extinguishment accounting should be reflected in the income statement or in equity (e.g.,

additional paid-in capital).

When the extinguishment accounting model results in a loss, the loss should only be recorded in equity if

all of the equity holders were also holders of the debt that was extinguished, as this situation is akin to a

dividend.

When the extinguishment accounting model results in a gain, a key consideration related to whether the

gain should be reflected in equity is whether the lender is modifying or exchanging the loan to protect its

equity investment in the borrower. If so, that would provide a strong indication that the gain on

extinguishment should be reflected in equity. When determining whether the lender is protecting its equity

investment in the borrower, consideration should be given to the significance of the lender’s equity

investment in the borrower. The Master Glossary of the Codification defines principal owners as those

that own more than 10% of the voting interests (including direct and beneficial interests) of an investee. If

the lender’s equity investment in the borrower would result in the lender being considered a principal

owner, we believe the lender’s equity investment in the borrower is significant, which we believe indicates

that the lender entered into the modification or exchange to protect its equity investment in the borrower.

As a result, any gain on extinguishment recognized in connection with the modification or exchange of the

loan should be reflected in equity. If the lender is not considered a principal owner, other relevant facts

and circumstances should be considered to determine whether the lender entered into the modification or

exchange to protect its equity investment in the borrower. Among those facts and circumstances is the

significance of the lender’s debt and equity investments in the borrower relative to each other and relative

to those held by other investors in the borrower.

2.3.3.2 Considerations when debt is accounted for at fair value

Relevant guidance: ASC 470-50-40-2A

The borrower may have elected the fair value option to account for its debt in accordance with ASC 815-

15 or ASC 825-10. When that is the case, and the borrower extinguishes the debt early, the carrying

amount of the debt and its fair value on the extinguishment date should be the same. As such, unlike

when debt is not accounted for at fair value, there is no difference between the carrying amount of the

debt and its reacquisition price for which to recognize a gain or loss. However, to the extent there is a

cumulative gain or loss reflected in other comprehensive income related to changes in the credit risk of

the debt (see ASC 825-10-45-6), the borrower should reclassify that gain or loss from other

comprehensive income to net income.

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2.3.3.3 Extinguishment accounting for a modification or exchange of loans

Relevant guidance: ASC 470-50-40-13

When extinguishment accounting is applied to a modification or exchange of loans, the loan that remains

after the modification, or the loan received in the exchange, should be recognized at its fair value. The fair

value is also used to determine the debt extinguishment gain or loss to be recognized and the effective

interest rate of the new loan.

Commentary: Applying extinguishment accounting to the modification or exchange of loans requires the

borrower to determine the fair value of the new loan (i.e., the loan that remains after the modification or

the loan that is received in the exchange).

GAAP defines the fair value of a liability as the price that would be paid to transfer the liability in an

orderly transaction between market participants at the measurement date. Under the fair value

measurement principles of ASC 820, the liability is assumed to continue (i.e., it is not settled or

extinguished), and the market participant to whom the liability is transferred would be required to fulfill the

obligation. Nonperformance risk (i.e., the risk that an obligation will not be fulfilled, which includes a

reporting entity’s own credit risk) is also assumed to remain unchanged before and after the transfer,

implying that the liability is hypothetically transferred to a market participant of equal credit standing.

The fair value of a liability is not based on the price to settle a liability with the existing counterparty, but

rather to transfer it to a market participant of equal credit standing (i.e., equal credit standing as the

current debtor). Consequently, this affects the assumptions about the principal (or most advantageous)

market and the market participants in the exit market for the liability.

When available, the fair value of a liability should be measured using the quoted price in an active market

for the identical liability held by another party as an asset. Although there is a public market for debt

securities, for most middle-market borrowers, a quoted price for the liability being measured will not be

available. Absent a quoted price for an identical or similar liability, ASC 820 indicates the fair value of a

liability should be measured from the perspective of a market participant that holds the identical

instrument as an asset at the measurement date. As with all fair value measurements, inputs used to

determine the fair value of a liability from the perspective of a market participant that holds the identical

instrument as an asset must be prioritized in accordance with the fair value hierarchy. Absent quoted

prices for the identical instrument held as an asset, other valuation approaches, including the income or

market approaches, would be used to determine the liability’s fair value.

Guidance on measuring the fair value of liabilities is included in ASC 820-10-35. When faced with the

challenge of determining the fair value of a new loan, the borrower should consider engaging the

assistance of a qualified valuation specialist.

2.3.4 Modification accounting model

Relevant guidance: ASC 470-50-40-14 to 40-16

There is no gain or loss recognized in the income statement under the modification accounting model.

Instead, modification accounting requires the calculation of a new effective interest rate for the modified

loan.

In determining the new effective interest rate, the old loan’s carrying amount is adjusted for an increase in

the fair value of an embedded conversion option. The adjustment increases any related debt discount or

decreases any related debt premium. As a result, the carrying amount of the loan decreases and

additional paid-in capital increases. Conversely, a decrease in the fair value of an embedded conversion

option does not result in an adjustment to the loan’s carrying amount or additional paid-in capital. For

purposes of determining whether the fair value of an embedded conversion option has increased or

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decreased, the fair values of the option right before and right after the modification or exchange are

compared to each other.

A beneficial conversion feature is not recognized or reassessed when modification accounting is applied

to an exchange or modification that is not accounted for as an extinguishment. Note that a borrower will

no longer separately recognize a beneficial conversion feature after its adoption of ASU 2020-06, which is

discussed in detail in our debt and equity guide.

2.3.5 Accounting for fees and costs incurred

Relevant guidance: ASC 470-50-40-17 to 40-18A

How a borrower accounts for fees and costs involved in an exchange or modification of loans depends

on: (a) whether the fees and costs are between the borrower and lender or between the borrower and a

third party (e.g., the borrower’s legal counsel) and (b) whether extinguishment or modification accounting

is applied to the exchange or modification:

If borrower

applies…

Fees between borrower

and lender are…

Costs incurred with third

parties are…

Unamortized debt

discount, premium

and issuance costs

on old loan are…

Extinguishment

accounting

Expensed

Deferred as debt issuance

costs and amortized over the

term of the new loan

Expensed

Modification

accounting

Deferred as a debt

discount or reduction of

debt premium (as

appropriate) and

amortized over the term

of the modified loan

Expensed

Continue to be

amortized over the term

of the modified loan

(Note 1)

Note 1: Refer to the commentary later in this section

Fees between the borrower and lender when the borrower is required to apply the extinguishment

accounting model are included in the calculation of the gain or loss on extinguishment. Such fees are

deemed to be related to extinguishing the old loan. Fees between the borrower and lender when the

borrower is required to apply the modification accounting model are not expensed. Such fees are deemed

to be related to the modified loan and should be recognized in interest expense over the remaining term

of the modified loan. If there is a debt premium for the loan at the time of the modification, then the fees

between the borrower and lender reduce the debt premium. Otherwise (i.e., there is a debt discount or

there is neither a debt premium nor a debt discount for the loan at the time of the modification), the fees

between the borrower and lender are recorded as a debt discount. Debt waiver fees are an example of a

fee paid by the borrower to the lender for which the accounting depends on whether the borrower is

required to apply extinguishment or modification accounting (see Section 2.3.6 for additional discussion).

Additionally, increases or decreases in the fair value of the borrower’s freestanding equity-classified

written call options held by the lender that were modified or exchanged either as a part of or directly

related to the debt modification are accounted for as fees between the borrower and the lender.

Designation of fees by the lender as being related to the old loan or new loan does not influence the

accounting for those fees. The model applied to the fees follows the accounting model used for the

modification or exchange itself. As such, the accounting guidance on this subject determines whether the

fees are in substance related to the old loan or new loan.

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Costs incurred with third parties when the borrower is required to apply extinguishment accounting are

recognized as debt issuance costs and amortized to expense over the term of the new loan. Deferred

debt issuance costs are presented with any debt discount as a contra-liability on the balance sheet. Costs

incurred with third parties when the borrower is required to apply modification accounting are expensed

as incurred. Additionally, increases (but not decreases) in the fair value of freestanding equity-classified

written call options held by a third party that were modified or exchanged either as a part of or directly

related to the debt modification are accounted for as fees between the borrower and third parties.

Commentary: When the modification accounting model is applied to a loan modification in which there

was a partial paydown of principal in connection with a prepayment option, we believe the borrower may

choose one of the following accounting policies to account for the unamortized debt discount, premium

and issuance costs related to the old loan:

(a) Leave those unamortized amounts on its books and continue to amortize them over the term of

the new loan (based on a literal application of the guidance in the table at the beginning of this

section on the treatment of these amounts under modification accounting) or

(b) Write off a portion of those unamortized amounts in proportion to the partial paydown and

continue to amortize the remaining portion over the term of the new loan.

When a borrower makes a partial paydown of principal that is not part of a loan modification and for which

there was an existing prepayment option, we believe that the borrower must apply the guidance in (b)

above.

This accounting policy election does not affect the borrower otherwise being required to: (a) defer and

amortize all fees charged to the borrower by the lender to change the debt and reflecting those fees in a

debt discount or as a reduction of debt premium (as appropriate) (i.e., none of these fees may be

expensed) and (b) expense all costs incurred with third parties (i.e., none of these expenses may be

capitalized).

2.3.5.1 Borrower pays lender’s third-party service providers

Commentary: In some cases, the borrower may agree to directly pay the lender’s third-party service

providers (e.g., its external legal counsel) for the services provided to the lender in connection with the

exchange or modification of a loan, or the lender may agree to directly pay the borrower’s third-party

service providers for services provided to the borrower in connection with the exchange or modification of

a loan. The appropriate characterization of these payments by the borrower is important, given the

different accounting treatment afforded fees between the borrower and the lender and costs incurred with

third parties. If the third-party service provider’s fees are charges for services provided to the lender, we

believe those fees should be characterized as fees between the borrower and lender for accounting

purposes because that is consistent with their substance. We believe this is the appropriate

characterization regardless of whether those fees are: (a) billed directly to the borrower by the third-party

service provider or (b) billed to the lender by the third-party service provider and ultimately paid by the

borrower based on payment instructions provided by the lender to the borrower. If the third-party service

provider’s fees are charges for services provided to the borrower, we believe those fees should be

characterized as third-party costs for accounting purposes because that is consistent with their

substance. We believe this is the appropriate characterization regardless of whether those fees are paid

directly by the borrower or paid by the lender on the borrower’s behalf.

Consider the following situation. The lender hires a law firm to provide the lender with legal counsel in

connection with the modification of a loan between the lender and one of its borrowers. The lender

instructs the law firm to bill the borrower directly for the legal services provided to the lender in connection

with the modification. While the borrower agrees to pay the law firm directly, it is the lender that was

provided the legal services. Based on these arrangements, the law firm bills the borrower $100,000. In

addition, the lender charges the borrower a fee of $400,000 to execute the modification. In this situation,

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the question arises as to how the borrower should characterize, from an accounting perspective, the

billings for the services provided by the law firm to the lender. Should those billings be characterized as:

(a) fees between the borrower and the lender or (b) direct costs incurred with third parties? Because the

law firm’s fees are charges for services provided to the lender, we believe the law firm’s fees should be

characterized as fees between the borrower and lender for accounting purposes. In other words, the total

fees charged by the lender to the borrower in connection with the loan modification are $500,000, of

which $400,000 is billed directly by the lender and $100,000 is billed by the law firm on the lender’s

behalf. In this example, the borrower is essentially acting as the lender’s agent for purposes of paying the

law firm for the legal services it provided to the lender. The same accounting treatment would result if

$100,000 was billed to the lender by the third-party service provider and ultimately paid by the borrower

(based on payment instructions provided by the lender to the borrower) rather than billed directly to the

borrower by the third-party service provider.

2.3.5.2 Fees and costs incurred in changing loans in a loan syndication

Commentary: As discussed further in Section 2.3.7, in a loan syndication, many lenders are individually

loaning specific amounts to the borrower, and the borrower is obligated to repay each individual lender.

The guidance on how to account for the modification or exchange of loans would only apply to

modifications or exchanges involving the borrower and the lenders taking part in the modification or

exchange. In addition, the guidance is applied separately to each loan in the syndication that is modified

or exchanged.

In some cases, one of the lenders in the syndicate will act in an investment banking or underwriting

capacity for purposes of coordinating the modification or exchange across all the lenders participating in it

(including itself). In those situations, we believe that the fees charged by the lender that is also acting in

that capacity should be evaluated to determine the portion of the fee related to the modification or

exchange of its loan and the portion representing a direct third-party cost related to the underwriting or

investment banking services it is providing to coordinate the modification or exchange across all lenders

taking part in it. We believe that treating the entire fee charged by the lender acting in the capacity of an

underwriter or investment banker as a lender fee could result in reaching the wrong conclusions with

respect to: (a) whether modification or extinguishment accounting should be applied to the changes made

to that lender’s individual loan and (b) whether the appropriate amount of the fee is capitalized or

expensed.

2.3.6 Fees between borrower and lender trigger accounting assessment

Relevant guidance: ASC 470-50-05-4

Cash flows are inevitably affected when a borrower and lender agree to modify or exchange loans. In a

more obvious sense, a loan’s cash flows change if the borrower and lender agree to change the loan’s

principal amount, interest rate or maturity date. Perhaps less obvious are changes to a loan’s cash flows

when the borrower and lender exchange fees to alter other terms of the loan. For example, paying a

lender a fee in connection with obtaining a debt waiver letter affects the loan’s cash flows. The

significance of this change in cash flows must be evaluated to determine whether applying the

modification or extinguishment accounting model is appropriate. This determination then plays a part in

how the fees themselves should be treated from an accounting perspective. Examples of other situations

in which fees may be exchanged between a borrower and a lender include those related to changing: (a)

recourse or nonrecourse features, (b) priority, (c) collateralization features, (d) guarantor and (e) option

features.

2.3.6.1 Commitment fees on delayed-draw term loans

Commentary: As discussed further in Section 2.3.1.2, DDTLs have characteristics of both term loans and

line-of-credit arrangements. A borrower will generally pay commitment fees to the lender related to a

DDTL, which are based on the size of the commitment by the lender and are generally payable based on

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either the undrawn commitment or the total commitment. Such fees are due whether or not the debt is

drawn. Therefore, these fees are consistent with fees paid on a line-of-credit arrangement. We believe,

therefore, that these fees should be treated consistently with fees related to line-of-credit arrangements

(see Section 2.4) and recorded as either: (a) an asset or (b) a reduction of the carrying amount of debt,

but only to the extent there is a debt balance on the balance sheet when paid. Once the DDTL is drawn,

we believe that the fees (related to the drawn portion) should be treated consistent with term loan fees

and reflected as a reduction of the debt balance and amortized over the life of the debt using the effective

interest method. To the extent that the DDTL remains undrawn, the fees should be amortized on a

straight-line basis over the life of the commitment.

2.3.7 Loan participations and syndications

Relevant guidance: ASC 470-50-55-1 to 55-3

In a loan participation, one lender (i.e., the lead bank) makes a loan to the borrower and then transfers

undivided interests in that loan to other banks (i.e., participating banks). For purposes of accounting for

an extinguishment, modification or exchange of a loan in this situation, the lender is the lead bank and not

the participating banks. As such, the guidance on how to account for the modification or exchange of

loans only applies to modifications or exchanges involving the borrower and the lead bank.

In a loan syndication or public debt issuance, many lenders are individually loaning specific amounts to

the borrower (the total of which is the full amount of financing sought by the borrower) and the borrower is

obligated to repay each individual lender. Because there are multiple lenders, the borrower must identify

which lenders are taking part in the modification or exchange. The guidance on how to account for the

modification or exchange of loans only applies to modifications or exchanges involving the borrower and

the lenders taking part in the modification or exchange. In addition, the guidance should be applied

separately to each loan in the syndication or public issuance that is modified or exchanged. For those

lenders not taking part in the modification or exchange, there is no accounting event. For example,

consider a situation where there are 20 loans with 20 different lenders in a syndication. Fifteen of those

loans are being changed and five of those loans are not being changed. Further to this, no fees are being

paid to those five lenders. For the five loans not being changed, there are no accounting events for the

borrower. For the 15 loans that are being changed, the borrower must separately consider whether the

changes made to each of those loans should be accounted for using the TDR, modification or

extinguishment accounting model. Depending on the facts and circumstances, the borrower may need to

separately perform the concession analysis (to determine whether there is a TDR) and the 10% cash flow

test for each of the 15 loans that are changed. The results of separately performing those analyses and

tests could result in some of the 15 changed loans being accounted for under one model and others

being accounted for under a different model.

To determine whether two or more lenders in the loan syndication or public issuance should be treated as

the same lender for accounting purposes, refer to the guidance in Section 1.1.

Section 2.3.5.2 discusses an issue that may arise with respect to the accounting for certain fees charged

by a lender when changes are made to multiple loans in the syndication.

Example 3.10 illustrates the application of this guidance.

2.3.8 Third-party intermediaries

Relevant guidance: ASC 470-50-40-19 to 40-20, ASC 470-50-55-4 to 55-5 and ASC 470-50-55-7

A third-party intermediary may be involved in the efforts to modify or exchange loans. For example, an

investment banker may buy back the borrower’s debt from its lenders and coordinate new debt

agreements between the borrower and its lenders. Whenever a third-party intermediary is involved in a

modification or exchange of loans, consideration should be given to whether the intermediary is acting as

a principal or an agent.

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If the intermediary is acting as an agent of the borrower, then the intermediary’s involvement in the

transaction would not affect the borrower’s accounting for the modification or exchange (other than

needing to account for any fees paid or payable to the intermediary). In other words, the borrower will not

change their accounting treatment solely due to involving an intermediary that is acting as its agent in the

modification or exchange of loans. For accounting purposes, the borrower should effectively look through

an intermediary that is acting as an agent, and any actions of the intermediary should be considered

actions of the borrower. Conversely, if the third-party intermediary is a principal in the modification or

exchange of a loan, then the borrower should treat the intermediary as the lender and not look through it

for accounting purposes.

A full analysis of the third-party intermediary’s role should be performed to determine whether it is acting

as a principal or an agent. Indicators to consider in this regard are presented in the following table:

Indicators

Principal

Agent of borrower

Intermediary places own funds at risk?

Yes

Basis of agreement with intermediary is…

Firmly committed

Best efforts

Borrower directs intermediary’s activities and

intermediary cannot act independently

Yes

Intermediary is subject to loss on transactions

entered into with lenders

Yes

Intermediary’s income is based on…

Value of borrower’s

security

Pre-established fee

Commentary: Legal counsel may need to be consulted when analyzing whether a third-party

intermediary is acting as a principal or an agent of the borrower in the exchange or modification of loans.

2.3.9 Transactions between lenders

Relevant guidance: ASC 470-50-40-7 and ASC 470-50-55-6

To the extent there are multiple lenders involved in a loan (e.g., bonds sold to several different parties,

several banks in a loan arrangement), transfers or exchanges between the lenders do not result in a

modification or exchange for the borrower. The borrower is not affected in this situation unless funds pass

through the borrower or an agent of the borrower. To the extent an intermediary is involved in a transfer

or exchange between lenders, consideration should be given to whether the intermediary is functioning as

a principal or an agent in the transfer or exchange (see Section 2.3.8). When the intermediary is

functioning as a principal in a transfer or exchange between lenders, it should be considered a lender.

2.4 Modification of a line-of-credit arrangement

Relevant guidance: ASC 470-50-40-21 to 40-23, and ASC 470-50-55-10 to 55-13

A borrower often incurs direct costs (e.g., lender’s fee, third-party legal costs) upon entering a line-of-

credit arrangement which should be deferred and amortized over the term of the arrangement. When

there is a modification or exchange involving a line-of-credit arrangement, the borrower must first

determine whether the modification or exchange should be accounted for as a TDR. If not, the question

arises regarding the accounting for any related preexisting unamortized deferred costs. To answer this

question, the borrower must compare the borrowing capacity of the old arrangement to the borrowing

capacity of the new arrangement. In addition, the borrower must also account for any direct costs incurred

to execute the modification or exchange.

The borrowing capacity of the old arrangement is determined by taking the arrangement’s commitment

amount and multiplying it by the arrangement’s remaining term at the date of the modification or

exchange. The borrowing capacity of the new or modified arrangement is determined by taking the new

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or modified arrangement’s commitment amount and multiplying it by the term of the new or modified

arrangement.

For example, if the borrower has a line-of-credit arrangement whose remaining term is three years and

the amount available under the line-of-credit arrangement (i.e., the commitment amount) is $10 million,

the borrowing capacity of that old line-of credit arrangement is $30 million ($10 million commitment

amount × 3-year remaining term).

As illustrated in the table below, accounting for the preexisting unamortized deferred costs related to the

line-of-credit arrangement depends on the change in the line-of-credit arrangement’s borrowing capacity,

while any direct costs incurred to execute the modification or exchange are deferred and amortized over

the term of the new arrangement:

Change in borrowing

capacity?

Preexisting unamortized

deferred costs

Costs incurred in connection

with modification

Increase (borrowing capacity of

new arrangement is greater than

the borrowing capacity of old

arrangement) or no change

(borrowing capacity of the new

arrangement is equal to the

borrowing capacity of old

arrangement)

Defer and amortize over term of

new arrangement

Defer and amortize over term of

new arrangement

Decrease (borrowing capacity of

new arrangement is less than

borrowing capacity of old

arrangement)

Write off in proportion to the

decrease in borrowing capacity;

for portion not written off, defer

and amortize over term of new

arrangement

Defer and amortize over term of

new arrangement

Any preexisting unamortized deferred costs written off as a result of applying this guidance should be

reported as a separate line item in the income statement.

The amount of unamortized deferred costs at the balance-sheet date may be presented in the balance

sheet as either: (a) an asset or (b) a reduction of the carrying amount of debt, but only to the extent there

is a debt balance.

The above assessment should be made on a lender-by-lender basis. If a lender exits the line-of-credit

arrangement completely, then all unamortized costs associated with that lender should be expensed.

An increase or decrease in the fair value of a freestanding equity-classified written call option held by a

lender or a third party that was modified together with a line-of-credit arrangement held by the same

lender is accounted in the same manner as fees paid in connection with the line-of-credit arrangement

modification.

Example 3.13 and Example 3.14 illustrate the application of this guidance.

2.4.1 Modifications of undrawn delayed-draw term loan commitments

Commentary: We believe the accounting guidance for modifications of line-of-credit commitments also

applies to modifications of undrawn DDTL commitments.

2.5 Changing from term loan to line-of-credit and vice versa

Relevant guidance: ASC 470-50-40-21

Section 2.3 discuss how to account for changes to a term loan that do not result in a TDR (term loan

guidance). Section 2.4 discusses how to account for changes to a line-of-credit arrangement that do not

JUNE 2023

result in a TDR (line-of-credit guidance). In some cases, a borrower may replace a line-of-credit

arrangement with a term loan with the same lender (i.e., a line-of-credit arrangement is converted to a

term loan), or a borrower may replace a term loan with a line-of-credit arrangement with the same lender

(i.e., a term loan is converted to a line-of-credit arrangement).

When the borrower replaces a line-of-credit with a term loan with the same lender (see Section 1.1), and

the replacement should not be accounted for as a TDR, the line-of-credit guidance should be applied to

account for that change.

Commentary: ASC 470-50 does not address how a borrower should account for the replacement of a

term loan with a line-of-credit arrangement with the same lender (see Section 1.1). However, as

discussed earlier in this section, the replacement of a line-of-credit arrangement with a term loan with the

same lender should be accounted for using the line-of-credit arrangement guidance, which is consistent

with the nature of the credit facility before it was changed. By analogy, we believe that the replacement of

a term loan with a line-of-credit should be accounted for using the term loan guidance, which is consistent

with the nature of the credit facility before it was changed.

2.6 Debt disclosures

Relevant guidance: ASC 470-10-50-5, ASC 505-10-50-3; for public entities SEC Regulation S-X,

Rules 4-08 and 5-02

The Codification requires a relatively limited number of disclosures about an entity’s borrowings.

Disclosure requirements include information, in summary form, about the rights and privileges of the

outstanding debt. A few of these disclosure requirements have been noted elsewhere in this guide. The

SEC requires more disclosures about a public company’s debt. Required disclosures for public

companies include the amount of each debt instrument, their nature and interest rate, maturity date, the

priority of the debt (i.e., if the debt is senior debt or subordinated debt) and whether the debt is

convertible. Disclosures are also required if there are any contingencies related to payments of principal

or interest. Further, a public company must disclose significant changes in the authorized or outstanding

debt amounts that occurred since the latest balance sheet date.

Commentary: In the absence of a specific disclosure requirement, a borrower should still consider

whether the users of its financial statements would be interested in, or influenced by, information

pertaining to the entity’s debts. For example, even though there is not a specific requirement that calls for

the disclosure of changes to a loan and whether those changes were accounted for using the modification

or extinguishment accounting model, the borrower should still consider whether the users of its financial

statements would find information about the changes and related accounting helpful and relevant. In

general, if the user of the financial statements would be influenced by such information, then it should be

disclosed. The extent of the disclosures would vary depending on the facts and circumstances.

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3 Examples

3.1 Liability derecognition threshold (Section 2.1.1)

Facts

Borrower and Lender entered into a debt agreement on March 31, 20X1, with the following terms:

• Principal amount is $5 million

• Stated interest rate is 10%

• Principal is repayable in one lump sum on March 31, 20X6

• Interest is payable annually in arrears on March 31

• Term is five years

• There is no embedded conversion option

• There is a prepayment penalty of 5% if the debt is paid off prior to March 31, 20X4

Lender charged Borrower a lender fee of $100,000 and Borrower incurred $50,000 in third-party debt

issuance costs, which was accrued, but not yet paid as of March 31, 20X1. Borrower’s debt is not rated

by a credit rating agency. Borrower has not elected to account for its debt using the fair value option.

There are no other outstanding loans with Lender and Lender does not have an equity investment in

Borrower. Borrower recognizes interest expense using the effective interest method (see Section 1.3).

Borrower records the following journal entry on March 31, 20X1:

Debit

Credit

Cash ($5 million principal – $100,000 lender fee)

$4,900,000

Debt discount ($100,000 lender fee + $50,000 debt issuance costs)

150,000

Debt

$5,000,000

Payable to third party (for debt issuance costs)

50,000

In addition, Borrower determines that its effective interest rate for the purpose of recognizing interest

expense over the term of the debt is approximately 10.8%. Borrower determined this by using the

following inputs in a present value software tool:

• Compounding period: Annual

• Net carrying amount of the debt on March 31, 20X1: $4,850,000 ($5 million principal amount −

$150,000 debt discount)

• Interest payments: $500,000 each year starting on March 31, 20X2 and ending on March 31,

20X6 ($5 million principal amount × 10% stated interest rate)

• Principal repayment: $5 million on March 31, 20X6

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Changes are made to the debt on March 31, 20X3. The following includes a roll forward of the debt

discount and the carrying amount of the debt (debt principal net of debt discount) from after its issuance

on March 31, 20X1 to before it is changed on March 31, 20X3, as well as the interest expense recognized

in the twelve months ending March 31, 20X2 and 20X3:

Debt

discount

Carrying

amount of

debt

Interest

expense

Balance on March 31, 20X1

$150,000

$4,850,000

Amortization of debt discount ($500,000 interest payment –

$524,178 interest expense)

(24,178)

24,178

Interest expense ($4,850,000 × 10.8%)

$524,178

Balance on March 31, 20X2

$125,822

$4,874,178

Amortization of debt discount ($500,000 interest payment –

$526,791 interest expense)

(26,791)

26,791

Interest expense ($4,874,178 × 10.8%)

$526,791

Balance on March 31, 20X3 before changes are made to the

debt

$99,031

$4,900,969

On March 31, 20X3, Borrower decides to extinguish the debt with Lender early, but as part of the

negotiation process, Borrower and Lender agree to modify the debt so that there is only a 2% prepayment

penalty. Upon paying Lender the principal amount of $5 million, a prepayment penalty of $100,000 and

the interest otherwise due on March 31, 20X3 of $500,000, Borrower is relieved of its obligation under the

debt agreement. Borrower is not experiencing financial difficulties on March 31, 20X3.

Analysis

Borrower determines that the liability derecognition threshold has been met, due to the fact that the

borrower was relieved of its obligation after paying the lender and because the borrower and lender did

not enter into new loans nor were there any other preexisting term loans between the borrower and the

lender. As a result, the borrower records the following journal entry on March 31, 20X3:

Debit

Credit

Debt

$5,000,000

Accrued interest payable

500,000

Loss on early extinguishment of debt (Note 1)

199,031

Cash

$5,600,000

Debt discount

99,031

Note 1: $99,031 derecognition of debt discount + $100,000 prepayment penalty

Even though the liability derecognition threshold has been met, Borrower considers whether the changes

to the debt meet the definition of a TDR for disclosure purposes. Because Borrower is not experiencing

financial difficulties, it determines that the changes to the debt do not meet the definition of a TDR.

3.2 TDR with modification of terms in which no gain is recognized (Section 2.2.4.3)

Facts

Borrower and Lender entered into a debt agreement on March 31, 20X1, with the following terms:

• Principal amount is $5 million

• Stated interest rate is 10%

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• Principal is repayable in one lump sum on March 31, 20X6

• Interest is payable annually in arrears on March 31

• Term is five years

• There is no embedded conversion option

Lender charged Borrower a lender fee of $100,000 and Borrower incurred $50,000 in third-party debt

issuance costs. Borrower’s debt is not rated by a credit rating agency. Borrower has not elected to

account for its debt using the fair value option. There are no other outstanding loans with Lender and

Lender does not have an equity investment in Borrower. Borrower recognizes interest expense using the

effective interest method (see Section 1.3).

Borrower records the following journal entry on March 31, 20X1:

Debit

Credit

Cash ($5 million principal – $100,000 lender fee)

$4,900,000

Debt discount ($100,000 lender fee + $50,000 debt issuance costs)

150,000

Debt

$5,000,000

Payable to third party (for debt issuance costs)

50,000

Borrower determines that its effective interest rate for the purpose of recognizing interest expense over

the term of the debt is approximately 10.8%.

Changes are made to the debt on March 31, 20X3. The debt discount and carrying amount of the debt on

March 31, 20X3 before the debt is changed are $99,031 and $4,900,969, respectively.

Due to increased competitive pressures and unexpected increases in its operating costs, Borrower is

falling behind its financial projections to a significant degree, and its cash flows in recent periods are

lagging significantly behind its cash flows in comparable prior periods. As such, Borrower is unable to

make the interest payment required ($500,000) on March 31, 20X3. In addition, Borrower’s revised

projections do not show sufficient cash flows in the remainder of 20X3 and beginning of 20X4 to support

making the interest payment required on March 31, 20X4. Borrower attempts to identify other sources of

financing and discovers that its financial situation severely hinders its ability to do so. In other words,

other lenders are either not willing to lend to Borrower or are only willing to lend to Borrower at extremely

disadvantageous terms.

On March 31, 20X3, Borrower and Lender agree to change the terms of the debt agreement in the

following ways:

• Principal amount is reduced to $4 million.

• Principal is still repayable in one lump sum; however, the due date is extended to March 31,

20X8.

• Accrued and unpaid interest of $500,000 is forgiven.

The stated interest rate remains 10%. Borrower incurred $50,000 in third-party costs related to making

changes to the debt.

Analysis

Borrower first determines that the liability derecognition threshold has not been met because it has not

been relieved of its obligation under the debt, nor has it been legally released as the primary obligor

under the debt.

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Borrower next determines that its creditworthiness has deteriorated and that it is experiencing financial

difficulties for the following reasons:

• It has fallen behind its financial projections to a significant degree.

• Its cash flows in recent periods are lagging significantly behind its cash flows in comparable prior

periods.

• It is not able to service its debt because it cannot make the interest payment that was otherwise

required on March 31, 20X3.

• Its revised projections do not show sufficient cash flows in the remainder of 20X3 and beginning

of 20X4 to support making the interest payment required on March 31, 20X4.

• Other lenders are either not willing to lend to it or are only willing to lend to it at extremely

disadvantageous terms.

Borrower next calculates the effective interest rate on the changed debt (for the purpose of determining

whether Lender has granted it a concession) to be approximately 2.5% by using the following inputs in a

present value software tool:

• Compounding period: Annual

• Net carrying amount of the debt on March 31, 20X3: $5,400,969 ($4,900,969 carrying amount of

the debt prior to the changes + $500,000 of accrued and unpaid interest)

• Interest payments: $400,000 each year starting on March 31, 20X4 and ending on March 31,

20X8 ($4 million principal amount after the changes × 10% stated interest rate)

• Principal repayment: $4 million after the changes on March 31, 20X8

Borrower determines that Lender has granted a concession because the effective interest rate on the

debt after the restructuring of 2.5% is less than the effective interest rate on the debt before the

restructuring of 10.8%.

Because Borrower is experiencing financial difficulties and Lender has granted a concession, Borrower

concludes it should account for the changes to the debt as a TDR. To properly account for the changes to

the debt as a TDR, Borrower must first determine whether the total cash outflows required under the

restructured debt are more or less than the current carrying amount of the debt. Borrower determines that

the total cash outflows required under the restructured debt are $6 million, which consists of repaying

principal in the amount of $4 million and making five annual interest payments of $400,000 ($4 million

principal amount × 10% stated interest rate). Because total cash outflows expected under the restructured

debt ($6 million) are greater than the carrying amount of the debt prior to the restructuring ($5,400,969),

Borrower concludes that no gain results from the TDR. As such, Borrower records the following journal

entry on March 31, 20X3 to expense the third-party costs incurred in conjunction with the restructuring

and reclassify the accrued interest to include it in the carrying amount of the debt:

Debit

Credit

Accrued interest payable

$500,000

Other expense (Note 1)

50,000

Debt

$500,000

Payable to third party

50,000

Note 1: Direct costs incurred with third parties in connection with a TDR are expensed as incurred (see Section

2.2.5)

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On a going-forward basis, Borrower recognizes interest expense using the effective interest rate on the

debt after the restructuring of 2.5% and recognizes the difference between interest paid and interest

expense as a reduction of the debt’s carrying amount.

Commentary

It is important to note that the carrying amount of the debt was not reduced on the date the debt was

changed to reflect the $1 million of principal and $500,000 of accrued and unpaid interest forgiven by

Lender. Instead, in accordance with Section 2.2.4.3, those forgiven amounts are removed from the debt’s

carrying amount as a result of recognizing interest expense at a rate of 2.5% while paying interest at a

rate of 10%. Provided below is an amortization table for the debt (assuming no further changes are made

to the debt), which illustrates the reduction in principal over time to remove the forgiven amounts from the

carrying amount of the debt:

March 31

20X4

20X5

20X6

20X7

20X8

Interest expense (beginning

carrying amount × 2.5%)

$133,300

$126,718

$119,973

$113,061

$105,979

Interest payment

($4 million × 10%)

$400,000

Beginning carrying amount of

debt

$5,400,969

$5,134,269

$4,860,987

$4,580,960

$4,294,021

Reduction in carrying amount of

debt (interest payment –

interest expense)

(266,700)

(273,282)

(280,027)

(286,939)

(294,021)

Principal repayment

(4,000,000)

Ending carrying amount of debt

$5,134,269

$4,860,987

$4,580,960

$4,294,021

$ -

3.3 TDR with modification of terms in which a gain is recognized (Section 2.2.4.3)

Facts

Borrower and Lender entered into a debt agreement on March 31, 20X1, with the following terms:

• Principal amount is $5 million

• Stated interest rate is 10%

• Principal is repayable in one lump sum on March 31, 20X6

• Interest is payable annually in arrears on March 31

• Term is five years

• There is no embedded conversion option

Lender charged Borrower a lender fee of $100,000 and Borrower incurred $50,000 in third-party debt

issuance costs. Borrower’s debt is not rated by a credit rating agency. Borrower has not elected to

account for its debt using the fair value option. There are no other outstanding loans with Lender and

Lender does not have an equity investment in Borrower. Borrower recognizes interest expense using the

effective interest method (see Section 1.3).