The Bankruptcy Code specifically limits postpetition interest on unsecured debt, but allows claims for postpetition interest on secured debt in certain instances. Interest accruing on unsecured debt subsequent to the date of petition generally will not be allowed as a claim unless there is surplus (a solvent debtor) and all unsecured creditors will receive full payment for their claims. Interest accruing on secured debt is allowed when the collateral securing the claims exceeds the principal amount of the debt and any accruing interest is secured.
provides guidance regarding reporting interest expense during bankruptcy.
Interest expense shall be reported only to the extent that it will be paid during the proceeding or that it is probable that it will be an allowed priority, secured, or unsecured claim. Interest expense is not a reorganization item.
Creditors also may be allowed to add reasonable fees, costs, and other charges incurred in connection with the bankruptcy proceedings to their claims, which could require the debtor to adjust the carrying amount of the claims in its financial statements.
Since some of a reporting entity's interest cost likely will not be accruing during the bankruptcy proceedings, this could have a significant impact on the results of operations because of lower interest expense being reflected in the current financial statements as compared to prior periods. Therefore, the contractual interest that would have accrued absent the bankruptcy filing should be disclosed in the notes to the financial statements or on the face of the statement of operations. Interest expense that will be accrued during the bankruptcy proceedings, including interest related to debtor-in-possession financing, is not included in reorganization items.
In certain circumstances, the Court may approve for the debtor to make adequate protection payments to its creditor. Adequate protection payments are intended to provide a secured (or partially secured) creditor consideration during the bankruptcy proceedings to compensate it from the loss in value of the collateralized asset the debtor continues to use in its operations. For example, the debtor may have a loan with a creditor which is secured by a manufacturing facility. Because the debtor will continue to operate the manufacturing facility during the bankruptcy proceedings, thereby precluding the creditor from accessing the collateral to minimize its losses as a creditor, the Court may approve adequate protection payments to compensate for the potential loss in value of the collateral due to the debtor's continued use of the facility. Given the nature of the payment, adequate protection payments are generally treated as a reduction in principal. However, the debtor should consider whether some or all of the payments should be treated as interest.
Question BLG 3-6 discusses if an entity can continue to capitalize interest during bankruptcy if interest expense is no longer being recognized on the related debt.
Question BLG 3-6
May a reporting entity that has filed for bankruptcy continue to capitalize interest related to an active construction project if interest expense is no longer being recognized on the project debt?
No. Unless interest on the project debt is being incurred in bankruptcy, capitalization would not be appropriate.
Question BLG 3-7 illustrates how a reporting entity should account for equity instruments with characteristics of debt during bankruptcy.
Question BLG 3-7
How should a reporting entity in bankruptcy treat dividends on mandatorily redeemable preferred stock that is classified as mezzanine equity?
While ASC 852
specifically addresses accounting for interest expense in a reorganization proceeding, it does not address the accounting for equity instruments with characteristics of debt such as mandatorily redeemable preferred stock. The debtor should carefully consider the terms of each of its equity instruments, including any modifications made to the instruments by the Court, to ensure an appropriate accounting model is being followed.
In cases where it is not expected that the Court will allow a claim for future dividends after filing for bankruptcy, we believe it is acceptable to analogize to ASC 852-10-45-11
(which addresses interest expense in a reorganization proceeding). Under this approach, the reporting entity would cease accrual of such preferred stock dividends as of the bankruptcy filing date, if the criteria in ASC 852-10-45-11