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12.5 Balance sheet classification — paid-in-kind notes
Publication date: 31 May 2022
us Financial statement presentation guide
The terms of debt instruments may permit or require the borrower to satisfy accrued interest on the debt with additional paid-in-kind (PIK) notes having identical terms (maturity date, interest rate, etc.) as the original debt. In such cases, the original debt is referred to as a PIK note. Typically, the interest may be paid either in cash or additional PIK notes, at the borrower's discretion. If the borrower intends to pay the interest with additional notes, the balance sheet classification of the accrued interest payable should be assessed under the guidance in ASC 470-10-45-14 for refinancing short-term debt (FSP 12.3.4), as illustrated in Example FSP 12-7.
EXAMPLE FSP 12-7
Classification of accrued interest settleable in PIK notes
Classification of accrued interest settleable in PIK notes
In October 20X1, FSP Corp issues floating-rate senior PIK notes that are due on September 30, 20X3.
The notes have semiannual interest payments payable in the form of cash or additional PIK notes at FSP Corp's option.
FSP Corp intends to pay the interest in the form of additional PIK notes. The maturity date of the PIK notes delivered to settle the interest payments is the same as the original note.
How should FSP Corp classify the accrued interest on the notes as of December 31, 20X1?
Analysis
FSP Corp should classify the accrued interest as a noncurrent liability since it has both the intent and ability to refinance the short-term liability (accrued interest) on a long-term basis.
The issuance of the original PIK notes demonstrates FSP Corp's ability to consummate a refinancing of the interest on a long-term basis, with terms that are readily determinable and meet all of the following conditions that are based on the requirements for ASC 470-10-45-14, as follows:
- The obligation does not expire within one year from FSP Corp's balance sheet.
- The agreement (i.e., the right to satisfy interest with long-term PIK notes) is not cancellable by the lender.
- The PIK notes issued under the agreement are not puttable, except for violations for which compliance is objectively measurable.
- There is no violation of any financing agreement provisions at the balance sheet date.
- There is no available information that indicates a violation has occurred after the balance sheet date and prior to the issuance of the financial statements, which would prevent the issuer from having the right to satisfy the interest with long-term PIK notes; for example, there is no covenant violation of the original PIK notes that would do either of the following:
- Accelerate their due date and the due date of any additional PIK notes that might be used to satisfy the interest
- Prevent the issuer from electing to pay the interest in PIK notes while there is a covenant violation of the original PIK notes
- The lender entered into the financing agreement permitting interest to be refinanced with PIK notes.
- FSP Corp is expected to be financially capable of honoring the agreement.
Given these facts, we believe FSP Corp should classify the accrued interest as noncurrent.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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