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A modification is a troubled debt restructuring (TDR) if (1) the borrower is experiencing financial difficulty, and (2) the lender grants the borrower a concession.
A debt restructuring that results in the full settlement of a debt obligation should be accounted for as a debt extinguishment; however, the borrower should still assess whether the restructuring is a TDR. Even when there is no remaining debt outstanding, the borrower is required to disclose the fact that the debt was extinguished as the result of a TDR in its financial statements. See FG 3.7 for further information on accounting for debt extinguishments.
If a borrower grants an equity interest to the lender as part of a restructuring, it should assess whether there is a change in control that results in pushdown accounting (see BCG 10.1 for a discussion of pushdown accounting). For example, if a reporting entity experiencing financial difficulty settles its debt by giving a lender a 95% equity interest in itself, and the lender elects push down accounting, the lender’s new basis will be pushed down to the reporting entity. In that case, the TDR may be recorded differently than described in this chapter.

3.3.1 Is the borrower experiencing financial difficulty?

To determine whether it is experiencing financial difficulty, a borrower should first determine whether its creditworthiness has deteriorated since its debt was issued. ASC 470-60-55-7 provides guidance on evaluating changes in creditworthiness.

Excerpt from ASC 470-60-55-7

Changes in an investment-grade credit rating are not considered a deterioration in the debtor’s creditworthiness for purposes of this guidance. Conversely, a decline in credit rating from investment grade to noninvestment grade is considered a deterioration in the debtor’s creditworthiness for purposes of this guidance.

If a borrower’s creditworthiness has not deteriorated based on the above guidance, any modification would not be considered a troubled debt restructuring (TDR).
If a borrower’s creditworthiness has deteriorated since its debt was originally issued, it should then assess all aspects of its current financial position to determine whether it is experiencing financial difficulty.
ASC 470-60-55-8 provides guidance on determining whether a borrower is experiencing financial difficulty. Notwithstanding those factors, if a borrower meets both of the conditions in ASC 470-60-55-9, it is not experiencing financial difficulty; therefore, its debt restructuring is not a TDR.

Excerpt from ASC 470-60-55-9

The following factors, if both are present, provide determinative evidence that the debtor is not experiencing financial difficulties, and, thus, the modification or exchange is not within the scope of this Subtopic (the presence of either factor individually would be an indicator, but not determinative, that the debtor is not experiencing financial difficulty):
a. The debtor is currently servicing the old debt and can obtain funds to repay the old prepayable debt from sources other than the existing creditors (without regard to the current modification) at an effective interest rate equal to the current market interest rate for a nontroubled debtor.
b. The creditors agree to restructure the old debt solely to reflect a decrease in current market interest rates for the debtor or positive changes in the creditworthiness of the debtor since the debt was originally issued.

If a borrower does not meet these conditions, or meets only one of these conditions, it should review the indicators listed in ASC 470-60-55-8 to determine whether it is experiencing financial difficulty.

ASC 470-60-55-8

All of the following factors are indicators that the debtor is experiencing financial difficulties:
a. The debtor is currently in default on any of its debt.
b. The debtor has declared or is in the process of declaring bankruptcy.
c. There is significant doubt as to whether the debtor will continue to be a going concern.
d. Currently, the debtor has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange.
e. Based on estimates and projections that only encompass the current business capabilities, the debtor forecasts that its entity-specific cash flows will be insufficient to service the debt (both interest and principal) in accordance with the contractual terms of the existing agreement through maturity.
f. Absent the current modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a nontroubled debtor.

If a borrower determines that it is not experiencing financial difficulty, its debt restructuring is not a TDR. If it determines that it is experiencing financial difficulty, it should then determine whether its lender is granting a concession to determine whether the restructuring is a TDR.

3.3.2 Is the lender granting a concession?

A lender is granting a concession when the effective borrowing rate on the restructured debt is less than the effective borrowing rate on the original debt. The effective borrowing rate of the restructured debt is calculated by solving for the discount rate that equates the present value of the cash flows under terms of the restructured debt to the current carrying amount of the original debt. ASC 470-60-55-11 through ASC 470-60-55-14 provides guidance on determining whether a lender is granting a concession.

ASC 470-60-55-11

The carrying amount for purposes of this test would not include any hedging effects (including basis adjustments to the old debt) but would include any unamortized premium, discount, issuance costs, accrued interest payable, and so forth.

ASC 470-60-55-12

When determining the effect of any new or revised sweeteners (options, warrants, guarantees, letters of credit, and so forth), the current fair value of the new sweetener or change in fair value of the revised sweetener would be included in day-one cash flows. If such sweeteners are not exercisable for a period of time, that delay is typically considered within the estimation of the initial fair value as of the debt’s modification date.

ASC 470-60-55-13

Although considered rare, if there is persuasive evidence that the decrease in the effective borrowing rate is due solely to a factor that is not captured in the mathematical calculation (for example, additional collateral), the creditor may not have granted a concession and the modification or exchange should be evaluated based on the substance of the modification.

ASC 470-60-55-14

Notwithstanding the guidance in this Section, if an entity has recently restructured the debt and is currently restructuring that debt again, the effective borrowing rate of the restructured debt (after giving effect to all the terms of the restructured debt including any new or revised options or warrants, any new or revised guarantees or letters of credit, and so forth) should be calculated by projecting all the cash flows under the new terms and solving for the discount rate that equates the present value of the cash flows under the new terms to the debtor’s previous carrying amount of the debt immediately preceding the earlier restructuring. In addition, the effective borrowing rate of the restructured debt should be compared with the effective borrowing rate of the debt immediately preceding the earlier restructuring for purposes of determining whether the creditor granted a concession (that is, whether the effective borrowing rate decreased).

Example FG 3-1 illustrates the process for determining whether a lender has granted a concession.
EXAMPLE FG 3-1
Determining whether a lender has granted a concession
FG Corp issues a $1,000,000 term loan on January 1, 20X2, at a discount of $25,000.
The terms and carrying amounts of FG Corp’s debt instrument as of December 31, 20X3 are:
Terms
Outstanding balance
$1,000,000
Remaining term
5 years
Maturity date
December 31, 20X8
Effective interest rate
5.95%
Unamortized discount
$18,856
Net carrying value
$981,144
Coupon
5.50%
Interest payments
Annually in December
Principal payment
Balloon payment at maturity
FG Corp is experiencing financial difficulty and on January 1, 20X4 negotiates a restructuring of its outstanding term loan. The following is a summary of the restructuring; there are no contingent payments in the restructured debt obligation.
Modifications made
Principal forgiveness
$100,000
New coupon
3.00%
Fair value of equity securities granted by FG Corp
$50,000
Has FG Corp received a concession?
Analysis
FG Corp should compare the effective interest rate of the restructured term loan with the effective interest rate of the original term loan. The effective interest rate of the restructured term loan would be determined by calculating the interest rate needed to equate the total payments on the modified debt, shown in the following table, to $931,144 (net carrying value of $981,144 less the $50,000 of equity).
12/31/X4
12/31/X5
12/31/X6
12/31/X7
12/31/X8
Total
Interest payments
$27,000
$27,000
$27,000
$27,000
$27,000
$135,000
Principal payment
-
-
-
-
900,000
900,000
Total undiscounted cash flows on debt
$27,000
$27,000
$27,000
$27,000
$927,000
$1,035,000
$931,144 is the present value of $1,035,000 if the discount rate used is 2.26%. Because this effective interest rate is lower than the original term loan effective interest rate (5.95%), the bank has granted a concession. Because FG Corp is experiencing financial difficulty and has received a concession, the modification would be considered a troubled debt restructuring.

See Example FG 3-2 for guidance on how to record the troubled debt restructuring in this fact pattern.

3.3.3 Accounting for a TDR involving a modification of debt terms

When a borrower has a troubled debt restructuring (TDR) in which the terms of its debt are modified, it should analyze the future undiscounted cash flows to determine the appropriate accounting treatment. The recognition and measurement guidance for a TDR depends on whether the future undiscounted cash flows specified by the new terms are greater or less than the carrying value of the debt. In calculating the future undiscounted cash flows specified by the new terms:
  • All payments under the new terms should be included
  • Any contingent payments should be included without regard to the probability of those payments being made
  • If the number of future payment periods may vary because the debt is payable on demand, the estimate of future cash payments should be based on the maximum number of periods that could be required under the terms of the revised debt agreement
Figure FG 3-2 summarizes the accounting treatment for a TDR which results in a modification of the debt’s terms.
Figure FG 3-2
Accounting for a TDR resulting in a modification of terms
If future undiscounted cash flows (including contingent payments) are:
Effect on gain recognition and interest expense
New fees paid to lender
New fees paid to third parties
Less than the net carrying value of the original debt
  • A gain is recorded for the difference
  • If the lender also holds equity securities, consider whether the gain should be recorded in equity. See FG 3.3.5 for further information
  • The carrying value of the debt is adjusted to the future undiscounted cash flow amount
  • No interest expense is recorded going forward
  • All future interest payments reduce the carrying value
Reduce the recorded gain
Reduce the recorded gain
Greater than the net carrying value of the original debt
  • No gain is recorded
  • A new effective interest rate is established based on the carrying value of the original debt and the revised cash flows
Capitalize and amortize
Expense
If a TDR involves a combination of actions, such as a partial settlement of the debt and a modification of the terms, the debtor should first reduce the debt’s carrying value by the fair value of the assets or equity interests transferred and then apply the modification of debt terms guidance to determine the appropriate accounting treatment.
Example FG 3-2 illustrates how to account for a TDR.
EXAMPLE FG 3-2
Accounting for a troubled debt restructuring
FG Corp issues a $1,000,000 term loan on January 1, 20X2, at a discount of $25,000.
The terms and carrying amounts of FG Corp’s debt instrument as of December 31, 20X3 are:
Terms
Outstanding balance
$1,000,000
Remaining term
5 years
Maturity date
December 31, 20X8
Effective interest rate
5.95%
Unamortized discount
$18,856
Net carrying value
$981,144
Coupon
5.50%
Interest payments
Annually in December
Principal payment
Balloon payment at maturity
View table
FG Corp is experiencing financial difficulty and on January 1, 20X4 negotiates a restructuring of its outstanding term loan. The following is a summary of the restructuring; there are no contingent payments in the restructured debt obligation.
Modifications made
Principal forgiveness
$100,000
New coupon
3.00%
Fair value of equity securities granted by FG Corp
$50,000
View table
The effective interest rate of the restructured term loan is 2.26%, which equates the total cash payments on the modified debt, shown in the following table, to $931,144 (net carrying value of $981,144 less the $50,000 of equity). Because this effective interest rate (2.26%) is lower than the original term loan effective interest rate (5.95%), the bank has granted a concession. FG Corp determines that its term loan restructuring is a TDR because it is experiencing financial difficulty and its lender has granted a concession.
How should FG Corp account for the TDR?
Analysis
This restructuring involves both (1) a grant of equity securities from the borrower to the lender, and (2) a modification of terms. The calculation to determine if there is a gain associated with the TDR is as follows:
Term loan carrying value
$981,144
Less: fair value of the equity securities granted by FG Corp
($50,000)
New net carrying value
$931,144
Less: future undiscounted cash flows
($1,035,000)
Difference
($103,856)
View table
Because the future undiscounted cash flows under the new terms are greater than the adjusted net carrying value of the original debt, there is no gain to record.
A new effective interest rate is established based on the net carrying value of the debt and the revised cash flows. In this example, the new effective interest rate is 2.26%, as described in Example FG 3-1.
The following table shows the amortization of the new loan. The cash payments of $27,000 are calculated by multiplying the new coupon of 3.00% by the new outstanding balance of $900,000. The 12/31/X8 payment includes the balloon payment of $900,000 on the maturity date. Interest is calculated by multiplying the effective interest rate of 2.26% by the net carrying value of the debt.
Date
Cash payment
Interest
Reduction of carrying value
Net carrying value
$931,144
12/31/X4
$27,000
$21,047
$5,953
925,191
12/31/X5
27,000
20,912
6,088
919,103
12/31/X6
27,000
20,774
6,226
912,877
12/31/X7
27,000
20,634
6,366
906,511
12/31/X8
927,000
20,489
906,511
Total
$1,035,000
$103,856
$931,144
View table

3.3.4 TDR of a variable-rate instrument

ASC 470-60-35-11 provides guidance for troubled debt restructurings involving an instrument with a variable interest rate.

ASC 470-60-35-11

If amounts of future cash payments must be estimated to apply the provisions of paragraphs 470-60-35-5 through 35-7 because future interest payments are expected to fluctuate—for example, the restructured terms may specify the stated interest rate to be the prime interest rate increased by a specified amount or proportion—estimates of maximum total future payments shall be based on the interest rate in effect at the time of the restructuring. Fluctuations in the effective interest rate after the restructuring from changes in the prime rate or other causes shall be accounted for as changes in estimates in the periods in which the changes occur. However, the accounting for those fluctuations shall not result in recognizing a gain on restructuring that may be offset by future cash payments (see the preceding paragraph and paragraph 470-60-35-7). Rather, the carrying amount of the restructured payable shall remain unchanged, and future cash payments shall reduce the carrying amount until the time that any gain recognized cannot be offset by future cash payments.

ASC 470-60-35-11 requires the cash interest payments used to calculate the future undiscounted cash flows to be based on the spot interest rate on the restructuring date. If the undiscounted future principal and interest payments, calculated at the restructuring date, are less than the carrying value of the debt, then a restructuring gain (equal to the difference) should be recognized. All future principal and interest payments should be recognized as a reduction to the carrying value of the debt. As a result, interest payments are not recognized as interest expense.
In the future, when interest rates change, actual cash flows will differ from the cash flows measured at the restructuring date. The accounting treatment for changes in cash flows due to changes in interest rates depends on whether there is an increase or decrease from the spot interest rate used in the initial troubled debt restructuring (TDR) accounting (referred to as the “threshold interest rate”).
Upon an increase in interest rates, the borrower should recognize additional interest expense in the period the expense is incurred. The additional interest expense is calculated by multiplying the difference between the current rate and the threshold rate by the current carrying value of the debt for the current period only (i.e., it should not include changes in interest relative to future periods). ASC 470-60-35-11 indicates that the additional interest expense should be accounted for as a change in estimate in the period in which the change occurs.
A decrease in interest rates could result in an additional restructuring gain (or interest windfall) due to lower payments than those at the restructuring date. There is always a potential for future cash payments to offset a gain generated by an interest rate decrease (the variable rate could increase in the future); therefore, the gain should not be recognized until the debt is settled and there are no future interest payments. The cash payments are applied against the carrying amount until it is settled and there is no possibility that the gain could be reduced by future interest rate increases.
When there are subsequent increases in interest rates above the threshold interest rate after a decrease in interest rates, we believe there are various acceptable alternatives to recognize the incremental interest above the threshold rate. Figure FG 3-3 summarizes two of these methods.
Figure FG 3-3
Accounting for incremental interest above the threshold rate in a TDR of a variable rate instrument
Alternative
Description
Current period method
  • Continue to use the original threshold interest rate to determine whether increases in interest rates result in incremental interest expense
  • Gains should be deferred until the point in time that the debt is settled and there are no future interest payments
Cumulative period method
  • Record all interest payments in excess of the original threshold interest rate as a reduction of the restructured debt’s carrying value until the prior interest windfall (described above) is recaptured on a cumulative basis. Thereafter, the original threshold interest rate should be used to determine whether increases in interest rates result in incremental interest expense.
A reporting entity should choose one of these methods and apply it consistently to similar instruments; the method applied should be disclosed in the financial statements if it is material.

3.3.5 Restructuring of debt by existing equity holders

If a lender holds equity securities of a borrower prior to a debt restructuring, it may be considered a related party. Transactions with equity holder lenders that benefit the borrower may be deemed capital transactions. This raises the issue of whether an extinguishment gain should be included in the borrower’s income statement or reflected as a contribution of capital. To make this determination, a borrower should consider the following points, with other relevant considerations, to determine the treatment of an extinguishment gain.
  • The role of the related party lender in the restructuring
  • The reason the related party lender agreed to a restructuring that resulted in the borrower recognizing an extinguishment gain (i.e., why the lender agreed to accept consideration of less than fair value)
  • Whether other debt holders that do not own equity agree to a restructuring under similar terms
  • Whether the substance of the restructuring was the forgiveness of debt owed to a related party
There is no specific guidance related to this issue; therefore, the appropriate accounting treatment requires judgment. However, if all debt holders have equity interests in the borrower, the debt restructuring typically would be considered a capital transaction. In that case, the gain should be recorded in equity.
Determining the appropriate accounting treatment is more complicated when only some of the debt holders are also equity holders. A key consideration is whether the restructuring results in a significant shift in economics away from debt holders to equity holders. A significant transfer of value from the debt holders to different equity holders is characteristic of a typical troubled debt restructuring (TDR) and should be recognized in income. If there are significant debt holders that do not own equity, that is a strong indicator that a gain should be recorded in the income statement and not in equity. Likewise, if significant equity holders own no debt, it is a strong indicator that a gain should be recorded in the income statement and not in equity.
This accounting analysis applies only to extinguishment gains. A TDR generally should not result in a loss because to qualify as a TDR, the lender has to have granted the borrower a concession.
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