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The legal form of a modification transaction, whether a legal exchange or a legal amendment, is irrelevant for purposes of determining whether it is an accounting modification or extinguishment. The accounting treatment is determined by whether (1) the lender remains the same, and (2) the change in the debt terms is considered substantial.
A transaction involving the issuance of a new term loan or debt security to one lender (or investor) and the concurrent satisfaction of an existing term loan or debt security to another unrelated lender (or investor) is always accounted for as an extinguishment of the existing debt and issuance of new debt. See FG 3.7 for a discussion of debt extinguishment accounting and FG 1 for the accounting for the issuance of new debt. See FG 3.4.9 for information on the use of a third-party intermediary to facilitate an exchange.
Figure FG 3-4 provides a summary of the accounting for a debt modification or debt extinguishment in a restructuring or exchange transaction when the lender remains the same.
Figure FG 3-4
Accounting for a debt modification and debt extinguishment when the lender remains the same
Type of transaction
Debt
New fees paid to, or received from, existing lender
New fees paid to third parties
Modification
  • No gain or loss is recorded
  • A new effective interest rate is established based on the carrying value of the debt and the revised cash flows
Capitalize and amortize as part of the effective yield
Expense
Extinguishment
  • The old debt is derecognized and the new debt is recorded at fair value
  • A gain or loss is recorded for the difference between the net carrying value of the original debt and the fair value of the new debt. See FG 3.7 for further information
  • If the lender also holds equity securities, consider whether the gain should be recorded in equity. See FG 3.3.5 for further information
  • Interest expense is recorded based on the effective interest rate of the new debt
Expense
Capitalize and amortize as a debt issuance cost
ASC 470-50-40-10 and ASC 470-50-40-11 provide guidance on whether a modification or exchange of a term loan or debt security should be accounted for as a modification or an extinguishment.

ASC 470-50-40-10

From the debtor’s perspective, an exchange of debt instruments between or a modification of a debt instrument by a debtor and a creditor in a nontroubled debt situation is deemed to have been accomplished with debt instruments that are substantially different if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. If the terms of a debt instrument are changed or modified and the cash flow effect on a present value basis is less than 10 percent, the debt instruments are not considered to be substantially different, except in the following two circumstances:
a. A modification or an exchange affects the terms of an embedded conversion option, from which the change in the fair value of the embedded conversion option (calculated as the difference between the fair value of the embedded conversion option immediately before and after the modification or exchange) is at least 10 percent of the carrying amount of the original debt instrument immediately before the modification or exchange.
b. A modification or an exchange of debt instruments adds a substantive conversion option or eliminates a conversion option that was substantive at the date of the modification or exchange. (For purposes of evaluating whether an embedded conversion option was substantive on the date it was added to or eliminated from a debt instrument, see paragraphs 470-20-40-7 through 40-9.)

ASC 470-50-40-11

With respect to the conditions in (a) and (b) in the preceding paragraph, this guidance does not address modifications or exchanges of debt instruments in circumstances in which the embedded conversion option is separately accounted for as a derivative under Topic 815 before the modification, after the modification, or both before and after the modification.

See FG 6.8 (post adoption of ASU 2020-06) and FG 6.8A (pre adoption of ASU 2020-06) for information on the modification of convertible debt instruments.
Cash flows can be affected by changes in principal amounts, interest rates, or maturity. They can also be affected by fees exchanged between the debtor and lender to effect changes in:
  • Recourse or nonrecourse features
  • Priority of the obligation
  • Collateralization features, including changes in collateral
  • Debt covenants or debt covenant waiver terms
  • The guarantor, or elimination of the guarantor
  • Option features
ASC 470-50-40-12 provides specific guidance on performing the 10% test. Key takeaways from this guidance include:
  • When performing the 10% test, the cash flows of the new debt instrument should include all amounts paid by the debtor to the lender (i.e., any fees paid to the lender in conjunction with the restructuring should be included in the cash flows of the new debt instrument) as a day-one cash flow
  • Third-party fees should not be included in the cash flow analysis
  • If there is a variable interest rate in any of the debt instruments, the spot interest rate on the restructuring date should be used to determine future interest payments
  • If either debt instrument is callable or puttable, then separate cash flow analyses should be performed assuming exercise and nonexercise of the put and call. The scenario that generates the smallest change should be used. See FG 3.4.1 for further information on prepayment options
  • For debt that has been amended more than once in a twelve-month period, the debt terms that existed just prior to the earliest amendment occurring in the prior twelve months should be used to apply the 10% test, provided modification accounting was previously applied. See FG 3.4.6 for further information
  • The effective interest rate of the original debt instrument should be used to calculate the present value of the cash flows on both the new and original debt instruments
See FG 3.4.8 for information on exchanges of publicly traded debt securities, and FG 6.8 (post adoption of ASU 2020-06) and FG 6.8A (pre adoption of ASU 2020-06) for information on modifications of convertible debt instruments.
Example FG 3-3 illustrates the application of the 10% test.
EXAMPLE FG 3-3
Applying the 10% test
FG Corp has a term loan that is not prepayable. Its credit rating has improved since the debt was issued, so FG Corp has decided to modify its debt to lower its borrowing costs and extend the term of its debt. Because FG Corp’s credit rating has improved, this restructuring is not considered a troubled debt restructuring.
The following table summarizes the terms of the original debt and new debt on the modification date.
Original debt
New debt
Principal amount
$5,000,000
$5,000,000
Coupon (paid annually in December)
5.5%
5.0%
Effective interest rate
6.0%
Not applicable
Remaining term to maturity
3 years
5 years
Lender fees
Not applicable
$200,000
View table
Should FG Corp account for the changes to its debt as a modification or an extinguishment?
Analysis
To perform the 10% test, the discounted cash flows of the original debt are compared to those of the new debt as of the modification date.
Cash flows on original debt
Present value of $5,000,000 at the stated interest rate of 5.5% discounted at the original effective rate of 6% for 3 years
$4,933,175
View table
Cash flows on new debt
Present value of $5,000,000 at the new stated interest rate of 5% discounted at the original effective rate of 6% for 5 years
$4,789,382
Lender fees, undiscounted because it is a day one cash flow
$200,000
Total cash flows
$4,989,382
View table
FG Corp would calculate the change in cash flows as follows:
Present value of cash flows on new debt
$4,989,382
Present value of cash flows on original debt
$4,933,175
Change in present value of cash flows
$56,207
Percentage change
1.14%
View table
Because the change in present value of cash flows is less than 10%, the change is considered a modification.

3.4.1 Prepayment options

Oftentimes, debt agreements allow a borrower to prepay the debt prior to maturity; this is especially common in variable rate debt instruments and bank loan syndications. A prepayment option is a call option that gives the borrower the right to call the debt from the lender and pay the amount owed.
ASC 470-50-40-12(c) provides guidance for applying the 10% test to debt instruments with prepayment options.

ASC 470-50-40-12(c)

If either the new debt instrument or the original debt instrument is callable or puttable, then separate cash flow analyses shall be performed assuming exercise and nonexercise of the call or put. The cash flow assumptions that generate the smaller change would be the basis for determining whether the 10 percent threshold is met.

If the change in cash flows is less than 10% in any scenario, then the restructuring is considered a modification.
If a prepayment option (or any put or call feature) is exercisable at any time, a borrower should assume it is exercised immediately. This will usually result in the smallest change in cash flows. When including prepayment options in the 10% test, it is not necessary to assess the ability of the borrower to prepay the debt; the 10% test should be applied to all noncontingent contractual scenarios.
When applying the 10% test, it may also be appropriate to consider contingent prepayment options, such as a call option exercisable upon a change in control, or upon completion of a qualified financing. Determining whether a contingent prepayment option should be included in a 10% test requires judgment based on the facts and circumstances at the modification date. For example, if it is probable that the contingent event that gives rise to exercise of the call option will occur, a cash flow scenario assuming exercise of the call should be performed. On the other hand, if the probability of the contingent event is remote, a contingent call or put option that is added to or deleted from a debt instrument is unlikely to be considered a substantial change and may not require further analysis.
Example FG 3-4 illustrates the application of the 10% test to a debt instrument with a prepayment option.
EXAMPLE FG 3-4
Applying the 10% test to debt with a prepayment option
FG Corp has a term loan that is prepayable without penalty. Its credit rating has improved since the debt was issued in August 20X3. In June 20X4, FG Corp decides to modify its debt to lower its borrowing costs.
The following table summarizes the terms of the original debt and new debt on the modification date.
Original debt
New debt
Principal amount
$5,000,000
$5,000,000
Coupon
5.5%
5.0%
Remaining term to maturity
3 year
5 years
Prepayment feature
Can be prepaid at any time without penalty
Can be prepaid at any time with a 1% penalty
Lender fees
Not applicable
$10,000
View table
Should FG Corp account for the change to the provisions of its debt as a modification or an extinguishment?
Analysis
To perform the 10% test, FG Corp should assume that the prepayment option in both the original and new debt is exercised on the modification date. The related cash flows on the original debt and the new debt are shown below. Because all cash flows occur on day one, the cash flows are not discounted.
Cash flows on original debt
Prepayment of debt without penalty
$5,000,000
View table
Cash flows on new debt
Lender fees paid
$10,000
Prepayment of debt
$5,000,000
Prepayment penalty (1% × $5,000,000)
$50,000
Total cash flows
$5,060,000
View table
FG Corp calculates the change in cash flows as follows:
Cash flows on new debt
$5,060,000
Cash flows on original debt
$5,000,000
Change in cash flows
$60,000
Percentage change in cash flows
1.2%
View table
Because the change in cash flows in the immediate prepayment scenario is less than 10%, FG Corp should account for the changes to its debt as a modification. Because the prepayment scenario resulted in modification accounting, it is not necessary to prepare a cash flow scenario that does not assume prepayment.

3.4.2 Non-cash consideration

ASC 470-50-40-12(a) provides guidance on the cash flows of a new debt instrument to be included in the 10% test.

ASC 470-50-40-12(a)

The cash flows of the new debt instrument include all cash flows specified by the terms of the new debt instrument plus any amounts paid by the debtor to the creditor less any amounts received by the debtor from the creditor as part of the exchange or modification.

The term “any amounts paid,” as used in ASC 470-50-40-12(a), does not indicate if the amounts must be cash, or whether non-cash consideration, such as freestanding financial instruments like warrants or preferred stock, should be considered an amount paid. We believe the fair value of non-cash consideration should be included as a day-one cash flow for purposes of determining the cash flows to be used in the 10% test. We believe the form of consideration should not affect the accounting. Treating warrants or preferred stock issued to a lender as a day-one cash flow is consistent with guidance in ASC 470-60-55-12 for troubled debt restructurings, which requires the fair value of any new or modified non-cash consideration (e.g., options, warrants, guarantees, letters of credit) to be included in the calculation to determine whether a lender is granting a concession. If non-cash consideration is not exercisable for a period of time, that delay should be considered in determining its fair value.
If a restructuring is considered a modification based on the 10% test, then any non-cash consideration should be capitalized similarly to a cash fee paid to a lender. The capitalized amount, along with any existing unamortized debt discount or premium, should be amortized as an adjustment to interest expense over the remaining term of the modified debt instrument using the effective interest method.
If a restructuring is accounted for as a debt extinguishment, then the fair value of any non-cash consideration is associated with the extinguishment of the original debt instrument (i.e., treated as an amount paid to extinguish the debt) and included in determining the extinguishment gain or loss.
A debt modification may involve changes to embedded features (e.g., covenants, collateral, or seniority position) that have no effect on cash flows. Modifications to these non-cash terms would not impact the cash flows used for the 10% test.

3.4.2.1 Non-cash consideration issued to third party advisors

If the non-cash consideration (e.g., warrants or preferred stock) is issued to third-party advisors rather than the lender, we believe the fair value of the non-cash consideration should be accounted for following the guidance in ASC 470-50-40-18 for third-party costs. The accounting for third-party costs depends upon whether the restructuring is accounted for as a modification or an extinguishment. See Figure FG 3-4 for further information.

3.4.3 Change in currency of the debt

If a debt instrument is modified such that the currency in which it is denominated changes, the change in currency should be included in the cash flows as part of the 10% test. To convert the cash flows on the new debt into the currency of the original debt, we believe there are two acceptable methods, use (1) the spot rate in effect at the debt modification or exchange date, or (2) the forward rates corresponding to each cash flow (i.e., interest payment and principal) payment date.

3.4.4 Restructured debt as the hedged item in a fair value hedge

When performing the 10% test, the effect of the required amortization of basis adjustments due to the application of fair value hedge accounting should be ignored for the purposes of calculating the effective interest rate of the original debt instrument. The goal of the 10% test is to determine whether the terms of the relationship between the debtor and lender before and after a modification or exchange are substantially different. The fact that the debtor designated the debt as the hedged item in a fair value hedging relationship does not affect the relationship between the debtor and lender.

3.4.5 Change in principal

Application of the guidance to a term loan debt restructuring is more complicated when the principal balance changes as a result of the restructuring. Increases and decreases in the principal balance of a loan should be included in the cash flows of the new debt used to perform the 10% test based on the guidance in ASC 470-50-40-12(a), which specifically refers to considering “any” amounts paid or received by the debtor. If the principal received is net of a discount, the principal amount net of the discount should be used as the principal balance for purposes of applying this guidance.
An increase in principal should be treated as a day-one cash inflow in the cash flows of the new debt instrument, and a decrease should be treated as a day-one cash outflow.
A borrower should account for unamortized fees, new creditor fees, and third-party costs in the same manner it would had there not been a change in principal. That is, when a loan is modified, unamortized fees should continue to be deferred, new creditor fees should be capitalized and amortized as part of the effective yield and new fees paid to third parties should be expensed. When a loan is extinguished, unamortized fees and new creditor fees should be expensed, and new fees paid to third parties should be capitalized and amortized as debt issuance costs associated with the new debt. See Example FG 3-7 for an illustration of the application of this guidance.
Question FG 3-1 discusses whether a portion of unamortized debt issuance costs should be expensed if a borrower pays-down a portion of its debt under a prepayment option.
Question FG 3-1

If a borrower pays-down a portion of its debt in accordance with an existing prepayment option, can a portion of the unamortized debt issuance costs associated with the debt balance be expensed?
PwC response
It depends on the borrower’s accounting policy.
Some borrowers continue to defer the unamortized debt issuance costs when they pay down a portion of their debt in connection with a modification (which is accounted for as a modification), based on the view that the prepayment is factored into the terms agreed to on the modified debt. In other words, they believe it is not possible to separately identify the prepayment amount.
Other reporting entities have a policy of expensing the portion of the unamortized costs associated with the partial pay down based on the guidance in ASC 470-50-40-2 because the debt has been partially settled. Since the debt has been partially settled, these reporting entities believe it is appropriate to consider the debt extinguishment guidance for the partial settlement.
This policy choice is not available when the original debt does not have an existing prepayment option or for a prepayment of debt made outside of a debt modification. See FG 3.7 for information on how unamortized fees should be accounted for in these circumstances.

3.4.6 Debt restructured more than once in one-year period

As discussed in ASC 470-50-40-12(f), if a debt instrument is restructured more than once in a twelve-month period, the debt terms (e.g., interest rate, prepayment penalties) that existed just prior to the earliest restructuring in that twelve-month period should be used to apply the 10% test, provided the restructuring was (or restructurings were) accounted for as a modification. In other words, this is a cumulative assessment in certain circumstances. Example FG 3-5 illustrates the application of the 10% test when debt has been restructured multiple times within a twelve-month period.
EXAMPLE FG 3-5
Multiple refinancing within a one-year period
FG Corp has a term loan that is prepayable without penalty. Its credit rating has improved since the debt was issued in August 20X3. In June 20X4, FG Corp modified its debt to lower its borrowing costs.
FG Corp restructures its term loan again in December 20X4.
In December 20X4, several days before the second restructuring, FG Corp paid $2,000,000 of principal and $225,000 of interest as required by the terms of the existing arrangement at that time.
The following table summarizes the terms of the original debt and new debt on the restructuring dates.
Original debt
June 20X4 amendment
December 20X4 amendment
Principal amount
$5,000,000
$5,000,000
$3,000,0001
Coupon
5.5%
5.0%
4.5%
Effective interest rate
6.0%
Not applicable
Not applicable
Remaining term to maturity at each restructuring date
3 years
5 years
4.5 years
Prepayment feature
Can be prepaid at any time without penalty
Can be prepaid at any time with a 1% penalty
Can be prepaid at any time with a 3% penalty
Lender fees
Not applicable
$10,000
$5,000
1 Reduced by $2,000,000 of normal principal payments made during the intervening period.
Should FG Corp account for the restructuring of its debt as a modification or an extinguishment?
Analysis
The cash flows used in each respective 10% test are as follows:
June 20X4 restructuring: As detailed in Example FG 3-4, the June 20X4 restructuring was accounted for as a modification. The cash flows used in that 10% test are shown below.
Cash flows on new debt (see Example FG 3-4)
$5,060,000
Cash flows on original debt
$5,000,000
Change in cash flows
$60,000
Percentage change in cash flows
1.2%
December 20X4 restructuring: Because the December 20X4 restructuring was done less than twelve months after the June 20X4 restructuring, FG Corp must consider the terms that existed just prior to the June 20X4 restructuring (because there were no other restructurings within twelve months of December 31, 20X4 and prior to June 20X4) when determining the cash flows of the original debt. FG Corp should combine the June and December restructurings to determine if together these two restructurings resulted in more than a 10% change in cash flows as compared to the original debt in June 20X4. The new cash flows should be discounted back at the original effective interest rate to the earliest restructuring date (i.e., the June 20X4 restructuring). FG Corp would calculate the cash flows for this test as follows.
Cash flows on original debt
Original cash flows
$5,000,000

Cash flows on new debt
Lender fees paid in June 20X4 restructuring
$10,000
Normal principal payment made in December 20X4 discounted at 6% for 6 months1
1,942,572
Interest payment of $225,000 paid in December 20X4 discounted at 6% for 6 months1
218,539
Present value of $5,000 lender fees paid in December 20X4 restructuring discounted at 6% for 6 months2
4,856
Present value of $3,000,000 prepayment of debt discounted at 6% for 6 months2, 3
2,913,858
Present value of $90,000 prepayment penalty (3% × $3,000,000) discounted at 6% for 6 months2, 3
87,416
Total cash flows
$5,177,241
1 All cash flows that occurred during the intervening period should be included in the cash flow test on the date they were made and discounted at the original effective interest rate back to the earliest restructuring (i.e., June 20X4 restructuring).
2 Cash flows related to the December 20X4 restructuring are discounted at the original effective interest rate back to the earliest restructuring (i.e., June 20X4 restructuring).
3 Assumes prepayment of the principal amount of $3,000,000 on the restructuring date in December 20X4.
FG Corp calculates the change in cash flows as follows:
Cash flows on new debt – December 20X4 restructuring
$5,177,241
Revised cash flows on original debt
$5,000,000
Change in cash flows
$177,241
Percentage change in cash flows
3.5%
View table
Because the change is less than 10%, the December 20X4 restructuring should also be accounted for as a modification.

3.4.7 Multiple debt instruments held by one lender

A borrower may have several debt instruments outstanding with one lender. When performing the 10% test, there is a general presumption that all of a lender’s debt instruments should be included whether the debt was modified or not in order to accurately capture the economics of the transaction. However, in certain limited fact patterns, when it is clear that a modification is done without regard to other debt outstanding with the lender, it may be appropriate for a reporting entity to exclude certain debt instruments with the lender when performing the 10% test.
For example, if a borrower has two debt instruments outstanding with one lender, Tranche A and Tranche B, and the borrower (1) increases the principal balance of Tranche A, and (2) pays off Tranche B, the borrower should perform the 10% test by combining the cash flows of the original Tranche A and Tranche B debt instruments and comparing the combined cash flows to the new cash flows of the restructured Tranche A. When discounting the cash flows of the restructured Tranche A, we believe a weighted average effective interest rate based on the original Tranche A and Tranche B interest rates should be used.
See FG 3.6.1 for information on costs associated with the concurrent modification of non-revolving (i.e., term debt) and revolving debt arrangements.

3.4.8 Publicly traded or certain private placement debt securities

ASC 470-50-55-3 provides guidance on applying the guidance in ASC 470-50-40 to publicly traded debt securities.

ASC 470-50-55-3

In a public debt issuance, for purposes of applying the guidance in this Subtopic, the debt instrument is the individual security held by an investor, and the creditor is the security holder. If an exchange or modification offer is made to all investors and only some agree to the exchange or modification, then the guidance in this Subtopic shall be applied to debt instruments held by those investors that agree to the exchange or modification. Debt instruments held by those investors that do not agree would not be affected.

There is no guidance on how to account for a refinancing of publicly traded debt securities that does not involve an exchange or modification offer (i.e., when a reporting entity issues new debt securities to investors, including holders of the issuer’s existing debt securities, and uses the proceeds to pay off existing publicly-traded debt securities held by the same investors). If a literal interpretation of ASC 470-50-55-3 is applied, each individual investor should be evaluated to determine whether the individual investor holds both the new and old debt securities. When the debt securities are publicly traded, this determination may be impossible because the borrower is not privy to the ultimate lender information. In that case, we believe it is reasonable to consider the substance rather than the form of the transaction. Unless the facts and circumstances indicate otherwise, we believe it is reasonable to assume that the investors in a new publicly-traded debt security are not the same as the investors in an existing publicly-traded debt security; therefore, the refinancing of publicly-traded debt securities should be accounted for as an extinguishment. This guidance may also be applicable to private placement debt instruments (e.g., 144A bond offering) depending on the specific facts and circumstances and the information reasonably available with respect to the identities of the old and new investors.
Similar accounting may be appropriate for “refunding” transactions on tax-exempt municipal bonds. If the tax-exempt municipal bond is widely held, it may be reasonable to conclude that an extinguishment has occurred. See NP 11.4.1 for additional information.

3.4.9 Third-party intermediaries

A third-party intermediary (e.g., an investment bank) may arrange a debt modification or exchange offer for a reporting entity. For example:
  • A reporting entity has multiple bonds issued under a single bond offering outstanding; the bonds are held by a number of third-party investors
  • An investment bank and reporting entity negotiate a modification to the terms of the bonds
  • The investment bank buys the bonds from the third-party investors
  • The terms are then modified pursuant to the modification agreement
  • The investment bank sells the new bonds under the modified terms to third-party investors (who may, or may not, be the same as the investors in the original bonds)
To determine the appropriate accounting treatment for a modification or exchange transaction arranged by a third-party intermediary, a reporting entity should determine whether the intermediary is a principal to the transaction (i.e., the investor in the bonds whose terms were modified) or the reporting entity’s agent (i.e., facilitating a refunding of the old bonds on behalf of the reporting entity through issuance of new debt).
ASC 470-50-55-7 provides indicators to be considered in evaluating whether a third-party intermediary is acting as principal or an agent.

ASC 470-50-55-7

Transactions between a debtor and a third-party creditor should be analyzed based on the guidance in paragraph 405-20-40-1 and the guidance in this Subtopic to determine whether gain or loss recognition is appropriate. Application of the guidance in this Subtopic may require determination of whether a third-party intermediary is an agent or a principal and consideration of legal definitions may be helpful in making that determination. Generally, an agent acts for and on behalf of another party. Therefore, a third-party intermediary is an agent of a debtor if it acts on behalf of the debtor. In addition, an evaluation of the facts and circumstances surrounding the involvement of a third-party intermediary should be performed. The following indicators should be considered in that evaluation:
a. If the intermediary’s role is restricted to placing or reacquiring debt for the debtor without placing its own funds at risk, that would indicate that the intermediary is an agent. For example, that may be the case if the intermediary’s own funds are committed and those funds are not truly at risk because the intermediary is made whole by the debtor (and therefore is indemnified against loss by the debtor). If the intermediary places and reacquires debt for the debtor by committing its funds and is subject to the risk of loss of those funds, that would indicate that the intermediary is acting as principal.
b. In an arrangement where an intermediary places notes issued by the debtor, if the placement is done under a best-efforts agreement, that would indicate that the intermediary is acting as agent. Under a best-efforts agreement, an agent agrees to buy only those securities that it is able to sell to others; if the agent is unable to remarket the debt, the issuer is obligated to pay off the debt. The intermediary may be acting as principal if the placement is done on a firmly committed basis, which requires the intermediary to hold any debt that it is unable to sell to others.
c. If the debtor directs the intermediary and the intermediary cannot independently initiate an exchange or modification of the debt instrument, that would indicate that the intermediary is an agent. The intermediary may be a principal if it acquires debt from or exchanges debt with another debt holder in the market and is subject to loss as a result of the transaction.
d. If the only compensation derived by an intermediary from its arrangement with the debtor is limited to a preestablished fee, that would indicate that the intermediary is an agent. If the intermediary derives gains based on the value of the security issued by the debtor, that would indicate that the intermediary is a principal.

There is a general presumption that a third-party intermediary is acting as an agent; however, this presumption can be overcome. The first indicator in ASC 470-50-55-7 is the most important; the third-party intermediary should be exposed to market risk to conclude it is acting as principal to the transaction. A reporting entity should evaluate all of the facts and circumstances to determine whether the third-party intermediary has funds at risk with regard to both the old bonds and new bonds. The following points should be considered.
•  The period the third-party intermediary will hold the new debt instruments before selling them. The holding period should be long enough to expose the third-party intermediary to sufficient market risk to conclude it is a principal to the transaction; how long that period is will vary from transaction to transaction. For example, if a third-party intermediary holds debt instruments for less than one day (that is, buying the bonds and reselling them intra-day or obtaining bids prior to, or concurrent with, an exchange), it is generally not subject to sufficient market risk to be a principal to the transaction.
•  Whether the new debt instruments will be sold on a best-efforts or firmly committed basis. A third-party intermediary may be acting as principal if the debt instruments are sold on a firmly committed basis, which requires the bank to hold any debt instruments that it is unable to sell to others. On the other hand, when a third-party intermediary sells new debt instruments under a best-efforts agreement it indicates that the bank is acting as the reporting entity’s agent. Under a best-efforts agreement, an agent agrees to buy only those debt instruments that it is able to sell to others; if the agent is unable to sell the debt instruments, the reporting entity is obligated to buy the debt instruments back.
•  Computation of the fee to be paid to the third-party intermediary by the reporting entity. If the third-party intermediary sets the interest rate on the new debt so that it is commensurate with the combined market and credit risk to which it is exposed, without including costs for hedging that risk, the third-party intermediary may be considered a principal to the transaction. On the other hand, if a third-party intermediary includes the cost of hedging its market risk associated with holding the new debt during the agreed-upon minimum holding period, it has not placed its own funds at risk, and is acting as the reporting entity’s agent. In addition, if the underwriting fees paid to the third-party intermediary by the reporting entity are higher than in similar market transactions, the reporting entity should assess whether the third-party intermediary is exacting a higher fee to reduce its exposure to market risk. In that case, the third-party intermediary may have limited its funds at risk, and may be acting as the reporting entity’s agent.
If the third-party intermediary acts as an agent, the reporting entity has refinanced the original debt with new debt to other third-party investors and the reporting entity should consider the guidance in FG 3.4.8.
If the third-party intermediary is considered a principal to the transaction, it is the investor. In that case, the reporting entity should perform the 10% test based on the cash flows of the debt held by the third-party intermediary before and after the modification or exchange.

3.4.10 Allocating debt issuance costs to issue and extinguish debt

When a reporting entity issues new debt and uses the proceeds to pay off existing debt, it may incur issuance costs with the same party to (1) issue the new debt, and (2) reacquire the existing debt. For example, a reporting entity may use the same advisor to issue a tender offer for its existing debt and a private placement of its new debt. If the costs associated with each transaction are not separately identifiable, the reporting entity should allocate the total costs incurred between the issuance of the new debt and the reacquisition of the existing debt, on a rational basis.

3.4.11 Fees paid in advance of restructuring of debt

A reporting entity may incur costs directly related to a debt modification or exchange that crosses a reporting period. To determine whether the costs should be capitalized as a prepaid expense or expensed in the period incurred, a reporting entity should consider the guidance in ASC 340-10-S99-1, SAB Topic 5.A, Expenses of Offering. Although this guidance relates to costs incurred in advance of an equity offering, we believe it can be analogized to costs incurred in advance of a debt restructuring. Based on that analogy, we believe that fees directly related to a debt restructuring incurred in advance of finalizing the transaction should be capitalized as a prepaid expense until the restructuring is finalized, unless facts and circumstances indicate that it is probable that the restructuring will be aborted or it is probable that the fees will be required to be expensed once the transaction is finalized in the subsequent period under the guidance in ASC 470-50-40. If it is probable that the restructuring will be aborted or that the fees will be expensed in the following period, they do not meet the definition of an asset (i.e., there is no probable future economic benefit) and should not be capitalized.
For example, if a reporting entity incurred legal fees in advance of a debt restructuring and it finalized the debt restructuring transaction shortly after the balance sheet date, the reporting entity would likely have the information to assess the transaction using the guidance in ASC 470-50-40. If the reporting entity determined that the debt restructuring should be accounted for as a modification in the subsequent period, that guidance would require that all third-party fees be expensed. Therefore, by analogy to ASC 340-10-S99-1, the reporting entity should expense those legal fees in the period incurred because it is probable as of the balance sheet date that the fees would be expensed in the subsequent period.
If the reporting entity had not finalized its debt restructuring prior to issuing the financial statements and the reporting entity did not have enough information to determine if the transaction will be a modification or extinguishment in the subsequent period, the legal fees should be capitalized as a prepaid expense in the period incurred. However, we typically would not expect a long time lag between incurring such costs and the finalization of the debt restructuring since the costs must be directly related to the restructuring.
Once the debt restructuring is completed, the fees should be accounted for using the guidance in ASC 470-50-40. See Figure FG 3-4 for further information on the accounting treatment for fees.

3.4.12 Parent’s involvement in a consolidated subsidiary’s debt

On a consolidated basis, the debt of a consolidated subsidiary represents debt of the parent. Therefore, if debt of a consolidated subsidiary is exchanged for debt of the parent company, the guidance in ASC 470-50-40 should be applied to determine whether the exchange should be accounted for as a modification or an extinguishment in the consolidated financial statements.
A parent company may also acquire the debt of a consolidated subsidiary for cash. When this occurs, the requirements for extinguishment accounting in the subsidiary’s standalone financial statements are generally not met; however, on a consolidated basis, the consolidated entity has reacquired its own debt so extinguishment accounting is appropriate. See FG 3.7 for information on accounting for a debt extinguishment.

3.4.13 Delayed draw term loan

When a loan modification or exchange transaction involves the addition of a delayed draw loan commitment with the same lender, we believe it would not be appropriate to include the unfunded commitment amount of delayed draw term loan in the 10% test since the commitment is not funded on the modification date. However, reporting entities should consider whether any fees paid in the restructuring should be allocated to the delayed draw commitment. If so, the fees should be accounted for based on the guidance in FG 1.2.4.
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