A creditor and debtor each must determine whether the modification or exchange of debt restructurings should be accounted for as (a) the creation of a new debt instrument and the extinguishment of the original debt instrument or (b) the modification of the original debt instrument.

When a change in cash flow arises in connection with a renegotiation or other modification, a careful analysis is required.

An entity first needs to determine whether the change in cash flows arises under the contractual terms. For example, in a fixed rate loan that is prepayable at par (or with only an insignificant amount of compensation), having the lender reset the interest rate to market may not be considered a change in contractual terms.

In this case, the entity would follow the guidance for changes in interest rates applicable to floating rate instruments.

A new or restructured debt instrument is considered an extinguishment of the existing instrument and origination of a new instrument by the lender/investor when both of the following conditions are met:

Where an entity determines that the change is due to a renegotiation, the entity then needs to determine whether the modification is substantial. If the change in terms is considered substantial, it is accounted for as a derecognition of a financial asset and the recognition of a new financial asset (i.e., an extinguishment). If the renegotiation does not result in a substantial change in terms, it is accounted for as a modification.

Judgment is required to assess whether the change in terms is substantial enough to represent an extinguishment (i.e., derecognition of the asset). The assessment is based on all relevant factors, such as deferral of certain payments to cover a shortfall, insertion of substantial new terms, significant extension of the term, change in interest rate, insertion of collateral or other credit enhancement, changes to loan covenants, or change in the currency of the instrument.