OUR THOUGHTS ON:

What You Need to Know About Debt Restructuring: A Debtor's Perspective

Audit

By Jay Meglich

Due to recent economic conditions, many entities have sought to modify the terms of their debt agreements to allow for cash flow improvement. Conversely, creditors might initiate a restructuring of an existing agreement to modify the terms of the current debt agreement given the financial condition of the borrower. Once an agreement is reached, the debtor must consider how the change in terms of the debt agreement will be reflected in the financial statements, if at all. Appropriate accounting for a modified debt agreement is determined by consideration of several factors. Insignificant changes, such as a change in covenants, might not require any changes to the financial statements other than by disclosure.

Does the revision in terms constitute a troubled debt restructuring? A troubled debt restructuring occurs when the debtor is experiencing financial difficulties such as default on any of its current debt or when substantial doubt exists about the entity’s ability to continue as a going concern, and the bank or creditor agrees to modify the terms of existing debt as a result of the financial condition of the borrower.

If the modification meets the definition of a troubled debt restructuring, a calculation is required to determine whether future undiscounted cash flow required under the new agreement is greater or less than the remaining balance of the original debt. If undiscounted cash flows are less than the carrying amount of the original debt, a gain is recognized and the carrying value of the new debt is established at the estimated future cash flow required. In this case, all future payments are treated as a reduction of the carrying value of the new debt, and no interest expense is recognized. If undiscounted cash flow is greater, no gain is recognized and a new effective interest rate is established and used in allocating future payments to principal and interest.

If the definition of a troubled debt restructuring is not met, you must determine whether or not the change is considered substantial. Substantial is defined as a change of 10% or more of required cash flow from the original to the new debt agreements. A substantial change in the cash flow results in an extinguishment of debt, which is accounted for by recognizing a gain or loss. The gain or loss is calculated based on comparing the balance outstanding on the old debt to fair value of the new debt. Future payments on the new debt are allocated to principal and interest using the effective interest rate of the new debt. If the change is not determined to be substantial, a modification of the debt has occurred and no gain or loss is recognized. Interest expense is recognized on future payments based upon the effective interest rate calculated on the new debt and the revised cash flow requirements.

What otherwise would appear to be a rather straightforward transaction can result in significantly different accounting treatment based on the facts and circumstances surrounding the debt restructuring.

For more information on debt restructuring, contact Jay Meglich at (614) 586-7124 or jmeglich@schneiderdowns.com.

Interested in receiving more timely articles like this one with topics that are relevant to your businessClick here to sign up for our weekly newsletters.  Or, if you'd like more information on our Audit and Assurance services, visit our webpage.

 

 

Schneider Downs provides accountingtax, wealth management, technology and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA and Columbus, OH. 

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.

 

You’ve heard our thoughts… We’d like to hear yours

The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at contactSD@schneiderdowns.com.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

comments