Private companies still find the accounting rules for debt modifications and extinguishments tough to understand, even with educational material the FASB issued a few years ago, board advisers signaled.
Applying debt rules is complicated, including when multiple lenders involved, according to the Private Company Council (PCC) — a panel that works with the FASB to amend US GAAP for private companies. A simple accounting workaround is needed, PCC members said on April 18, 2024.
“If you gave private companies, for example, an expedient of sorts or a way to just apply extinguishment accounting, I think that would give clarity to how those costs ultimately are being treated – gains, losses, lender costs, third-party costs,” Douglas Uhl, director, corporate accounting policy at Chick-fil-A, Inc., said. “And so, I think users would have the information that they would need to understand what happened in that ultimate change in your debt but take away a lot of those 10% cash flows test and things that are really difficult for private companies.”
Simplifications should be considered for the “modification versus extinguishments” debt accounting, including “the specific treatment of the extinguishment calculation itself” and “the fair value of the new debt consideration,” David Finkelstein, director with SingerLewak LLP, added.
Another area is “how to account for debt issuance and debt discounts and whether the application of the effective rate method is required for private companies,” Michael Cheng, national professional practice partner for Frazier & Deeter LLC, said. “I think that that’s an easy solution.”
The PCC was established in 2012. It is composed of 12 members who work at various companies and organizations as financial statement preparers, auditors, and users.
‘High Interest Rate Environment’
The topic was also raised during last year’s PCC discussions in December which suggested that simplifications be provided so that private companies can bypass the required evaluations and account for the transaction as a debt extinguishment. Some accountants also questioned whether it is necessary to have different guidance for term debt and line-of-credit or revolving-debt arrangements when evaluating debt modifications and extinguishments.
Debt issues come at a time when companies are starting to see the impact of “the high interest rate environment that we’re currently experiencing,” the discussions revealed. There are significant challenges with commercial real estate resulting in many companies either refinancing to stay in compliance with debt covenants or banks rewriting covenants to help their clients stay in compliance when other company metrics are fairly sound. “Over the next few months, the number of defaults seen will tell a lot of the story about commercial real estate exposure.”
Also mentioned is that refinancing issues go beyond just banks as “there has been an increase in middle-market and smaller companies coming to banks as they are nearing violation of debt covenants, and this is resulting in going concern issues arising.” However, there “haven’t been any increases in recalled loans, just more clients refinancing or debt covenants being rewritten.”
Current Rules.
About four years ago, the FASB issued Borrower’s Accounting for Debt Modification, an educational staff paper that explains current guidance on debt, including Subtopic 470-50, Debt—Modifications and Extinguishments.
Subtopic 470-50 requires that a company assess whether a modification or extinguishment of debt has occurred when a company modifies the terms of an existing debt instrument or issues a new debt instrument and concurrently satisfies an existing debt instrument, according to meeting papers.
To determine whether the original debt has been modified or extinguished, a company needs to compare the present value of the cash flows from the terms of the new debt instrument and the present value of the remaining cash flows from the original debt instrument on a lender-by-lender basis.
If the difference in the present value of the cash flows is greater than 10%, the transaction is accounted for as an extinguishment of the original debt instrument. When debt is extinguished, the original debt is derecognized and a gain or a loss equal to the difference between the carrying amount of the original debt and the fair value of the new debt is recognized. Any new fees paid to, or received from, the existing lender(s) are required to be expensed, and any new fees paid to third parties are capitalized and amortized as debt issuance costs. If the difference in the present value of the cash flows is less than 10%, the transaction is accounted for as a modification of the original debt. When debt is modified, no gain or loss is recognized, and any new fees paid to or received from the existing lender(s) are capitalized and amortized.
This article originally appeared in the April 28, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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