In today’s volatile marketplace, businesses may seek financial relief by renegotiating their existing debt. For example, you may be able to ease the burden of loan payments by extending a loan’s term or switching from a fixed rate to a variable one. But it’s not always a sure thing, and, if you’re successful, the restructuring will affect your financial statements, possibly significantly.

Preparing for the Negotiating Table

The good news is that lenders usually want to make the best of a difficult situation — in other words, they want to recover as much of their original investment as they can, ideally without going to court. But they aren’t going to consent to major loan modifications just because you ask.

You’ll need to fully explain:

• Your circumstances, financial and otherwise,
• The types of modifications you seek, and
• How you expect to satisfy the revised terms.

This will require extensive written documentation, including current financial statements and projected cash flows. Transparency is key, as is timeliness. Don’t wait to reach out until you are far in arrears; be proactive.

Beware: Timing is paramount in today’s inflationary market. The Federal Reserve has announced plans to raise the federal funds rate — a key benchmark for personal and commercial loans — at least six times in 2022, assuming quarter-point increments.

Accounting for Debt Restructuring

For businesses that adhere to U.S. Generally Accepted Accounting Principles (GAAP), the first step when reporting a debt restructuring is to determine whether the new arrangement qualifies as a “troubled debt restructuring” (TDR). It should be noted that a TDR does not include situations where a business restates its liabilities generally, such as in a bankruptcy proceeding.

According to the Financial Accounting Standards Board, a restructured debt is a TDR if the lender agrees to grant a borrower with financial difficulties a concession it wouldn’t otherwise consider — for example, a reduced interest rate, payment deferrals or a an extension of the maturity date. . A “concession” occurs when the effective borrowing rate on the restructured debt is less than the effective rate on the original debt.

The proper accounting for a TDR depends on the type of restructuring. For a TDR that involves only a modification of terms, you calculate the future undiscounted cash payments required by the restructuring. If the sum of these payments exceeds or equals the net carrying amount of the original debt pre-restructuring, no gain or loss is recognized and there’s no change to the debt’s carrying amount. A new effective borrowing rate is established based on the carrying value of the original debt and the revised cash payments.

Conversely, if the sum of these payments is less than the carrying amount of the original debt, the borrower recognizes a gain equal to the amount by which the carrying amount exceeds the future cash payments. All subsequent payments reduce the carrying amount of the debt, with no interest expense recognized.

When the restructured debt isn’t a TDR, you must determine whether it’s a modification or an extinguishment. The categorization as a modification or an extinguishment will affect how you report:

• New fees paid to or received from the existing lender,
• New costs incurred with third parties directly related to the restructuring (for example, legal fees), and
• Previously deferred fees related to the existing debt.

A restructuring is deemed an extinguishment if the new terms are “substantially different” from the original terms — meaning the present value of the cash payments under the new terms is at least 10% different than the present value of the remaining cash payments under the original terms.

With an extinguishment, the original debt is de-recognized, and the new debt is recorded at fair value. The difference between the original debt and the new debt’s fair value is recognized as a gain or loss. For a modification, a new effective interest rate is determined based on the carrying amount of the original debt and the revised cash payments.

A Tangled Web

Negotiating and accounting for debt restructuring can be complicated. Our Accounting & Assurance Team can help you achieve the optimal solution for your situation and account for it accurately and transparently.