What is troubled debt

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A modification is a troubled debt restructuring TDR if 1 the borrower is experiencing financial difficulty, and 2 the lender grants the borrower a concession. A debt restructuring that results in the full settlement of a debt obligation should be accounted for as a debt extinguishment; however, the borrower should still assess whether the restructuring is a TDR.

Even when there is no remaining debt outstanding, the borrower is required to disclose the fact that the debt was extinguished as the result of a TDR in its financial statements.

See FG 3. If a borrower grants an equity interest to the lender as part of a restructuring, it should assess whether there is a change in control that results in pushdown accounting see BCG In that case, the TDR may be recorded differently than described in this chapter. To determine whether it is experiencing financial difficulty, a borrower should first determine whether its creditworthiness has deteriorated since its debt was issued. ASC provides guidance on evaluating changes in creditworthiness.

ASC provides guidance on determining whether a borrower is experiencing financial difficulty. Notwithstanding those factors, if a borrower meets both of the conditions in ASC , it is not experiencing financial difficulty; therefore, its debt restructuring is not a TDR. Excerpt from ASC The following factors, if both are present, provide determinative evidence that the debtor is not experiencing financial difficulties, and, thus, the modification or exchange is not within the scope of this Subtopic the presence of either factor individually would be an indicator, but not determinative, that the debtor is not experiencing financial difficulty :.

If a borrower does not meet these conditions, or meets only one of these conditions, it should review the indicators listed in ASC to determine whether it is experiencing financial difficulty. ASC All of the following factors are indicators that the debtor is experiencing financial difficulties:.

If a borrower determines that it is not experiencing financial difficulty, its debt restructuring is not a TDR. If it determines that it is experiencing financial difficulty, it should then determine whether its lender is granting a concession to determine whether the restructuring is a TDR.

A lender is granting a concession when the effective borrowing rate on the restructured debt is less than the effective borrowing rate on the original debt. The effective borrowing rate of the restructured debt is calculated by solving for the discount rate that equates the present value of the cash flows under terms of the restructured debt to the current carrying amount of the original debt.

ASC through ASC provides guidance on determining whether a lender is granting a concession. ASC The carrying amount for purposes of this test would not include any hedging effects including basis adjustments to the old debt but would include any unamortized premium, discount, issuance costs, accrued interest payable, and so forth. ASC When determining the effect of any new or revised sweeteners options, warrants, guarantees, letters of credit, and so forth , the current fair value of the new sweetener or change in fair value of the revised sweetener would be included in day-one cash flows.

ASC Although considered rare, if there is persuasive evidence that the decrease in the effective borrowing rate is due solely to a factor that is not captured in the mathematical calculation for example, additional collateral , the creditor may not have granted a concession and the modification or exchange should be evaluated based on the substance of the modification.

Example FG illustrates the process for determining whether a lender has granted a concession. Outstanding balance. Remaining term. Maturity date. Effective interest rate. Unamortized discount. Net carrying value. Interest payments. Principal payment. FG Corp is experiencing financial difficulty and on January 1, 20X4 negotiates a restructuring of its outstanding term loan.

The following is a summary of the restructuring; there are no contingent payments in the restructured debt obligation. Modifications made.

Principal forgiveness. New coupon. Fair value of equity securities granted by FG Corp. FG Corp should compare the effective interest rate of the restructured term loan with the effective interest rate of the original term loan. Total undiscounted cash flows on debt. Because this effective interest rate is lower than the original term loan effective interest rate 5.

Because FG Corp is experiencing financial difficulty and has received a concession, the modification would be considered a troubled debt restructuring. See Example FG for guidance on how to record the troubled debt restructuring in this fact pattern.

When a borrower has a troubled debt restructuring TDR in which the terms of its debt are modified, it should analyze the future undiscounted cash flows to determine the appropriate accounting treatment. The recognition and measurement guidance for a TDR depends on whether the future undiscounted cash flows specified by the new terms are greater or less than the carrying value of the debt. In calculating the future undiscounted cash flows specified by the new terms:. If future undiscounted cash flows including contingent payments are:.

Effect on gain recognition and interest expense. New fees paid to lender. New fees paid to third parties. Less than the net carrying value of the original debt.

A gain is recorded for the difference. If the lender also holds equity securities, consider whether the gain should be recorded in equity. The carrying value of the debt is adjusted to the future undiscounted cash flow amount.

Greater than the net carrying value of the original debt. No gain is recorded. A new effective interest rate is established based on the carrying value of the original debt and the revised cash flows. The effective interest rate of the restructured term loan is 2. Because this effective interest rate 2.

FG Corp determines that its term loan restructuring is a TDR because it is experiencing financial difficulty and its lender has granted a concession. This restructuring involves both 1 a grant of equity securities from the borrower to the lender, and 2 a modification of terms.

The calculation to determine if there is a gain associated with the TDR is as follows:. Modifications to terms of loans may include, but are not limited to, one or a combination of the following: Reduction of the stated interest rate for some or all of the remaining term of the loan Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new loans with similar risk Reduction of the face amount or maturity amount of the loan as stated in the instrument or other agreement Reduction of accrued interest Regulators have encouraged financial institutions to consider modifications and loan accommodation programs to assist borrowers facing setbacks from the COVID outbreak e.

Determining whether a financial institution has granted a concession A loan modification or restructuring is only considered a TDR if the financial institution grants a concession it would not otherwise consider. Accounting standards clarify when a concession is granted by noting the following: A financial institution has granted a concession when, as a result of the restructuring, it does not expect to collect all amounts due, including interest accrued at the original contract rate.

A concession has been granted by a financial institution if the institution restructures the debt in exchange for additional collateral or guarantees from the borrower and the nature and amount of the additional collateral or guarantees received do not serve as adequate compensation for other terms of the restructuring. If a borrower does not otherwise have access to funds at a market rate for debt with similar risk characteristics as the restructured debt, the restructuring would be considered to be at a below-market rate, which may indicate that the financial institution has granted a concession.

However, as noted in FIL, a loan deferred, extended or renewed at a stated interest rate equal to the current interest rate for new debt with similar risk is not reported as a TDR. A temporary or permanent increase in the contractual interest rate as a result of a restructuring does not preclude the restructuring from being considered a concession because the new contractual interest rate on the restructured debt could still be below the market interest rate for new debt with similar risk characteristics.

The following factors, when considered together, may indicate that a restructuring results in an insignificant delay in payment: The amount of the restructured payments subject to the delay is insignificant relative to the unpaid principal or collateral value of the debt and will result in an insignificant shortfall in the contractual amount due.

Determining whether a borrower is experiencing financial difficulties A loan modification or restructuring is only deemed a TDR if the borrower is experiencing financial difficulties. When determining whether a borrower is experiencing financial difficulties, the accounting standards clarify that the financial institution should consider whether: The borrower is currently in payment default on any of its debt or it is probable that the borrower would be in payment default on any of its debt without the modification.

In other words, the borrower may be experiencing financial difficulties even though the borrower is not currently in payment default. The borrower has declared or is in the process of declaring bankruptcy.

There is substantial doubt as to whether the borrower will continue to be a going concern. Without the current modification, the borrower cannot obtain funds from sources other than the existing financial institution s at an effective interest rate equal to the current market interest rate for similar debt for a nontroubled borrower.

Accounting for troubled debt restructuring TDRs are required to be accounted for as impaired loans under ASC Topic , even if the loan was exempt from the impaired loan accounting standards prior to the restructuring for example, a residential loan that was evaluated collectively as part of a homogenous loan pool. Nonaccrual loans Generally accepted accounting principles do not provide specific guidance as to whether a loan that has been modified in a TDR should be classified as nonaccrual.

Delinquent loans Typically, a loan that is past due 30 days or more is considered delinquent. Concluding thoughts Accounting standards related to TDRs have not changed in recent years, but these standards will be more relevant given recent events and the current world environment.

See our articles on: Talent and strategy Business finance Legislation and regulation Cybersecurity Technology Personal finance. Author s. Brett D. Lydia R. Article Download Please Register. Need help now? Fill out the form below and a member of our team will get in touch with you. Together, we work with you to identify risks, update processes and finalize your plan. Depending on the results of the tests, the debtor may have to account for the restructured debt by: Troubled debt restructuring — Changing the amount of interest expense recognized in the statement of operations prospectively or recognizing a gain in the statement of operations using the basic extinguishment model see below.

Modification or extinguishment — Modifying the effective interest expense recognized in the statement of operations prospectively or derecognizing the carrying amount of the original loan using the basic extinguishment model see below.

There is diversity in practice on the classification of the gain or loss upon the extinguishment of debt. Certain companies classify the gain or loss in interest expense. Other companies report the gain or loss on debt extinguishments separately. Both classifications are acceptable. It is not acceptable to classify a gain or loss on extinguishment of debt as an extraordinary item unless the gain or loss meets the criteria for presentation as an extraordinary item in ASC , Extraordinary and Unusual Items.

We believe it will be rare that a gain or loss on extinguishment of debt meets those criteria. The Practice Aid also considers accounting for preferred stock modification and extinguishments. The Aid does not discuss situations in which the debtor restates its liabilities generally, for example a debtor that has filed a petition with the bankruptcy court and expects there will be a general restatement of its liabilities as part of its reorganization as a going concern under Chapter 11 of the Bankruptcy Code.