Further Clarification on Troubled Debt Restructurings

5/12/2011

By Andrew Marshall, CPA

Last month the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-02, Receivables (Topic 310): A Creditors Determination of Whether a Restructuring is a Troubled Debt Restructuring. This update was released to help further clarify for creditors whether a modification to the terms of a note should be considered a troubled debt restructuring.

The following items help provide clarification for ASC 310-40 – Troubled Debt Restructurings by Creditors, and were taken directly from Update 2011-02.

Determining Whether a Creditor Has Granted a Concession

• A creditor 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. In that situation, and if the payment of principal at original maturity is primarily dependent on the value of collateral, an entity shall consider the current value of that collateral in determining whether the principal will be paid.
• A creditor may restructure a debt in exchange for additional collateral or guarantees from the debtor. In that situation, a creditor has granted a concession when the nature and amount of that additional collateral or guarantees received as part of a restructuring do not serve as adequate compensation for other terms of the restructuring. When additional guarantees are received in a restructuring, an entity shall evaluate both a guarantor's ability and its willingness to pay the balance owed.
• If a debtor 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 creditor has granted a concession. In that situation, a creditor shall consider all aspects of the restructuring in determining whether it has granted a concession.
• 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 market interest rates for new debt with similar risk characteristics. In that situation, a creditor shall consider all aspects of the restructuring in determining whether it has granted a concession.

Evaluating Whether a Restructuring Results in a Delay in Payment That Is Insignificant

• A restructuring that results in only a delay in payment that is insignificant is not a concession. The following factors, when considered together, may indicate that a restructuring results in a delay in payment that is insignificant:
  • 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.
  • The delay in timing of the restructured payment period is insignificant relative to any one of the following:
    • The frequency of payments due under the debt
    • The debt's original contractual maturity
    • The debt's original expected duration.
• If the debt has been previously restructured, an entity shall consider the cumulative effect of the past restructurings when determining whether a delay in payment resulting from the most recent restructuring is insignificant.

Determining Whether a Debtor Is Experiencing Financial Difficulties

• In evaluating whether a receivable is a troubled debt restructuring, a creditor must determine whether the debtor is experiencing financial difficulties. In making this determination, a creditor shall consider the following indicators:
  • The debtor is currently in payment default on any of its debt. In addition, a creditor shall evaluate whether it is probable that the debtor would be in payment default on any of its debt in the foreseeable future without the modification. That is, a creditor may conclude that a debtor is experiencing financial difficulties, even though the debtor is not currently in payment default.
  • The debtor has declared or is in the process of declaring bankruptcy.
  • There is substantial doubt as to whether the debtor will continue to be a going concern.
  • The debtor has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange.
  • On the basis of estimates and projections that only encompass the debtor's current capabilities, the creditor forecasts that the debtor's entity-specific cash flows will be insufficient to service any of its debt (both interest and principal) in accordance with the contractual terms of the existing agreement for the foreseeable future.
  • Without the current modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a nontroubled debtor.
  • The above list of indicators is not intended to include all indicators of a debtor's financial difficulties.

Additionally, this update states that creditors are precluded from using the effective interest rate test found in debtors guidance on the restructuring of payables (paragraph 470-60-55-10), when trying to determine whether or not a restructuring should be classified as a troubled debt restructuring and includes several examples with different fact situations that may be helpful to review.

This new guidance will be effective for interim and annual periods beginning on or after June 15, 2011, for public companies, and will be retroactive for restructurings occurring on or after the beginning of the fiscal year of adoption. For all non-public companies this update will become effective for annual periods ending on or after December 15, 2012, and will include interim periods within that annual period. Early adoption is also permitted.