Troubled Debt Restructuring, Debt Modification, and Extinguishment

Companies frequently fund their operations in part using debt and may renegotiate their debt for a variety of reasons from increasing borrowings to finance an expansion of their operations to managing cash flow difficulties. The debtor and creditor may agree to modify the current loan agreement (or debt instrument) or to exchange one loan agreement (or debt instrument) for another.  The accounting guidance applicable to accounting for the restructuring of obligations does not distinguish between a loan agreement, a payable, and a debt instrument and we will use the term “loan” and “debt’ interchangeably in this practice aid. 

This practice aid discusses the accounting for restructured debt from the perspective of the debtor. The document is intended to be used by practitioners of all experience levels. Users interested in only the accounting standards and interpretive guidance can pass over the highlighted areas of the Practice Aid. The examples within the body of the Practice Aid are simple and designed to explain the concepts. Appendix A provides complex examples designed for users who understand the basics of debt modification.

This Practice Aid provides the tests to determine the applicable model for accounting for a loan that is restructured with the same lender. The flowcharts in the Practice Aid summarize these tests.  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 225-20, 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.