A creditor should account for the refinancing or restructuring of debt as either a modification of the original instrument or as the extinguishment of the original instrument and issuance of a new instrument. Figure LI 10-1 can be used to determine the appropriate accounting treatment for a loan refinancing or restructuring.
Figure LI 10-1All loan modifications, refinancings and restructurings (including those with borrowers that are experiencing financial difficulty) are subject to the modification guidance in ASC 310-20. As such, an entity needs to evaluate whether the modification creates a new loan or rather should be treated as a continuation of an existing loan. As discussed in ASC 310-20-35-9, a loan refinancing or restructuring should be accounted for as a new loan (i.e., as an extinguishment of the original debt instrument and issuance of a new loan) when both of the following occur:
If these conditions are not met, the refinancing or restructuring should be accounted for as a modification of the original debt instrument, not as a new loan. The determination of whether the restructuring is a modification or the creation of a new instrument impacts the accounting for certain fees and costs and is important in determining the origination date for certain “vintage disclosures.” See LI 12 for information on presentation and disclosure.
Many modifications of loans with borrowers experiencing financial difficulty will not meet the first criterion and as a result, will not result in the modified loan being treated as a new loan.
If the terms of the new loan resulting from a loan refinancing or restructuring are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the lender, the refinanced loan shall be accounted for as a new loan. This condition would be met if the new loan's effective yield is at least equal to the effective yield for such loans and modifications of the original debt instrument are more than minor. Any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted. The effective yield comparison considers the level of nominal interest rate, commitment and origination fees, and direct loan origination costs and would also consider comparison of other factors where appropriate, such as compensating balance arrangements.
When determining if the modification of a contract to replace LIBOR, or another reference rate expected to be discontinued should be accounted for as a continuation of the existing contract or as an extinguishment and creation of a new contract, a reporting entity may elect to apply the guidance in ASC 848. See REF 2 for further details.
To determine whether a modification is considered “more than minor,” a reporting entity should perform the assessment shown in Figure LI 10-2, which starts with comparing the present value of cash flows of the new debt with the remaining cash flows of the old debt.
However, when determining if a modification of a contract to replace LIBOR, or another reference rate expected to be discontinued should be accounted for as a continuation of the existing contract or as an extinguishment and creation of a new contract, a reporting entity may elect to apply the guidance in ASC 848. See REF 2 for further details).
Figure LI 10-2In accordance with ASC 310-20-35-11, compare the present value of the cash flows of the new debt with the present value of the remaining cash flows of the original debt utilizing the guidance in ASC 470. See FG 3 for an illustration of this assessment.
If the present value of cash flows differs by at least 10%, the modification is considered more than minor.
If the present value of cash flows differs by less than 10%, further analysis should be performed under Step 2.
ASC 470-50-40-12 provides specific guidance on performing the 10% test. Key takeaways from this guidance include:
The creditor should evaluate whether the modification is more than minor based on the specific facts and circumstances surrounding the modification and other relevant considerations. The accounting literature does not provide specific guidance on what factors a reporting entity should consider.
Relevant facts may include considering the impact of the modification on the following: