Reg. Midway through 2021, it is really encouraging to see some of that unevenness disappear and more industries participating in the overall recovery. Here are just a few examples borrowers should be aware of: To determine how to account for a debt modification that is not a TDR, an entity must assess whether the terms of modified debt instrument and the original debt instrument are substantially different. Despite facing pressure, telecommunication companies are handling the roll-out of new network technologies and an insatiable demand for bandwidth. a. Our solutions include dealing with emigration and tax mitigation on the income and capital growth of overseas assets. During the periods where no interest is paid, the interest charge in the profit or loss will continue to be presented, by applying the EIR (adjusted, if need be, for any fees relating to the modification) to the revised amortised cost of the instrument. Stay informed with our latest quarterly review. In addition, the IRS confirmed that the modifications will not change the tax treatment of a "synthetic" debt instrument (i.e., an integrated debt instrument and hedge under Treas. As an example, let's say Company A has a net operating income of $2,000,000 for one year and the total debt servicing . 1. IFRS 9 states this test should compare the discounted present value amount of the cash flows under the new term, including any fees paid net of any fees received, discounted at the original EIR, with the discounted present value amount of the remaining cash flows of the original liability. Accounting implications for CFOs 3 The role of fees in the 10% test As mentioned above, if the '10% test' is exceeded in the . . IFRS 9 contains guidance on non-substantial modifications and the accounting in such cases. revision of cash flows in amortised cost calculation. Modification accounting under FASB Subtopic 470-50 is applied when the modification is deemed significant, and if not significant, the borrower . As part of this modification the entity: The net present value of the future cash flows, (discounted at the original EIR inclusive of fees paid to the lender) is CU 976,000 plus CU 10,000 = CU 986,000. Debt restructuring can take various legal forms including: There are two tests to check whether the modification is substantial, and these are as follows: The following flowchart sets out how to assess whether or not a debt modification is substantial: As mentioned above, if the 10% test is exceeded in the quantitative test, this results in a substantial modification. This amount is compared to the previous carrying amount and the difference is recognised in the profit or loss. Here are the Click here to extend your session to continue reading our licensed content, if not, you will be automatically logged off. 3 To issue debt: Any increase in fair value is accounted for as a debt issuance cost or a discount under ASC 835. Because all cash flows occur on day one, the cash flows are not discounted. Known as the "10 per cent test," the borrower should first use the original effective interest rate (EIR) to discount the cash flows under the new terms, including any fees paid net of any fees received. off course? 1.1001-3, a change in yield of the existing debt is significant if it is more than the greater of 25 basis points or 5% of the unmodified yield. For example: To determine the appropriate accounting treatment for a modification or exchange transaction arranged by a third-party intermediary, a reporting entity should determine whether the intermediary is a principal to the transaction (i.e., the investor in the bonds whose terms were modified) or the reporting entitys agent (i.e., facilitating a refunding of the old bonds on behalf of the reporting entity through issuance of new debt). Examples of this type of modification include issuing new debt in different currency from old debt, or equity instrument embedded in the new debt. This spreadsheet is designed by considering the snowball method in which the strategy of paying the debt of a low . Changes to the Outsourcing legislation, specifically when offshoring. The power of diversity: can life sciences maintain their lead? 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). One of those consequences is their ability to repay loans. 3. Given the market rate of interest is 12% for a comparable liability, the fair value of the liability amounts to CU 8,122,994. We can support you throughout the transaction process helping achieve the best possible outcome at the point of the transaction and in the longer term. The first step is to determine whether the "10% test" is met. From the debtors perspective, an exchange of debt instruments between or a modification of a debt instrument by a debtor and a creditor in a nontroubled debt situation is deemed to have been accomplished with debt instruments that are substantially different if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. Several complexities that might arise when performing this 10% test include: Two common scenarios in which a debt modification might involve multiple lenders are loan syndications and loan participations. Calculating the Debt Service Coverage Ratio in Excel Example. Are you still working? 36\+E,NGDud^{@Nt yYZV8Tt41YuD**?7^yYE[z j?- Vym"rZCy)3{3G9H&fkCL B{m )! As a result the calculation will be $28,546.45 / 77 = $370.73. Please seewww.pwc.com/structurefor further details. The COVID-19 global pandemic has resulted in economic consequences that many reporting entities may not have had to previously consider. Most 3-statement models and case studies fall into one of three categories: Blank Sheet / Strict Time Limit: These are more about working quickly, knowing the Excel shortcuts, simplifying, and making decisions under pressure. |!uoSC$|{e Because the change in cash flows in the immediate prepayment scenario is less than 10%, FG Corp should account for the changes to its debt as a modification. If you have any questions pertaining to any of the cookies, please contact us us_viewpoint.support@pwc.com. Should FG Corp account for the changes to its debt as a modification or an extinguishment? a '10 percent test' 1. It cannot be assumed that the fair value equals the book value of the existing liability. US GAAP. In syndications, separate debt instruments exist between each lender and the borrower, even when one lender has been identified as the lead lender. An increase in principal should be treated as a day-one cash inflow in the cash flows of the new debt instrument, and a decrease should be treated as a day-one cash outflow. Cash flows can be affected by changes in principal amounts, interest rates, or maturity. Get modification 10 signed right from your smartphone using these six tips: In a public debt issuance, for purposes of applying the guidance in this Subtopic, the debt instrument is the individual security held by an investor, and the creditor is the security holder. The fact that the debtor designated the debt as the hedged item in a fair value hedging relationship does not affect the relationship between the debtor and lender. We help businesses navigate todays changing private equity landscape, ensuring that you can respond to ever-changing regulations and investor demands. 1 Create a Macro: Swap Values | Run Code from a Module | Macro Recorder | Use Relative References | FormulaR1C1 | Add a Macro to the Toolbar | Enable Macros | Protect Macro. If a prepayment option (or any put or call feature) is exercisable at any time, a borrower should assume it is exercised immediately. To perform the 10% test, FG Corp should assume that the prepayment option in both the original and new debt is exercised on the modification date. In these situations, the Financial Accounting Standards Board (FASB) requires that a separate accounting model be used under which the modified debt arrangement generally would be treated as the continuation of the old debt arrangement subject, of course, to the type of restructuring (for example, full termination of the debt versus solely a modification of the debt terms). In that case, the reporting entity should perform the 10% test based on the cash flows of the debt held by the third-party intermediary before and after the modification or exchange. There is no guidance on how to account for a refinancing of publicly traded debt securities that does not involve an exchange or modification offer (i.e., when a reporting entity issues new debt securities to investors, which potentially may include holders of the issuers existing debt securities, and uses the proceeds to pay off existing publicly-traded debt securities potentially held by the same investors). On adoption of IFRS 9 on January 1, 2018, a transitional ad . Holding banking to account: the real diversity and inclusion picture. Crowe accounting professionals have deep expertise in the accounting for debt modifications, including those that represent troubled debt restructurings. us Financing guide 3.2. Changing the interest rate. In addition, these amendments also clarify that when the exchange or modification is not accounted for as an extinguishment, any costs or fees incurred adjust the carrying amount of the liability and are amortised over the remaining term of the modified liability. Having a robust process of quality control is one of the most effective ways to guarantee we deliver high-quality services to our clients. For example, that may be the case if the intermediarys own funds are committed and those funds are not truly at risk because the intermediary is made whole by the debtor (and therefore is indemnified against loss by the debtor). When applying the 10% test, it may also be appropriate to consider contingent prepayment options, such as a call option exercisable upon a change in control, or upon completion of a qualified financing. Company P derecognises the original loan with a carrying amount of $10 million and recognises a new loan of $10 million with 3% p.a. All rights reserved. Make sure the table is aligned correctly . This is less than 10%, so the loan modification (waiver of 6 months of interest) considered to be a non-substantial modification. This article will explore the federal income tax consequences of common transactions that can create CODI, including: Debt modifications. An entity's debt-to-equity funding is sometimes expressed as a ratio. Time to review funding and financing arrangements? Value of the right of use asset divided by total remaining useful life days. 1. If you have questions, please contact your supervisory office, the Office of the Chief Accountant at (202) 649-6280, or the Credit and Market Risk Department at (202) 649-6360. The first indicator in, If the third-party intermediary acts as an agent, the reporting entity has refinanced the original debt with new debt to other third-party investors and the reporting entity should consider the guidance in. Thin capitalisation. As this evolves, it is unclear what recovery looks like. The legal form of a modification transaction, whether a legal exchange or a legal amendment, is irrelevant for purposes of determining whether it is an accounting modification or extinguishment. 2. Globalisation and company growth ambitions are driving an increase in M&A activity worldwide. Exchanging existing debt for new debt with the same lender. When including prepayment options in the 10% test, it is not necessary to assess the ability of the borrower to prepay the debt; the 10% test should be applied to all noncontingent contractual scenarios. Menu. debt for assessing whether a concession has been granted under the TDR guidance and in applying the 10% cash flow test under the debt modification guidance: Other modifications (unrelated to . Examples of this type of modification include issuing new debt in different currency from old debt, or equity instrument embedded in the new debt. The difference of CU 1,877,006 between this initial fair value of the new liability and the carrying amount of the liability derecognised (CU 10,000,000) is recognised as a gain upon extinguishment. The following decision tree provides a high-level overview of the analysis used by borrowers to determine the accounting for modifications of debt arrangements: Ultimately, to properly account for modifications to debt agreements, its important to know which questions to ask and what complexities might arise along the way. When performing the 10% test, the effect of the required amortization of basis adjustments due to the application of fair value hedge accounting should be ignored for the purposes of calculating the effective interest rate of the original debt instrument. IFRS 9 prescribes a quantitative test to assess whether the modification is substantial. All fees incurred (CU 200,000) are immediately expensed, thus reducing the amount of the net gain upon extinguishment to CU 1,677,006. The cash flow assumptions that generate the smaller change would be the basis for determining whether the 10 percent threshold is met. Home; About; Maps; FAQ; debt modification 10% test example excel Whereas above, in the final step, the fees included as an adjustment to the EIR are all fees, including external fees (such as lawyer fees). This is described as the '10% test'. The debt and equity tests determine whether a return on an interest in an entity may be frankable and non-deductible (like a dividend) or may be deductible to the entity and not frankable (like interest). With a finance lease under ASC 842, the calculation methodology to calculate the amortization rate post modification follows the same methodology at initial recognition. As most businesses brace for an economic downturn, tech and telecom could see new prospects. And it is even more so today. If a debt instrument is modified such that the currency in which it is denominated changes, the change in currency should be included in the cash flows as part of the 10% test. Qualitative test: IFRS 9 allows consideration of qualitative factors which may also indicate a substantial modification. Dynamic businesses must continually innovate to maintain competitiveness, evolve and grow. The calculation of yield for tax purposes may differ from the calculation of yield that a company uses for book purposes. cr,; 2N+!>@Ko6m?jRhP See, When a loan modification or exchange transaction involves the addition of a delayed draw loan commitment with the same lender, we believe it would not be appropriate to include the unfunded commitment amount of delayed draw term loan in the 10% test since the commitment is not funded on the modification date. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory. In many instances, a gain or a loss might need to be recorded in profit or loss and depending on facts and circumstances, derecognition of the financial arrangement might be required as a result of modifying the financial instrument arrangement that existed. The author of the spreadsheet and the Squawkfox blog, Kerry Taylor, paid off $17,000 in student loans over six months using this downloadable Debt Reduction Spreadsheet. 80 0 obj <>stream Some companies might need to modify existing loan terms to alleviate financial distress, while other companies that are on solid footing might modify their debt arrangements to procure additional financing for acquisitions or other . The media industry is in the grip of a technological revolution as the industry responds to the shift to digital and personalisation. In addition, the contractual rate of interest is increased to 8% starting 1 January 2021. In terms of the 10% test, CU 976,000 is less than 10% different to the previous carrying amount, therefore this is treated as a non-substantial modification. Given the differences in the accounting requirements applicable to TDRs versus other types of modifications, failure to properly classify a debt modification as a TDR could result in: The proper accounting treatment for a TDR is driven by the form of the modification. Under IFRS 9, the gain of $85,000 would have been recognized in profit and loss at January 1, 2016. This is because the unamortised portion of any transaction costs deducted from the original loan is included in the determination of the gain or loss on extinguishment. We understand the commitment and scrutiny within this sector and will work with you to meet these challenges. Below are sample excel test questions and answers to give you a sense of what you will face on your test. As explained above, in a non-substantial modification, the liability is restated based on the net present value of the revised cash flows discounted at the original EIR. There is a general presumption that a third-party intermediary is acting as an agent; however, this presumption can be overcome. Any changes to the terms of loan agreements, for example providing any kind of payment holidays on either principal or interest or changing interest rates, should be carefully assessed. X$1M[c2/TS'-$D?`z:=[kj+,zkDU&U&"B" In a matter of seconds, receive an electronic document with a legally-binding signature. However, we believe fees paid to the counterparty bank that represent part of the cash flows should normally be accounted for in the same way as other as other cash flows on the debt instrument, which would lead to such fees being part of the gain or loss rather than amortised over the remaining life of the loan. What are the shortcut keys for AutoSum? Now more than ever the need for businesses, their auditor and any other accounting advisors to work closely together is essential. Do Not Sell or Share My Personal Information. Mid-market recovery spreads to more industries. Because the change in present value of cash flows is less than 10%, the change is considered a modification. FG Corp restructures its term loan again in December 20X4. The laws surrounding transfer pricing are becoming ever more complex, as tax affairs of multinational companies are facing scrutiny from media, regulators and the public. For example, given the business interruptions caused by COVID-19, a borrower and a lender might agree to defer or forgive certain principal and interest payments, reduce the stated interest rate, or change debt covenants or collateral requirements, among other things. The International Financial Reporting Standards (IFRS) are a set of global accounting standards developed by the International Accounting Standards Board (IASB) for the preparation of public company financial statements. The primary decision points considered by the . But, to turn the headwinds to your advantage, you need to find your unique opportunities and risks. If so, the fees should be accounted for based on the guidance in, Company name must be at least two characters long. If a restructuring is accounted for as a debt extinguishment, then the fair value of any non-cash consideration is associated with the extinguishment of the original debt instrument (i.e., treated as an amount paid to extinguish the debt) and included in determining the extinguishment gain or loss. If the change in cash flows is less than 10% in any scenario, then the restructuring is considered a modification. If a literal interpretation of, Similar accounting may be appropriate for refunding transactions on tax-exempt municipal bonds. What does the funding landscape look like for public sector organisations in 2022? Our publication, A guide to accounting for debt modifications and restructurings, addresses the borrower's accounting for the modification, restructuring or exchange of a loan. Under ASC 470-50, modifications and exchanges not considered TDRs are accounted for as either: