Accounting for troubled debt restructurings (TDRs) has always been a pain point for many accountants, especially those who work in or have clients in the banking industry. The implementation of ASC 326, the current expected credit loss (CECL) standard, didn’t make things any easier, rather it seems to have added complexity to the accounting for TDRs.
It’s not all doom and gloom though! Relief may be in sight as the FASB has a proposal out for comment that would eliminate the TDR accounting guidance. Let’s take a look at current TDR accounting and a peek at the FASB’s proposal.
Accounting for TDRs
The accounting for TDRs is specified in ASC 310-40 Troubled Debt Restructuring by Creditors. One of the difficulties in accounting for TDRs is the identification of whether a restructuring of debt meets the definition of a TDR and falls under TDR accounting, or whether it is not a TDR and thus falls under modification accounting.
ASC 310-40 indicates that a restructuring of a debt constitutes a troubled debt restructuring if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider.
The definition is clear that in order for a debt restructuring to be considered a TDR, (1) the borrower must be experiencing financial difficulty AND (2) a concession must be made by the lender.
In making the determination as to whether a debtor is experiencing financial difficulties, a creditor considers indicators. ASC 310-40 provides 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.
While these indicators may help, the devil is in the details and the guidance does make it clear that the list is not intended to be all inclusive.
Making a determination of whether the creditor is granting a concession can be just as difficult. A creditor has granted a concession when an entity does not expect to collect all amounts due according to the contractual terms of the original loan as a result of a restructuring. All information available to a creditor must be evaluated in making the determination of whether a concession has been made. This analysis can be challenging, especially when collateral and guarantees come into play.
If a restructured loan is determined to be a TDR, it is not accounted for as a new loan because a troubled debt restructuring is part of a creditor's ongoing effort to recover its investment in the original loan.
ASC 326 requires measurement of credit losses and for those credit losses to be recorded through an allowance. Concessions given to a borrower in a TDR are required to be recorded through the allowance for credit losses. While various measurement methodologies are permitted for measuring credit losses under ASC 326, certain concessions can be captured only through a discounted cash flow or reconcilable model; thus, for some TDRs a discounted cash flow model is required.
Proposed ASU to Eliminate TDR Accounting
In conducting outreach with stakeholders on the implementation of ASC 326, the FASB received feedback that the additional designation of a loan modification as a TDR and the related accounting and disclosures are unnecessarily complex and do not provide decision-useful information.
As a result of the feedback, the FASB issued a proposed ASU that would eliminate the accounting guidance for TDRs by creditors. Instead, a creditor will evaluate whether the modification represents a new loan or a continuation of an existing loan. Disclosures would also be enhanced for loan refinancings and restructurings by creditors made to borrowers experiencing financial difficulty.
Stakeholders should review the proposed ASU and provide any feedback by December 23, 2021.
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