FASB Proposes Changes to Debt Exchange Accounting

Breaking it down

Under current guidance in Subtopic 470-50, when a borrower modifies the terms of debt or exchanges it for new debt, the borrower must determine whether the transaction should be accounted for as a modification or an extinguishment. For term debt, this determination is based on a quantitative analysis known as the 10% cash flow test, which compares the present value of the cash flows of the new debt to the present value of the remaining cash flows of the old debt. If the difference is 10% or more, the exchange is accounted for as an extinguishment; otherwise, it is treated as a modification.

If the amendment or exchange is determined to be an extinguishment, the existing debt is derecognized and the new debt is recognized at its fair value with any difference recognized as a gain or loss on extinguishment. New fees with existing creditors and unamortized costs of the existing debt are included in the gain or loss on extinguishment. New third-party costs are amortized to interest expense over the term of the new debt. If the amendment or exchange is determined to be a modification, the debtor determines a new effective rate for the modified debt based on the carrying amount of the existing debt and the new cash flows. New fees with existing creditors are amortized to interest expense over the remaining life of the modified debt, and new third-party costs are expensed as incurred.

Stakeholders have expressed various concerns with the current guidance. Because the 10% test is applied on a creditor-by-creditor basis, some debt exchanges may result in having different effective interest rates for the same debt depending on whether a creditor previously held existing debt. Additionally, stakeholders noted that under the current guidance, an entity might encounter significant challenges in determining the creditors’ identity.

These circumstances can result in reporting outcomes that do not reflect the economic substance of a refinancing transaction, particularly when the retirement of existing debt and the issuance of new debt are independent transactions. Stakeholders also have noted that the 10% test can be costly to apply, particularly when many creditors are involved.

To address these concerns, the proposal, which is based on a consensus-for-exposure of the Emerging Issues Task Force (EITF), adds a new threshold test to Accounting Standards Codification (ASC) 470-50 that would be applied before the 10% test. If the proposed threshold test is met, the transaction would be accounted for as an extinguishment, and the 10% cash flow test would not be applied. If the proposed threshold test is not met, the existing guidance would apply, including performing the 10% cash flow test on a creditor-by-creditor basis to determine whether the exchange should be accounted for as a modification or an extinguishment.

Proposed threshold test

The proposed amendments to ASC 470-50-40-9 would require debtors to treat contemporaneous exchanges of cash involving new and existing debt with the same creditor as extinguishments if the new debt has multiple creditors and the following conditions both are met:

• The existing debt obligation has been repaid in accordance with its contractual terms or repurchased at market terms.
• The new debt obligation was issued at market terms following the issuer’s customary marketing process for new issuances.

According to the proposal’s basis for conclusions, the EITF generally considered the first condition to demonstrate that the satisfaction of existing debt and issuance of new debt are independent transactions. To reinforce this conclusion, the second condition was included to demonstrate that new creditors were provided an opportunity to participate in the new debt issuance at market terms and existing creditors were not provided preferential treatment or incentives. If both conditions are met, accounting for the exchange as an extinguishment would seem to best reflect the economics of the transaction and provide the most decision-useful information to investors.

Following is a summary of the proposed changes compared with the current guidance on exchanges of term debt involving contemporaneous exchanges of cash with the same creditor when the new debt has multiple creditors.

Scope

The proposal would apply to all debtors with transactions within Subtopic 470-50 that involve the contemporaneous exchange of cash with the same creditor when new debt is issued to multiple creditors and existing debt is satisfied.

Consistent with the existing scope of Subtopic 470-50, the amendments in this proposed update would not apply to exchanges of debt instruments in a transaction that is 1) a troubled debt restructuring, 2) a conversion of debt instruments, or 3) between a debtor (or its agent) and a third party that is not a creditor.

Transition

Entities would adopt the amendments prospectively to debt exchanges occurring on or after the effective date. Early adoption would be permitted.

Crowe observation: The proposed guidance reflects the FASB’s intent to align accounting outcomes with the economic reality of certain debt-for-debt exchanges. In addition, the proposal would reduce the number of debt exchanges that are required to be assessed under the 10% test, reducing the cost and complexity under the current guidance. It also would require more exchanges to be accounted for as extinguishments and would require new considerations associated with the proposed threshold test. We expect that the threshold test would be straightforward to apply in many cases. However, in some cases, entities might encounter challenges in determining if the new debt was issued at market terms, particularly when no new investors participate in the new debt.

Effective date and next steps

The FASB will set the effective date after reviewing feedback received during the comment period, which ends on May 30, 2025.

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