Debt restructuring: Accounting for borrowers

Debt restructuring accounting remains top of mind for borrowers as companies refinance debt that may have been issued in a very different interest rate environment. This episode discusses the accounting models for debt restructurings, including lender-by-lender assessments, modification versus extinguishment outcomes, troubled debt restructurings, fee allocations, and syndicated debt transactions. We break down the key considerations and share insights on navigating common challenges in applying ASC 470 guidance.

For further guidance on the accounting for this topic, see chapter 3 of PwC’s Financing transactions guide. For cash flow presentation, see section 6.8 and for debt presentation and disclosure, see chapter 12 of PwC’s Financial statement presentation guide. 

This episode is part of our debt-related miniseries. Stay tuned for our final episode next week, and in case you missed them, listen to our previous episodes:

• Beyond debt: Accounting for other liability-classified arrangements
• Current or noncurrent? Getting debt classification right

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About our guests 

Suzanne Stephani is a director in PwC’s National Office specializing in the statement of cash flows as well as the application and interpretation of the accounting guidance related to financing, leasing, and foreign currency transactions. 

Christopher Gerdau is a partner in PwC’s National Office specializing in accounting for financial instruments and banking-related topics. Chris also conducts technical reviews of SEC filings and provides technical support to PwC’s practice offices. Chris’s client service expertise includes the banking, capital markets, and insurance industries. 

About our guest host 

Diana Stoltzfus is a partner in PwC’s National Office who helps to shape PwC’s perspectives on regulatory matters, responses to rulemakings and policy development, and implementation related to significant new rules and regulations. Prior to rejoining PwC, Diana was the Deputy Chief Accountant in the Office of the Chief Accountant (OCA) at the SEC where she led the activities of the OCA’s Professional Practices Group. 

Transcripts available upon request for individuals who may need a disability-related accommodation. Please send requests to us_podcast@pwc.com

Transcript

SPEAKER_00 0:00

Thought Leadership from PwC's National Office.

SPEAKER_04 0:06

Hello, and welcome to PwC's Accounting Podcast. I'm Heather Horn. Thanks for joining us today as we jump into current topics in accounting and reporting. For today's discussion, I'm pleased to welcome guest host, Diana Stoltzfitz, a partner in PwC's National Office and a podcast regular. I'll hand it over to Diana for more details on today's episode.

SPEAKER_02 0:34

Welcome to our mini-series on debt and financing transactions. Today we're focusing on debt restructurings, an area that's becoming increasingly relevant as many companies refinance debt that was originally issued in a very different interest rate environment. It's also a timely topic because the FASB recently had a project focused on some of the long-standing challenges in applying debt restructuring guidance. While that project has been paused, many of those practice issues still remain. Joining me today are Chris Gerdo, a partner, and Suzanne Stefani, a director from PWC's National Office, where they help companies and engagement teams navigate these complex accounting questions every day. We're going to talk through some of the biggest challenges we're seeing in practice and how companies can work through them. So, Chris and Suzanne, thanks so much for joining me today.

Debt restructuring landscape and accounting overview

SPEAKER_02 1:23

So let's start with the broader environment overall. Chris, why are we seeing more restructurings right now?

SPEAKER_01 1:30

Well, thanks, Diana, and thanks for having us today. Um, so if you go back, I guess maybe five or six years ago, um, if you think about where we were, sort of in the middle of COVID and an interest rate environment where rates were historically low, there was a lot of debt that was issued at that point in time. And that debt, a lot of it anyway, is now maturing um or set to mature soon. And so companies need to think about, you know, do I refinance or restructure that debt in an interest rate environment uh that's very different today than it was uh when the debt was issued, you know, say five, six years ago. So now today, you know, there's also tighter lending standards, um, there's higher rates, yet on the possibility of liquidity issues, um, which we're seeing a lot of today. And that leads to um a lot of complex restructurings. In addition, um we see a lot of complexity in applying the standard too, which was one of the major pain points uh raised to the FASB when they were looking at um changing the guidance. Um and as you mentioned, though, some of that guidance they were thinking about has now been indefinitely paused. So who knows where that'll wind up. I guess we'll just have to see. But the current guidance has been around for a very long time, and transactions have evolved uh since the the guidance was issued. Today's situations are very different. Uh and transactionally, you know, you think a lot about syndicated lending arrangements, um, you get a lot of secondary loan trading, and you know, now you have the expansion of private credit as well. So all that has led to different types of restructurings.

SPEAKER_02 3:14

Yeah, and the guidance maybe wasn't necessarily built for all these different types of transactions. Suzanne, we've been using the term debt restructuring a few times now. And, you know, I think there's what that means in practice, and we've talked about there's all these different types of transactions that maybe fall within that. But then when you actually get into what does that mean from an accounting perspective, those can sometimes be a little bit different. Maybe can you walk us through that?

SPEAKER_03 3:37

Yeah, it is, it is different. So I think um, I think I'm gonna use an example just to kind of walk through because it helps illustrate. So this is a very common transaction that we see when we're dealing with with clients and companies. So a company will go out and issue new syndicated debt and take the proceeds, the money they get from that new debt, and pay off their old debt same day. Um usually in the syndicate, there's gonna be new lenders, there's gonna be lenders that just leave, get out of the old debt, don't come into the new debt. And then there'll be these, we call them rollover lenders. So they're in the old debt and the new debt. And that's pretty common in syndicated debt, but you'll see the same lender come over from the old debt. So when companies have this, they're they usually will say, Hey, we refinanced our debt. And they think about it as like one big transaction, one debt restructuring. But for accounting, unfortunately, it's not one big transaction. It needs to be assessed lender by lender. So these rollover lenders, the ones that are in the old and the new, for accounting purposes, those are the ones that are considered debt restructurings, like when we say debt restructuring from an accounting perspective. Yeah, yeah, yep. So there's specific guidance, which we'll go through today in ASC 470 to think about whether it's a troubled debt restructuring. And then if not, there's a cash flow test to determine the accounting. It's either going to be a modification or an extinguishment. Then you have the exiting lenders, those guys just leave, right? They were in the old debt and they don't come to the new debt, they're just paid off. So those are just regular extinguishments. Those are not restructuring. And then you have the new lenders that just came into the new debt. Those are just new, right? They're just going on the book, debt's just going on the books at the cash proceeds and they're capitalizing all the fees. So what you get, what you end up with is all different accounting depending on the lender types, roll over new, or exiting. And the FASB project was trying to come up with an overall model. So it would have been much simpler. But at this point, you know, that that project is paused. So we're we're left with what we have today.

SPEAKER_02 5:46

Okay. So so I guess we don't have that. We have to do this lender-by-lender assessment. Yep. So maybe we'll get into the debt restructuring guidance. I know, Chris, there's more than one accounting model. I think Suzanne touched on that briefly, this TDR, non-TDR, and then even some more complications, I think, within that. So depending on the facts and circumstances, can you walk us through what those different models look like?

SPEAKER_01 6:10

Sure. Yeah. So the first place that you usually usually start or need to start, really, is whether it is a troubled debt restructuring. It's kind of step one or the first filter you go through. Um and so what is a troubled debructuring? Um, you know, a TDR is basically um a restructuring for a borrower that's experiencing financial difficulty and that the lender has granted a concession. Um and that could be in the form of interest rate reductions, um, it could be in the form of principal reductions or forgiveness. Um, so you have to kind of think about the cash flows in totality and whether there's been um a concession granted there. Um if it's TDR, then you know there's very specific guidance which um we'll put we'll put on pause for now. Because most restructurings are gonna be non-TDRs. It's gonna be you know, just general looking to refinance uh your your debt or whatever the case is. And so those are the non-TDRs or the straight, you know, straightforward to the extent any of this is straightforward. The straightforward um restructurings. Um and so there's two basic models that you think about as gonna determine or it's going to be based on um what kind of debt you have. Um and so basically that's you know, for term loans, which you think about as just kind of like your basic, you know, I borrowed money, I agreed to pay it back in you know, certain you know, terms. That's term loan. Um and the other is uh revolver, so that's like lines of credit and things like that, where I may continually you know borrow, repay, borrow, repay over a period of time. Um for the term loans, the test is you know, kind of what's a modification versus extinguishment is referred to as like a 10% test. And so basically what you do is you kind of schedule out the the cash flows of the new debt and you discount those back at the current debt's effective interest rate. Um and you compare that um to the carrying value of the current debt. And if it's greater than 10%, uh it's uh an extinguishment. Um if it's less than 10%, uh it's a modification. For the revolvers, there's what's called a borrowing capacity test. So you basically you you kind of multiply the amount that you can draw with the time period that you can draw it over, um, and you determine um whether or not it's a modification or extinguishment based off of that. And that basically really impacts, you know, how how do you account for the new or deferred costs associated with the revolver.

SPEAKER_02 8:41

Okay. And Chris, when we're talking through today, and I guess you're the end too, this is from the perspective of the borrower that we're talking about this, right? And so there can be different considerations if you're talking about from the lender side. Yes. Okay, just making sure we're all level set.

SPEAKER_01 8:56

Yeah, it is this is all dead. I mean, there's yeah, there's some similarities, but there's probably a little more bells and whistles when you're with the lender.

SPEAKER_02 9:04

Yes. Okay. So, Chris, now that you've talked through these different different models that companies can get through when they're in their debt restructuring, maybe we can talk through what the accounting looks like for each of these when you're applying these models.

SPEAKER_01 9:17

Sure. So for term loan, like I said, you know, you you you do that test, the 10% test, um, based off of the the new cash flows and you know compared to the old carrying value. Um, and if it's less than 10%, it's modification. If it's greater than 10%, it's an extinguishment. So if it's a modification, um, there's no gain or loss that's recorded with the um transaction with the restructuring because it's you're continuing the old debt really. Um and so there's no gain or loss. You consider the new cash flows and you readjust or recalculate what your effective interest rate is on the debt, and then you just apply that new rate um going forward. And a lot of times what it comes down to is like then the fees. Like, how do I account for the fees? There's could be third-party fees for the restructuring, there could be new lender fees that were paid. And so if it's a modification, then um you would expense the third-party fees um and the lender fees would get capitalized um back into the debt and the deferred costs. Um if it's greater than 10%, it's an extinguishment. Um, and that basically means that I no longer have the old debt, I've taken out new debt, and that new debt has paid off the old debt. Um, and when I do that, I take the new debt, I put it on my balance sheet at its fair value. Um, so if everything's issued perfectly at a market, you would think that's par, but that's not necessarily always the case. So you need to think about what the fair value is of that new debt. And then the fair value of the debt is effectively the proceeds that you paid to pay off the debt. So the difference between the fair value of the new debt and the carrying value of the old debt would result in a gain or loss on the extinguishment transaction. Um, and again, you know, a lot of it comes down to then how do I deal with the fees? Um, for this, it's sort of reversed. So the third-party fees would get capitalized as part of the issuance of the new debt that you brought in the books. The lender fees would be expensive because it's kind of part of the paying off of the old debt, so it's part of the overall gain or loss. Um, we mentioned TDRs before. Uh you know, again, I don't think we'll go into great detail on TDRs today because that'll probably take up a whole hour and up itself. Um, but you just simply or as simply as TDRs could ever be, um, for TDRs, you actually calculate what the future undiscounted cash flows are going to be. Um, and so you know, what that means is I take not just the principal but the interest payments, and I look at the totality of what the cash flows are. Um and that would include even if I have any contingent payments built in, I have to factor in the contingent payments as well, include them um into the calculation.

SPEAKER_02 11:59

And you include those contingent payments no matter what, there's no sort of probability test or anything like that.

SPEAKER_01 12:04

Correct. Correct for for the TDRs. And so once I have those undiscounted cash flows, I can now compare that to what the carrying value is of the old debt. And only if the undiscounted cash flows are less than what my carrying value is on the old debt, would I be able to record a gain on the um on the restructuring. If they're not, if they're the same or greater than the carrying value, then I use those undiscounted cash flows to then calculate what my effective interest rate would be, and I accrue my interest expense based off of that.

SPEAKER_02 12:41

Okay.

SPEAKER_01 12:42

Um, but you know, it's sort of in a way, like safeguarding, if you will, against recording a restructuring gain on a TDR. Um, you know, you you really have to get through like all of the cash flows in totality before I can start taking any gains on the TDR.

SPEAKER_02 12:59

Okay. Well, it seems like, you know, it's important to obviously understand which model you're in, because there's different analyses that need to take place and and the accounting income can be very different.

Syndicated debt lender analysis

SPEAKER_02 13:10

So, Suzanne, maybe let's go back to the syndicated debt example that you introduced at the beginning of the podcast. And I know this is one of the more common transactions that we see, but there's still operational challenges that exist in in practice. So, where should a company start with this analysis?

SPEAKER_03 13:29

Yeah. So the first thing we're gonna do when we're assessing one of these syndicated transactions, debt transactions, is you're gonna get the listing of the lenders and the old and the new debt. And there could be a lot. It depends. Demp depends how how big the debt is and all sorts of things. But we're gonna start. We'll get the old debt, the lender listing, like I say, the minute before the transaction occurs. And the reason I say that is don't get the listing that you had when you initially issued the debt because it is pretty common for lenders to kind of trade the debt around and sell it. So those lenders that were there in the beginning might not be there now. So just make sure you get that list like right before the transaction happens. And then with the new debt, you know, you get the listing of the new lenders. But there are a couple of questions or I guess challenges that sometimes come up with that. Um, one question we get quite a bit is when you have a lots of times for syndicates, especially when they're big, you have a lead bank or an arranger who's kind of doing everything, getting getting all the other lenders together. And sometimes the lead bank is listed as the initial purchaser of the new debt, but then the debt gets placed very quickly, could be the same day with other lenders.

SPEAKER_02 14:41

Okay.

SPEAKER_03 14:42

So sometimes there's this question of like, I see this bank, this lead bank that's listed as the initial purchaser, but then there's these other lenders. Who's the lender, right? When I'm trying to figure out to do the debt restructuring test. So for this, you need to determine if the lead bank is principal to the transacting, to the transaction, sorry, or acting as agent for the other lenders. If the lead bank is principal, then they're the lender in the new debt and they're the ones you're going to assess the transaction on. If they're the agent, you just obviously look through them, look to the other lenders. Usually there's a general presumption that that lead bank is the agent for the other lenders and you just look through them. You know, there is guidance in the debt restructuring guidance to consider to make that determination. And it's really looking at what risk that initial purchaser actually takes on, if any. Um, so like for example, one of them is how long does the lead bank hold the debt? You know, if it's like an intraday transfer, same day, that lead bank really had no risk. Usually they have the lenders already lined up. Right. Right. So then that's agent. Um, so like I said, usually we don't see those lead banks taking meaningful risks there. So usually we're looking through them.

SPEAKER_02 15:56

Okay.

SPEAKER_03 15:57

Um, one other thing that comes up quite a bit, it's around publicly traded debt. So when you have a transaction where somebody or company takes out new publicly traded debt and they take the money and they pay off the old public debt same day, a lot of times a company cannot get the lender listing. It's like impossible for those other people.

SPEAKER_02 16:19

There's probably so many, too, right? Yeah.

SPEAKER_03 16:21

But they're just not even available. Available. Not not, you cannot force somebody to give you the list. So that means it forgoes when someone goes to do this debt restructuring test, they can't figure out like who which lender which category they're in. Yeah. It's not possible to do the test. So in that case, so when it's you're taking new debt, paying off old debt with the public debt, we think it's reasonable to assume that the lenders in that new public debt are different from the old debt. So, meaning they're not rollover lenders. We're not doing the debt restructuring test for those because we can't. So, what we do is we treat the new debt as a new debt issuance and the old debt just as an extinguishment of the old. Okay. Um, this can also happen in some private placement 144A debt, like depending on the transaction, facts, and circumstances. But I just want to be clear this is only applied when it's a new debt issuance and repayment with these kinds of instruments. It's a not for an exchange transaction. Because sometimes you'll say you'll have an exchange of public debt instruments. So in those, you don't know who the lenders are, that's true, but you know, by definition, they have to be the same because the lender has to take their old debt, you know, turn it into you. You're gonna like rip it up and give them a new debt instrument. So you know, by definition, they're the same. So in those, you can do the debt restructuring tests because you know what each, you you know what the exchange was. So you kind of do it in the aggregate. Okay.

SPEAKER_02 17:51

So maybe we'll take a fact pattern where we're gonna assume that we have a correct listing for both the old debt and the new debt. What is the next step in the process then?

SPEAKER_03 18:01

Yeah. So the next step, I talked about this earlier, is you're gonna identify the lenders as new, exiting, or these rollover lenders, the ones that we have to do the test on. Um, there is one common question that we get on these though, with trying to figure out if you have a rollover lender or not. And that's when you have funds, like you'll see funds participating as lenders. So multiple funds in the syndicate that are being managed by the same fund manager. So for example, say I have old debt and I have a fund in there as a lender, fund one, and it's managed by FG Group, just made up not. Um, in the new debt, I get the listing and I don't see FG one as a lender, but I do see FG two, and that's also managed by FG Group. So it's a different fund, but it has the same manager. So the question we often get is should we treat FG one as a rollover lender because FG2 is in the new debt and they have the same manager?

SPEAKER_02 19:00

Right.

SPEAKER_03 19:01

Um, and typically there's only that one manager that's negotiating for both. Um, so the answer is it really depends. It depends on how these funds are structured and managed. So if the funds are operated as separate funds, they should be treated as separate lenders. So, you know, how do you think about if it's a separate fund? Um, some of the things we think about is are the funds separate legal entities? Are they consolidated by the manager by FG group, my example? And does the manager, so FG group in my example, have a fiduciary responsibility to manage each fund for the best interest of the holders of like that particular front? If that's the case, then they should be separate. Um, so and often we do see them as separate, but you know, it really depends. So, in my example, FG fund one would just be an exiting lender, doesn't roll over, and FG fund two would just be a new lender in the new debt. So we wouldn't be doing the test on those two.

SPEAKER_02 20:01

So it's even complicated to figure out if you're a new lender, an exiting lender, a rollover. Can be at least. Yeah. Maybe new is easier, but

Allocation of lender and third-party fees

SPEAKER_02 20:09

I don't know. Yeah. Um, okay. So, Suzanne, what's the next step then in the analysis?

SPEAKER_03 20:14

Okay, so we've got all our lenders in in the correct groups now. Now we're gonna take the fees. We've got lender fees and third party fees. Because like Chris said earlier, there's different accounting depending on which model you fall into, right? So for lender fees, you know, it's it's usually straightforward. It's usually straightforward, right? To see if I have a lender fee or a third-party fee. But sometimes questions come up on the arranger fee. So it's back to this investment banker working as arranging the transaction, which is super common for syndicate. They usually get a fee. And it's usually probably one of the biggest fees in the transaction to arrange everything, right? Right. And questions come up and get a little tricky if the arranger is also a lender. Sometimes the arranger also holds some debt, right? So the question is, is this a lender fee or a third-party fee? And you need to assess there whether those fees that arranger got is for doing kind of third-party services to arrange the whole transaction. Like any third party could have done it. They didn't have to be a lender. Or are they being compensated to hold the debt as a lender? If the investment banker is being performed to do these third-party services, then obviously it'd be treated as a third-party cost. I think often you'll see that the arranger, you'll see maybe all the lenders get a 1% fee or something. And this arranger, if you look at their fee compared to their debt, it could be like 75%. It's huge, right? It doesn't make sense. Yeah. So you have to really look at that. And that, um, and then once you do that, you you bucket it. If it's, let's say it's a third party fee, put it in the third party fee bucket. Then the next step is you're gonna assign these fees to the old and new. Dad. Um, usually for the lender fees, it's it's specifically identified. So it's not even like an allocation, you know, there might be a prepayment penalty that paid in the old dad or an upfront lender fee for the new debt. So that's pretty straightforward. Third party fees, sometimes you have to, they might not be specifically identified, like maybe legal fees or something like that. So you might have to try to allocate them on a some sort of reasonable basis between the old and new debt. You know, sometimes it's more skewed to the new debt if the old debt is just prepayable, because you didn't really need to do any work. Yeah. And then once you do that, so you you've allocated them now to the old and new debt, you're going to allocate fees to each lender. Um, because remember, it's the accounting's done lender by lender. So usually for lender fees, that's pretty easy because it it's specific and you can tie it to each lender. And then usually it's the third-party fees that have to get allocated. Usually it's um just kind of done on the outstanding balance each lender holds in the data instrument. And so then once you do all that, um, now you're ready to do the 10% test for those rollover lenders.

SPEAKER_02 23:09

Okay. And maybe one follow-up question on the arranger fees. Is there, is there, can you have to split the arranger fee in some way? Like you might.

SPEAKER_03 23:18

Yeah, yeah, yeah. There might be some, like in my example, when I said all the lenders get 1% fee and this one gets so much more. Maybe you have to put the 1% fee on that lender and then the rest is third party.

SPEAKER_02 23:28

Okay. So there can be allocation that's involved in these

Rollover lenders and the 10% test

SPEAKER_02 23:31

different fees. Yeah. Okay. So now that we've identified the fees, we've allocated the fees appropriately between the different parties, we're ready to perform the 10% test for the rollover lenders. So, Chris, can you walk us through how this analysis works?

SPEAKER_01 23:46

Sure. Um, so like I mentioned uh before, like at a high level, and really what you're doing is you're scheduling out the cash flows on a lender-by-lender basis. So if you take one lender, you schedule out what the new cash flows would be, you discount it back at the original debts or the old debts um effective interest rate, and you compare um the calculation to the carrying value, and you see if you have a greater than 10% uh change or not. One of the things that I didn't mention earlier is you think about day one cash flows. And so what is a day one cash flow? You know, sometimes there's exchanges of cash um between you and the lender on day one. It could be new principal, like I took out additional money. It could be that I partially paid off some of the old debt, um, or it could be non-cash consideration, like I issued warrants or or stock um to the lender. So cash is is a little bit easier. I take the the cash that was exchanged on day one, I factor that into a day one cash flow. Um, if I give non-cash consideration, I need to take the fair value of that non-cash consideration and include that as a day one cash flow as well. So it seems straightforward, but there's a lot of complexities that we can get into as well.

SPEAKER_02 24:59

Yeah. And so all of that goes then into this 10% test. Right.

Common application challenges

SPEAKER_02 25:04

Okay. So I think there's some counterintuitive aspects to this analysis that can sometimes companies might miss in practice. So, Chris, can you walk us through some of the common examples that you see?

SPEAKER_01 25:15

So, probably the biggest one is prepayment options. Um the guidance tells you to think about the contractual possibilities and all the contractual possibilities that can occur. And then you look for the smallest change in the value when you're doing the the modification versus extinguishment 10% test. So, in a way, the guidance is sort of biased towards getting a modification answer because I have to find the smallest set of changes and the smallest set of cash flows. Um, and if you think about, you know, debt that's prepayable at any time, you know, that's I could prepay it the next day.

SPEAKER_02 25:52

Right.

SPEAKER_01 25:52

Right. And so that seems very counterintuitive. Like, why would I go through all this trouble of restructuring? Exactly, and just prepay the next day. But yet that's what you do. And so a lot of times, think about like, you know, what we were talking about earlier, you know, debt five, six years ago was issued at very low rates. Um a lot of the debt is issued on like an interest only or a very small amortizing principle over the time, and then there's a large payment due. And as that comes close to due, that's when companies are re you know, refinancing because they don't just have all that cash sitting around ready to pay off. Um, and so I may go out and get new debt from other people, but I may just work with you as the lender and say, okay, let's, you know, restructure into what a current market rate is, right? And so if you think about where the rates have gone, like I could restructure, I can, you know, I'll pay you a fee probably to do so as well. Right. And I may, you know, be, you know, a rate that's greater than you know 10% of of what it was before.

SPEAKER_02 26:47

Sure.

SPEAKER_01 26:47

And so, yeah, that's all great. It's I'm gonna easily think about that. Clearly, it was, you know, significant greater than 10% is an extinguishment, but oh wait, the debt's prepayable. And so I have to assume now that I've done that, I actually do have the cash laying around. Big assumption. Um, and I prepay it the next day, um, in which case that kind of wipes out all that change in the cash flows. Um, and you get to a modification answer.

SPEAKER_02 27:12

Okay. That definitely seems like an area that the companies do not want to miss. So, Suzanne, another aspect of the test that can sometimes trip people up is these changes in principal amounts. Can you talk us through that?

SPEAKER_03 27:24

Yeah, that's the other one that sometimes gets missed. So, very common, right, with syndicated facilities where you take out new debt and pay off old debt, that these rollover lenders are going to change their principal balances around. And like Chris said earlier, when you're doing the 10% test, all the cash flows exchanged on the restructuring date, including cash exchange for principal changes, have to be put as day one cash flows in the 10% test. So let's say I have a rollover lender and they were in the old debt for 100 and they're only in the new debt for 75. So they got $25 in cash as a principal pay down on the transaction date. We'll assume no lender fees here. So when I'm doing the 10% test, and we'll say it's prepayable, um, when I'm doing the 10% test, I have to figure that um $25 principal change into the test. So my old debt cash flows, I'm gonna assume immediate repayment, $100. My new debt cash flows are going to be a $25 immediate principal repayment and then in a $75 prepayment of the new principal, because that was the principal, all on the same day, because it's prepayable. So there, the change in cash flows is nothing, right? Because $25 plus $75 is $100. Um, so it's a modification that see how we neutralized like that principal change there because we did get cash on day one. The lender did. So even with this pay down of 25%, we're getting to a mod here, but sometimes we still see companies kind of missing putting that $25 change in there on day one. So if that was missed, they would automatically get to extinguishment because they'd say I have a cash flow change of $25 or 25%. And that would not be right. So I want to point that out.

SPEAKER_02 29:15

I think it just goes back to your point too, Chris, that like obviously there's like a strong preference towards modification or yeah, when you have these terms. Yes. So another area of complexity is when the debt is restructured multiple times within a relatively short period of time. So, Chris, how does the analysis change when there's been multiple restructurings within the past 12 months?

SPEAKER_01 29:38

Yeah. So if a debt has been restructured multiple times in the 12-month period and the prior restructurings were accounted for as a modification, uh, you would need to continue to look at the totality of the modifications that have happened, the totality of the restructurings um over that period. Um and so you need to look to the terms of the when you look at think about the old debt, the terms of the debt that existed prior to the first modification um within that period. And that's kind of your starting point of what the old debt was. Um and then you combine all the restructuring, all the fees from from the restructurings, um, consider if the principal changed in any of the modifications or any of the restructurings, um, and you calculate all that in, you adjust for all that in the 10% test, and you're still doing that on a lender-by-lender basis. Um, but you continually do that 10% test, not just you know, from point A to point B, from point B to point C. I have to go you know from point A to point C and look at everything in totality.

SPEAKER_02 30:46

Okay. So there's also a separate model for convertible debt restructurings. Chris, can you walk us through some of the special considerations there?

SPEAKER_01 30:54

Uh yeah. So, you know, convertible debt, um, you know, simply what is it? It's uh you know debt that has uh some sort of conversion option to usually common shares, sometimes preferred shares, but some form of equity of the company. And so um, you know, I I have the debt. Um I instead of getting paid at the end of the day, I may say, okay, um, I'd rather you know convert it into equity. Um and because of the nature of that, um, there are different considerations that you need to think about when an instrument um gets modified that includes a conversion option. Um so the starting point is um whether or not I added or removed a substantive conversion option. Because if I've removed uh if it had a conversion option, a substantive conversion option, I remove it. Or if it didn't have it in the old and I now you know did the restructuring and put it in, um, that's kind of an automatic extinguishment of the old. Um, and I bring the new one at fair value.

SPEAKER_02 31:58

Okay.

SPEAKER_01 31:58

Um, and you know, you may ask what is the substantive conversion option? Um, that's basically uh conversion option where there's a reasonable possibility um that it could be exercised in the future. So it doesn't have to be probable that it would be just reasonably possible. But you know, if it's kind of remote that it would ever get exercised, then that's not really a substantive conversion option.

SPEAKER_02 32:21

Okay.

SPEAKER_01 32:22

So then I if I've changed a conversion option, um, or if I restructure debt and you know the conversion option is there and and it's non-substantive, um, or if added it and you know, and it's non-substantive, um, then there's a a two-step approach that gets done. Um, the first is you know, as we've been talking about, we do the 10% test. Right. Like you're not gonna avoid that um you know, when when you're getting into looking at you know modifications and restructurings. And so, you know, I do that without real consideration to the conversion option. I just look at the steep cash flows of the debt, I do my 10% test. Um, if I get greater than 10%, even after considering all prepayments and multiple restructuring and everything else that we've been talking about, um, then it's an extinguishment. If it's less than that, I go to the next step. The next step is to look at the change in fair value of the conversion option. And if the change in the fair value of the conversion option is at least 10% of the carrying value of the old debt, then it's an extinguishment. Okay. Otherwise, it's a modification.

SPEAKER_02 33:27

This seems like one of the areas where you're actually looking at probability because when we were talking about the cash flows on the other things like prepayment and that type of stuff, it seems like you don't factor in probability, but this substand whether or not it's a substantive conversion option, it seems like this is the one place where it's kind of bringing in looking at, you know, whether you think that is actually going to get exercised or not.

SPEAKER_01 33:46

Right. Or at least whether it's reasonably possible. Right.

Accounting outcomes for exiting, new, and rollover lenders

SPEAKER_02 33:50

Right. Yes. Okay, great. So now that we've gone through the lender analysis, the fee allocations, the 10% test for rollover lenders, maybe we're can bring this all together and talk about the accounting outcomes of how it would be treated. So, Suzanne, can you walk us through that?

SPEAKER_03 34:08

Yeah, sure. So I'll go back to my original example, not convertible debt. We'll just stay simple. Um, so for the exiting lenders, you know, these are the ones that just were in the old debt. The their debt, their carrying value of their debt, it's gonna come off the books and just any related fees will be expensed, and there'll be a gain loss recognized from the difference. Then for new lenders, that's just like issuing new debt because we're doing it lender by lender. So the new debt is coming on the books, usually at proceeds received, so cash received, and all the fees, lender fees and third-party fees are capitalized. And then you have your rollover lenders, and we'll assume they're all modifications based on the 10% test because we're we were assuming prepayable debt. Um, the carrying value of the old debt is not changed. So we're not writing off any unamortized costs. Um, any lender fees, if there were any, it would be capitalized as a discount. Any third-party fees are expensed, and then we'll figure out a new effective interest rate for each of those lenders based on the revised cash flows.

SPEAKER_02 35:10

Okay. Well, that's extremely helpful. So I think this example highlights that, you know, there's it are all the different permutations that we've talked about. There's a lot of operational complexity and accounting complexity when we get into these different types of restructuring. And this was why the FASBE was looking at potential simplifications in this area. But Chris, is there anything else that you want to add?

SPEAKER_01 35:32

Well, yeah, as you said, you know, the FASBE had heard the feedback that the accounting was not aligned with the economics for these rollover lenders and things like that. And in addition, it was difficult for investors to understand why there were accounting differences for different lenders and why one transaction um would be accounted for in multiple ways. So as the FASBE continues to think about whether they should do something, I think that feedback is still sitting out there.

SPEAKER_02 35:59

Right. It's so relevant.

SPEAKER_01 36:01

That's right. Um, but you know, overall, you know, one thing to keep in mind is like this takes time. You know, we just kind of talked through situations that seemed complex, but it was actually a relatively simple fact pattern, right? I mean, in reality, there's many lenders, there's complex situations, and it takes even longer. So, you know, when companies are thinking about or doing these, you know, restructurings or refinancings, um, they need to make sure that they leave time to do the analysis before the um things get reported.

SPEAKER_02 36:34

Yeah, I mean, I think that's always a a good reminder to start early. And I think to your point, we tried to take it or simplify the examples a little bit, even though it still seemed very complex. And I'm sure when you get into a lot of these transactions, they have a lot of these different terms that are all taking place at the same time. So it makes it even more challenging. Suzanne, how about you? What practical advice do you have for companies as they start to think about evaluating any restructuring transactions?

SPEAKER_03 36:57

Um, well, I know we talked about a lot today and kind of these nuances that people miss. Um we do have all of the, we have all of those nuances covered along with a detailed example of the syndicate example we just walked through today in our financing guide. So chapter three. So really good to check it out because I think it's good to hear it here, but I think it's nice to see it in writing as well to see real numbers on paper, so easier to follow. So check out the financing guide chapter three for that. But also, Chris mentioned earlier TDRs, and we didn't spend a lot of time today because we just didn't have time. But that chapter also has all the TDR guidance to think about. And I think with the current economy and all, is you know, you always have to assess that first, but maybe now, maybe you will see a bit more. Sure. So, so definitely check that out and don't forget to think about that when you're when you have your restructurings. And then last, I can't not mention the cash flow statement because I um I like work because I work in that area as well with Chris. So there's lots of cash flow things to think about there because there's a lot of cash moving around.

SPEAKER_02 38:07

Sure.

SPEAKER_03 38:08

So for that, um, different guide, but financial statement presentation guide, chapter six has all the things to think about there. And we take our syndicated debt example from the financing guide and take it over and talk about the cash flow implications as well. So please check that out too if you need to.

SPEAKER_02 38:24

Yeah, well, that's super helpful and a lot of great resources for our listeners to check out. So thank you, Chris and Suzanne, so much for joining me today. It's been a great discussion.

SPEAKER_03 38:32

Sure. Thanks.

SPEAKER_04 38:34

That's our show for today. Tune in next week for more fresh episodes so that you never miss any of our audio content. Follow the PwC Accounting Podcast wherever you listen to your podcast. And to stay up to date on all our latest accounting and reporting news, sign up for our newsletter at viewpoint.pwc.com. From Thought Leadership at PwC, I'm Heather Horn. Thanks for tuning in.

SPEAKER_00 39:07

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