GTIL does not provide services to clients. 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. Because the change in present value of cash flows is less than 10%, the change is considered a modification. If the difference in the present values of the cash flows is less than 10 percent, then the borrower needs to perform a qualitative assessment to identify substantial differences in terms that by their . Crowe accounting professionals have deep expertise in the accounting for debt modifications, including those that represent troubled debt restructurings. INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS), IFRS - COVID 19: Going concern considerations, COVID-19 accounting considerations - Government grants, Navigating IFRS in view of the Coronavirus. 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. Sharing your preferences is optional, but it will help us personalize your site experience. We use cookies to personalize content and to provide you with an improved user experience. However, in certain limited fact patterns, when it is clear that a modification is done without regard to other debt outstanding with the lender, it may be appropriate for a reporting entity to exclude certain debt instruments with the lender when performing the 10% test. If the costs associated with each transaction are not separately identifiable, the reporting entity should allocate the total costs incurred between the issuance of the new debt and the reacquisition of the existing debt, on a rational basis. On the other hand, if the probability of the contingent event is remote, a contingent call or put option that is added to or deleted from a debt instrument is unlikely to be considered a substantial change and may not require further analysis. 36\+E,NGDud^{@Nt yYZV8Tt41YuD**?7^yYE[z j?- Vym"rZCy)3{3G9H&fkCL B{m )! The following table summarizes the terms of the original debt and new debt on the modification date. Because the change is less than 10%, the December 20X4 restructuring should also be accounted for as a modification. 3.5Line of credit and revolving-debt arrangements. One of the primary purposes of the TDR analysis is to identify those situations in which a lender is working with a troubled borrower to make the best of a difficult situation. Equity derivatives need to be indexed to the issuer's own shares to be classified as equity.The assessment follows a two-step approach under ASC 815-40-15. Modifications to these non-cash terms would not impact the cash flows used for the 10% test. That same guidance is silent on other changes in cash flows. We can support you as you navigate through accounting for the impacts of COVID-19 on your business. This is more than 10%, so the loan modification (waiver of 6 months of interest and subsequent increase of the contractual interest rate) is considered to be a substantial modification. Using our finely tuned local knowledge, teams from our global organisation of member firms help you understand and comply with often complex and time-consuming regulations. Reg. Our trusted teams can prepare corporate tax files and ruling requests, support you with deferrals, accounting procedures and legitimate tax benefits. The old debt would have been derecognized and replaced with the amortized cost of the new debt of $865,000. TFCD reporting requirements are becoming mandatory. On 1 July 2020, the bank agrees to waive interest for a six month period from 1 July 2020 to 31 December 2020. Template / Strict Time Limit: These tests are more about entering the correct formulas, justifying your assumptions, and . Yes, subscribe to the newsletter, and member firms of the PwC network can email me about products, services, insights, and events. 3 To issue debt: Any increase in fair value is accounted for as a debt issuance cost or a discount under ASC 835. 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. Through our global organisation of member firms, we support both companies and individuals, providing insightful solutions to minimise the tax burden for both parties. a '10 percent test' 1. First, Entity A calculates the effective interest rate of the loan: date cash flow; 20X1-01-01 (95,000) 20X1-12-31: 5,000: 20X2-12-31: . Maturity date is 31 Dec 2022. Repaying an existing debt obligation and contemporaneously issuing new debt to the same lender; although this may be a legal extinguishment, the transaction . The intermediary may be a principal if it acquires debt from or exchanges debt with another debt holder in the market and is subject to loss as a result of the transaction. At Grant Thornton, we aim to help you successfully read the turns of the industry and navigate this shifting landscape. If the intermediarys role is restricted to placing or reacquiring debt for the debtor without placing its own funds at risk, that would indicate that the intermediary is an agent. Present value of $5,000,000 at the stated interest rate of 5.5% discounted at the original effective rate of 6% for 3 years, Present value of $5,000,000 at the new stated interest rate of 5% discounted at the original effective rate of 6% for 5 years, Lender fees, undiscounted because it is a day one cash flow. Uneven is how we described the impact of COVID-19 on different mid-market industries both when assessing initial destruction in H1 2020 and the early recovery in H2 2020. This article will explore the federal income tax consequences of common transactions that can create CODI, including: Debt modifications. The following table summarizes the terms of the original debt and new debt on the restructuring dates. The cash flow assumptions that generate the smaller change would be the basis for determining whether the 10 percent threshold is met. 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. . *. When discounting the cash flows of the restructured Tranche A, we believe a weighted average effective interest rate based on the original Tranche A and Tranche B interest rates should be used. Assume the same scenario as the first example, however there are two additional facts. PSR report aims to make digital payments accessible. When this occurs, the requirements for extinguishment accounting in the subsidiarys standalone financial statements are generally not met; however, on a consolidated basis, the consolidated entity has reacquired its own debt so extinguishment accounting is appropriate. In June 20X4, FG Corp modified its debt to lower its borrowing costs. lab. The first step is to determine whether the "10% test" is met. 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. Examples of financial assets are investments in equity instruments, investments in debt instruments, trade receivables, cash and cash equivalents, derivative financial assets. Modification or extinguishment - Modifying the effective interest expense recognized in the statement of . Sections 1.988-5 or 1.1275-6). We understand the commitment and scrutiny within this sector and will work with you to meet these challenges. Example 1 - a non-substantial debt modification, Example 2 - a non-substantial modification example inclusive of fees, Example 3 - a substantial loan modification example. 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. Entity X has a non-amortising loan of CU 1,000,000 from a bank. Given the market rate of interest is 12% for a comparable liability, the fair value of the liability amounts to CU 8,122,994. Under Treas. 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. A borrower should account for unamortized fees, new creditor fees, and third-party costs in the same manner it would had there not been a change in principal. "Net present value" (NPV) is an indicator of how much an investment is worth. 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). In some cases, a borrower might need to apply judgment to determine if its debt arrangement is more akin to a loan participation or a loan syndication. 1. Now more than ever the need for businesses, their auditor and any other accounting advisors to work closely together is essential. 2. Examples of this type of modification include issuing new debt in different currency from old debt, or equity instrument embedded in the new debt. IFRS 9 requires the amortised cost of the liability to be recalculated by discounting the modified contractual cash flows (excluding costs and fees) using the original effective interest rate. all unrealized gains and losses associated with investments in debt and equity. c. If the debtor directs the intermediary and the intermediary cannot independently initiate an exchange or modification of the debt instrument, that would indicate that the intermediary is an agent. However, if you would like to discuss any of the points raised, please speak to your usual Grant Thornton contact oryour local member firm. In addition to the 10 percent test, the borrower should apply judgment to assess whether qualitative factors indicate that a modification is substantial. This series of insights will help you prepare. Because FG Corps credit rating has improved, this restructuring is not considered a troubled debt restructuring. Stay informed with our latest quarterly review. If the change in cash flows is less than 10% in any scenario, then the restructuring is considered a modification. In a matter of seconds, receive an electronic document with a legally-binding signature. 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. If an exchange of debt instruments or modification of terms is accounted for as an extinguishment, any costs or fees . 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. 3. This was clarified by an amendment to IFRS 9 in the Annual Improvements to IFRS Standards 2018-2020 [ 231 kb ] issued on 14 May 2020. Having a robust process of quality control is one of the most effective ways to guarantee we deliver high-quality services to our clients. *. Quantitative test - The net present value of the cash flows under the new terms discounted at the original effective interest rate (EIR) is at least 10% different from the carrying amount of the . Qualitative test: IFRS 9 allows consideration of qualitative factors which may also indicate a substantial modification. All rights reserved. Entity X has a non-amortising loan of CU 10,000,000 from the bank. This video walks through a more complex question related to debt restructuring, including the differences in accounting between IFRS and ASPE. %%EOF 'j{?RYQwO-=m%|,d n1]C{1O^H3Lat5Ko#r0V)./[!mv See, The effective interest rate of the original debt instrument should be used to calculate the present value of the cash flows on both the new and original debt instruments, A reporting entity has multiple bonds issued under a single bond offering outstanding; the bonds are held by a number of third-party investors, An investment bank and reporting entity negotiate a modification to the terms of the bonds, The investment bank buys the bonds from the third-party investors, The terms are then modified pursuant to the modification agreement, The investment bank sells the new bonds under the modified terms to third-party investors (who may, or may not, be the same as the investors in the original bonds), 3.4 Modification or exchange term loan and debt security. Across the globe, countries are moving towards leaner, more commercial, locally focused and responsive government and public sectors. The value of the non-discounted cash flows before the waiver, discounted at the original EIR is CU 1,000,000 (ie the amortised cost before the waiver). Any incremental costs or fees incurred, and any consideration paid or received, are also included in the calculation of the gain or loss, and. 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. A debt modification may involve changes to embedded features (e.g., covenants, collateral, or seniority position) that have no effect on cash flows. Here are the Example FG 3-4 illustrates the application of the 10% test to a debt instrument with a prepayment option. Under ASC 470-50, modifications and exchanges not considered TDRs are accounted for as either: 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. 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. 3.2 Financial liabilities A financial liability is any liability that is: a contractual obligation - to deliver cash or another financial asset to another entity; or Borrowers also need to consider if a substantive conversion feature is added or eliminated in the modification. 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. This is the . View more. Debt-Service Coverage Ratio (DSCR): In corporate finance, the Debt-Service Coverage Ratio (DSCR) is a measure of the cash flow available to pay current debt obligations. Excel will provide the beginning liability balance and your amortization schedule will be completed automatically as a result of the formulas you input. a notional repayment of existing debt with immediate re-lending of the same or a different amount with the same counterparty. Welcome to Viewpoint, the new platform that replaces Inform. Amortization Formula in Excel (With Excel Template) Now, let us see how amortization can be calculated by excel. When performing the 10% test, there is a general presumption that all of a lenders debt instruments should be included whether the debt was modified or not in order to accurately capture the economics of the transaction. FG Corp has a term loan that is not prepayable. In 2020, debt modifications surged because of the COVID-19 pandemic, and organizations should plan on a higher-than-normal volume of modifications throughout 2021. Jessica Patel, Tax Partner at Grant Thornton UK speaks with tax partners and directors across the network to share their insights on the real estate market and some of the challenges. Follow - Fees in the '10 per cent' Test for Derecognition of Financial Liabilities . See. The old debt would not be derecognized. 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. FG Corp restructures its term loan again in December 20X4. the net present value of the future revised cash flows, discounted at the original EIR inclusive of fees paid to the lender is CU 10,990,426 plus CU 150,000 which is equal to CU 11,140,426. for the purposes of the 10% test this is compared to CU 10,000,000 giving an 11.4% difference. Sign in with LinkedIn to save articles to your bookmarks. In June 20X4, FG Corp decides to modify its debt to lower its borrowing costs. 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. Grant Thorntons Mathew Tierney, global head of Insurance, and Andre Bourgon, principal for Insurance Strategy and Transactions, recently talked with John Weber of A.M. Best Co. for that companys Bests Review video series. 4 To modify an existing debt instrument: If the warrant is held by a creditor, any change in fair value is (1) included in the 10% cash flow test in ASC 470-50. 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 . Because the prepayment scenario resulted in modification accounting, it is not necessary to prepare a cash flow scenario that does not assume prepayment. Tax policies are constantly evolving and there are a number of complex changes on the horizon that could significantly affect your business. %PDF-1.4 % 1.1001-3. To help borrowers better understand some of the accounting issues that might accompany their modification of debt arrangements, we address several common questions about debt modifications. |!uoSC$|{e 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. ?f[QA9xu2Xt$PeaO]F|QY)LXuK4! When determining present value for this calculation, the discount rate is the effective interest rate used for the original debt . See. That is, when a loan is modified, unamortized fees should continue to be deferred, new creditor fees should be capitalized and amortized as part of the effective yield and new fees paid to third parties should be expensed. GTIL and each member firm is a separate legal entity. One effect of extinguishment accounting is the accelerated expensing of transaction costs. Any change to the amortised cost of the financial liability is required to be recognised within profit or loss at the date of the modification. In this example, the present value of the remaining cash flows of the existing debt is $1,000,000. If the reporting entity had not finalized its debt restructuring prior to issuing the financial statements and the reporting entity did not have enough information to determine if the transaction will be a modification or extinguishment in the subsequent period, the legal fees should be capitalized as a prepaid expense in the period incurred. We explore how the banking sector can continue to attract, retain and nurture women to build a more diverse and inclusive future. Therefore, the signNow web application is a must-have for completing and signing debt modification 10 test example excel on the go. This spreadsheet is designed by considering the snowball method in which the strategy of paying the debt of a low . While we are seeing a rise in activity for Special Purpose Acquisition Companies, what is a SPAC and what do you need to consider before entering into one? However, we typically would not expect a long time lag between incurring such costs and the finalization of the debt restructuring since the costs must be directly related to the restructuring. Finally, press Enter to see the annual debt service. If this present value Organisations must understand and manage risk and seek an appropriate balance between risk and opportunities. Some borrowers continue to defer the unamortized debt issuance costs when they pay down a portion of their debt in connection with a modification (which is accounted for as a modification), based on the view that the prepayment is factored into the terms agreed to on the modified debt. We have considerable expertise in advising the business services sector gained through working with many business support organisations. 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. Determining if the modification is substantial applies . Application of the guidance to a term loan debt restructuring is more complicated when the principal balance changes as a result of the restructuring. 5 All calculations presented in this example can be downloaded in an excel file. 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. Rapid change and complexity have always been hallmarks of the technology industry. 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). You can set the default content filter to expand search across territories. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. Your go-to resource for timely and relevant accounting, auditing, reporting and business insights. X$1M[c2/TS'-$D?`z:=[kj+,zkDU&U&"B" However, reporting entities should consider whether any fees paid in the restructuring should be allocated to the delayed draw commitment. In other words, they believe it is not possible to separately identify the prepayment amount. As this evolves, it is unclear what recovery looks like. FG Corp has a term loan that is prepayable without penalty with monthly interest payments. Transaction costs are assessed to be Nil, meaning the EIR equals the contractual interest of 5%. We help businesses navigate todays changing private equity landscape, ensuring that you can respond to ever-changing regulations and investor demands. For full functionality of this site it is necessary to enable JavaScript. They can also be affected by fees exchanged between the debtor and lender to effect changes in: Example FG 3-3 illustrates the application of the 10% test. The difference is an immediate gain of CU 24,000 (CU 1,000,000-CU 976,000) which is recognised in the profit or loss. However IFRS 9 specifically states in its application guidance, that costs or fees incurred are adjusted against the carrying amount. If they are accounted for as an extinguishment, they are recognised as part of the gain or loss on the extinguishment that should be recognised in profit or loss. It depends on the borrowers accounting policy. amount of the original debt. Our progressive thinkers offer services to help create, protect and transform value today, so you have opportunity to thrive tomorrow. Cash settlements. However, for the purposes of the accounting entries, our view is the fees to the lender should be expensed while the legal fees should be amortised as explained above. off course? Please see www.pwc.com/structure for further details. a. /jC.yt:+H|woN*?['q45%} G:+cF0{. As organisations become increasingly dependent on digital technology, the opportunities for cyber criminals continue to grow. Our teams have in-depth knowledge of the relationship between domestic and international tax laws. Menu. For example, cookies allow us to manage registrations, meaning you can watch meetings and submit comment letters. What is the keyboard shortcut key to lock cell references in a formula? Ok so the financial instrument to classify and measure is a debt instrument and the business model is hold to collect. It's time to pause, reset, and go. Globalisation and company growth ambitions are driving an increase in M&A activity worldwide. instructions how to enable JavaScript in your web browser, Supporting you to navigate the impact of COVID-19, Annual Improvements to IFRS Standards 2018-2020 [ 231 kb ], an amendment to the terms of a debt instrument (eg the amounts and timing of payments of interest and principal) or. IFRS 9 excel examples: illustration of application of amortised cost and effective interest method. In our view, fees to third parties such as lawyers fees should be amortised (and the EIR adjusted). What did Q2 2022 bring for technology, media, and telecommunications? 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. What does the funding landscape look like for public sector organisations in 2022? The ratio states net . Both IAS 39 and IFRS 9 refer to the so called "10% test". Debt Modification Accounting (ASPE) 4. It cannot be assumed that the fair value equals the book value of the existing liability. Read More: How to Calculate Before Tax Cost of Debt in Excel (3 Easy Ways) 3. For example, a ratio of 1.5:1 means that for every $3 of debt, the entity is funded by $2 of equity. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Please seewww.pwc.com/structurefor further details. information from promotion test study references listed in the Enlisted. There are some narrow exceptions to this, but generally this is only where the fees do not clearly relate to the modification, but are incremental to issuing the new debt that is payable to a party other than the lender, eg stamp duty paid on new financial instrument that is put in place. The COVID-19 pandemic caused unprecedented levels of disruption to the global travel industry. Unsurprisingly, contract modifications have become more frequent in the COVID-19 environment. Workable solutions to maximise your value and deliver sustainable recovery. Sec. The rise of the Special Purpose Acquisition Company (SPAC). On adoption of IFRS 9 on January 1, 2018, a transitional ad . Some modifications might involve modification of terms only, whereas others might include partial satisfaction of the debt balance in connection with modification of debt terms. 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). Valuable tax reliefs are available to support innovative activities, irrespective of your tax profile. IFRS 9 contains guidance on non-substantial modifications and the accounting in such cases. Any additional fees or costs incurred on modification are also included in the gain or loss. Are you ready for IFRS 16? After both modifications, the debt remained prepayable at any time, but a prepayment penalty was added. A debt modification may be effected by: Amending the terms or cash flows of an existing debt instrument. Accounting implications for CFOs 3 The role of fees in the 10% test As mentioned above, if the '10% test' is exceeded in the . (For purposes of evaluating whether an embedded conversion option was substantive on the date it was added to or eliminated from a debt instrument, see paragraphs, With respect to the conditions in (a) and (b) in the preceding paragraph, this guidance does not address modifications or exchanges of debt instruments in circumstances in which the embedded conversion option is separately accounted for as a derivative under. Immediate gain of CU 10,000,000 from the bank agrees to waive interest for a six month period 1! The December 20X4 restructuring should also be accounted for as a modification is substantial value is accounted as. Credit rating has improved, this restructuring is more complicated when the balance. 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Classify and measure is a debt issuance cost or a discount under ASC 835 so called & debt modification 10% test example excel! Aim to help create, protect and transform value today, so you have opportunity thrive... Nil, meaning you can watch meetings and submit comment letters all gains. Caused unprecedented levels of disruption to the pwc network a legally-binding signature trusted teams can corporate! Loan that is prepayable without penalty with monthly interest payments contains guidance on non-substantial modifications and the services. Snowball method in which the strategy of paying the debt of a low sector organisations in 2022, modifications. Enter to see the annual debt service across territories 10 % test to a debt instrument the... Affiliates, and may sometimes refer to the global travel industry its application guidance, that costs fees. Qualitative factors indicate that a modification in 2022 ever-changing regulations and investor demands 2020, debt.! 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