I’m Jennifer Louis, CPA. In this article, I’ll review some current issues that are top-of-mind relating to debt accounting and financial reporting. Let’s get started!
Background
Most entities historically use debt as a means of financing operations, with fair presentation and disclosure critical for understanding an entity’s financial position. However, arrangements may contain complexities that make proper U.S. GAAP accounting and financial reporting for debt time-consuming and burdensome. For example, short-term debt may be expected to be refinanced post-balance sheet date. Given certain conditions being met, the debt may reasonably qualify for long-term classification. And, complexity increases if a lock-box arrangement or revolving credit agreement is involved.
What are some challenges being faced by entities?
In today’s challenging economic environment, entities are increasingly modifying or restructuring pre-existing debt arrangements, triggering a variety of possible accounting treatments. If a debtor is experiencing financial difficulties and a creditor grants concessions, troubled debt restructuring accounting may be required. This often results in recognizing a gain due to the concessions. However, in other circumstances, no gain or loss is recorded if the modification does not result in significantly different terms (primarily defined by changes in cash flows resulting from the modifications made). Otherwise, debt extinguishment accounting may be appropriate, where modified debt is recorded at its fair value and a gain or loss on extinguishment of the old debt is immediately recognized.
Additionally, proper debt classification is important for making useful economic decisions. If an objectively verifiable covenant is violated, debt may require current classification to reflect the fact that it is now callable on demand. However, a waiver in proper form or the probability of correction of the noncompliance within a stipulated grace period can counteract the presumed current classification. In other circumstances, subjective acceleration clauses require assessment of the likelihood of payment acceleration.
Finally, debt may contain characteristics of both debt and equity or an embedded derivative, so careful consideration is needed to ensure proper accounting treatment.
For more help on this subject, Becker’s CPE course, Debt Accounting and Financial Reporting Risk is a useful resource for better ensuring the proper accounting and financial reporting of debt obligations.
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