Background

In April 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-02 (ASU 2011-02), Receivables – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  This update is further clarification of FASB’s existing generally accepted accounting principles (GAAP) for creditors to determine if a restructuring is a troubled debt restructuring (TDR) for financial reporting purposes.  Historically GAAP has indicated that a restructuring is a TDR when the creditor grants a concession to the debtor.  This update provides specific guidance to creditors about what constitutes a concession, and also requires the creditor to make a separate determination as to whether the debtor is experiencing financial difficulties.  The FASB’s goal with these clarifications is to improve consistency in financial reporting among creditors for debt restructurings. The impact to creditors may be that additional TDRs that were thought to be non-troubled are identified in the current financial reporting season.

In 1977, the FASB issued Statement of Financial Accounting Standards No. 15 (FAS 15), Accounting by Debtors and Creditors for Troubled Debt Restructuring, the first significant GAAP guidance related to TDRs.  FAS 15 has been modified over the years by the FASB to mirror changes in the economy and markets, and ASU 2011-02 is the most recent modification.  For public companies, ASU 2011-02 is effective beginning the first interim or annual period beginning on or after June 15, 2011.[1]  The guidance is required to be applied retrospectively to the beginning of the fiscal year.  For example, if an entity’s fiscal year is December 31, the guidance must be applied beginning January 1, 2011.  As a result, creditors may identify receivables that have to be reclassified as TDRs, and if so, the additional impairment must be taken in the first prospective reporting period after June 15, 2011.

While the FASB’s intent is to increase financial reporting consistency, it could have more of an impact on creditors’ financial statements this fiscal year than originally anticipated.  To understand the potential impact of ASU 2011-02, this discussion compares it to current GAAP and explain how the two treat receivables, general impairment and impairment specific to TDRs.

Current GAAP Related to TDRs

 Accounting Standards Codification (ASC) Topic 310, Receivables

ASC Topic 310 governs financial reporting for debt receivable by creditors, and includes guidance for recognition and measurement of these receivables as assets on the balance sheet.  In general, the initial measurement of receivables by creditors on the balance sheet should be at the amount of cash exchanged and/or the present value of other consideration.

ASC Subtopic 310-10-35, Receivables - Subsequent Measurement[2]

 GAAP requires creditors to recognize a loss when it is probable that a debt receivable is impaired.    ASC Subtopic 310-10-35 provides guidance to creditors with, among other things, assessing whether a receivable is impaired and, if so, measuring the impairment.  This guidance applies when a debt receivable, whether involved in a restructuring or not (e.g., deterioration of credit quality), becomes impaired.  Following is some of the more relevant guidance.

1.    Impairment occurs when its probable, or that future events are likely to occur, that the creditor will be unable to collect interest and principal based on the original contract.

2.    The impairment must be reasonably estimable and measured in the following ways depending on the type of receivable:

a.    Based on the present value of future cash flows, discounted at the loan’s effective interest rate;

b.    Based on the loan’s observable market price;

c.    Based on the fair value of the collateral, or;

d.    Based on lower of cost or market (trade receivables).

3.    Impairment calculations should include accrued interest, deferred loan fees, unamortized premium or discount, costs to sell the underlying collateral and other costs.

4.    Impairment can be measured based on homogeneous pools of receivables with similar risk characteristics, or on a loan by loan basis.

5.    The loss measured must be based on fair valuations and best information.

6.    The amount of the loss should be recorded to a valuation allowance to reduce the asset value on the balance sheet, with a corresponding charge to bad debt expense or loss on the income statement.

ASC Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors

ASC Subtopic 310-40 provides guidance to creditors on what constitutes a TDR for purposes of measuring impairment on the financial statements under Subtopic 310-10-35.  The primary tests to determine if a restructuring is a TDR are as follows:

1.    The creditor granted a concession to the debtor for economic or legal reasons related to the debtor’s financial difficulty;

2.    The concession was an attempt to protect as much of its investment as possible;

3.    The concession was intended to reduce near-term cash requirements to help improve the debtor’s financial position so they may eventually be able to pay the creditor, and;

4.    The creditor accepts cash, other assets or equity in satisfaction of the debt for value less than the amount of debt in the original contract in order to maximize recovery.

Additional concessions that could indicate a TDR include reduction of interest rate, extension of maturity date and reduction of face amount or accrued interest, to name a few.  The guidance further clarifies that restructurings that do not involve a reduction in consideration less than the original contract or market value do not constitute a TDR.  A restructuring is not a TDR if the debtor can obtain funds from other sources at non-troubled rates as well.

Once a creditor makes the determination that a restructuring is a TDR, the guidance for measurement in Subtopic 310-10-35 and Subtopic 310-40 apply in recording the impairment.

ASU No. 2011-02, Receivables – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring

ASU No. 2011-02 is an update to Subtopic 310-40, and provides enhanced guidance about determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of identifying TDRs.  Prior to this update, concern existed among stakeholders and other constituents about the diversity in financial reporting among creditors that could adversely affect the comparability of financial information.  This update provides the following clarifications to increase consistency in applying GAAP and financial reporting.

1.    Determining whether a creditor has granted a concession.

a.    The guidance clarifies that a concession is granted when, as a result of the restructuring, it does not expect to collect all amounts due, including interest at the original contract rate.  In addition, if collateral is involved, the current value of the collateral should be considered when determining if the restructuring is troubled.

b.    A creditor has granted a concession when additional collateral and guarantees are given as part of the restructuring but do not serve as adequate compensation for other terms of the restructuring.

c.    A creditor may have granted a concession if the interest rate negotiated in the restructuring is lower than market rate for debt with similar risk characteristics and the debtor does not have access to those alternative funds.

d.    A creditor may have granted a concession even if the restructuring includes a temporary or permanent increase in the contractual interest rate, and that rate is below market for new debt with similar risk characteristics.

e.    A restructuring that results in only a delay in payment that is insignificant is not a concession.

 2.    Determining Whether a Debtor is Experiencing Financial Difficulties.

The requirement for the creditor to determine if the debtor is experiencing financial difficulties is new in the guidance, and requires the creditor to consider the following indicators:

a.    If the debtor is, or will be, in payment default on any of its debt;

b.    The debtor will or has declared bankruptcy;

c.    There is doubt that the debtor is a going concern;

d.    The debtor’s securities have or will be delisted;

e.    Based on projections, the debtor’s cash flows will be insufficient to service any of its debt, and;

f.     The debtor is unable to obtain funds from other sources at market rate for debt with similar risk characteristics.

Conclusion

It is important to note that as the markets and economy evolve, particularly in the valuation of commercial and residential real estate as it relates to TDRs, so too will GAAP.  More importantly perhaps, beginning June 15, 2011,[3] public companies must apply the additional guidance provided in ASU 2011-02 when evaluating whether a restructuring constitutes a TDR.  As a result, additional debt receivable may be classified as TDRs, and if so, the additional impairment must be taken in the first prospective reporting period after June 15, 2011.  The impact of ASU 2011-02 will be that some creditors may experience a larger than expected loss in its first reporting period subsequent to June 15, 2011, which will have some yet to be determined ripple effect on the markets and economy.  Just as important, and certainly the intent of the FASB, is that creditor entities will continue to become more homogeneous with both reporting of impairment losses and disclosures related to TDRs. 

Susan Henry is a Managing Director with GlassRatner Advisory & Capital Group LLC in Chicago.  She has over twenty-five years of experience as a forensic accountant, and specializes in restructuring, litigation consulting and fraud investigations.  Susan can be reached at (312) 462-4942 or This e-mail address is being protected from spambots. You need JavaScript enabled to view it .