For a TDR to occur, the debtor must be experiencing “financial difficulties.” The proposed ASU provides that in determining whether a debtor is experiencing such difficulties, a creditor should consider the following “indicators”:
• The debtor is currently in default on any of its indebtedness;
• The debtor has declared, or is in the process of declaring, bankruptcy;
• There is “significant doubt” as to whether the debtor will continue to be a going concern;
• The debtor issued securities that have been delisted from an exchange, or are in the process of being delisted, or are “under threat” of being delisted;
• The creditor forecasts that the debtor’s entity-specific cash flows will be insufficient to service the debt in accordance with the contractual terms of the existing agreement through maturity; and
• Absent the modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a nontroubled debtor.
In addition, a creditor may conclude that a debtor is experiencing financial difficulties even though the debtor is not currently in default if the creditor determines that payment default is probable “in the foreseeable future.”
By contrast, the proposed ASU sets forth factors (both of which need to be present) that provide determinative evidence that the debtor is not experiencing financial difficulties and, thus, the modification or exchange is not a TDR. These exculpatory factors are as follows:
• The debtor is currently servicing the original debt and can obtain funds to repay the old prepayable debt from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for a nontroubled debtor; and
• The creditors agree to restructure the old debt solely to reflect a decrease in current market interest rates for the debtor or “positive changes” in the creditworthiness of the debtor.
Finally, the proposed ASU provides that a restructuring that results in an “insignificant delay” in current cash flows may still be considered a TDR if other incriminating factors are present.
To be sure, if and when this proposed ASU is finalized, it will expand, perhaps materially, the number of arrangements between debtors and creditors that are accounted for under the special regime appurtenant to TDRs. Most notably, FAS 15′s most vexing imponderable — the question of when the debtor is in the throes of financial difficulties — is clarified to a significant extent by the proposed ASU.
Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
1 See SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings (Subtopic 310-40).
2 Alternatively, in measuring the impairment loss, the loan’s observable market price may be used. In cases where the loan is said to be “collateral-dependent,” the value of such collateral would be employed for purposes of gauging the extent of the impairment loss.
3 See SFAS No. 114, Accounting by Creditors for Impairment of a Loan.
4 In general, a debtor that can obtain funds from sources other than the existing creditor at market interest rates at or near those for nontroubled debtors will not be viewed as involved in a TDR.