Troubled Debt Lecture

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Loan Impairments Troubled Debts

• Sequence of Events

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With altered agreement, maybe the debtor will
make it maybe not
?
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Concessions Granted to Debtor

• Troubled debt restructure provides for concession
  to debtor by creditor
• Transfer of assets or equity shares to settle all
  or part of debt
• Modification of terms of debt

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When assets or equity are used to settle debt,
there are effects on debtor and creditor
Creditors record ordinary loss (or charge
allowance account) for difference between
carrying value of debt and fair market value of
asset received.
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Debtors will recognize a gain. Value of assets
surrendered in satisfaction of debt will be less
than carrying value of debt. That is nature of
concession
Debtors must first update their books to reflect
the fair value of assets surrendered
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Another concession often granted to debtors
involves renegotiation of amounts due to
creditor. The modification of debt terms results
in a restructure of future cash flows.
Debtor recognizes gain on difference between book
value of debt and restructured cash flows. No
interest expense.
No gain is recognized by debtor. Debtor finds
implicit rate that equates cash flows with book
value of debt.
Can result in low or zero rate of interest on
debt.
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Concessions Granted to Debtor
Assets/Equity used to settle debt
Debt Terms Modified
Book value of debt lt restructured cash flows?
Creditor
Debtor
YES
NO
Loss equal to difference between carrying value
of receivable and fair market value of
compensation received.
Gain on debt restructure is equal to difference
between book value of debt and FMV of
compensation given.
No gain is recognized. Debtor finds implicit rate
that equates cash flows with book value of debt
and recognizes interest expense.
Debtor recognizes gain on difference between book
value of debt and restructured cash flows. No
interest expense.
First book gain or loss on difference between
book value and FMV of assets given. No gain or
loss for securities
Accounting for Troubled Debt Restructuring Prepare
d by Jeff Harkins, edited by T Gordon
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Creditor Accounting

• Modification of terms is indication of impairment
  of debt
• Creditor will follow basic rules for debt
  impairment (FAS114 FAS118)
• Only difference from non-troubled debt situation
• The creditor will disclose any commitments to
  loan a troubled debtor additional funds

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Is the debt settled In full??
Record ordinary gain or loss on asset.
Difference between fair value of asset or equity
interest and amount due on debt is a gain for
debtor and ordinary loss for creditor
Yes
Yes
No
Record ordinary gain or loss on asset.
Difference between fair value of asset or equity
interest and amount due on debt is ordinary
gain for debtor and ordinary loss for creditor
No
The difference between carrying value of debt and
total future cash flows is recorded as
an ordinary gain for debtor. No interest
expense will be recorded in future years.
Are cash flows to be made under the modified
terms greater than the carrying value of the
debt after transfer of asset or equity interest?
No
No gain is recorded by debtor. Find interest
rate to equate cash flows to carrying value of
debt. Use this interest rate to
amortize restructured debt over its term
Yes
Troubled Debt Restructuring After FAS 145