Common Misconceptions in Avoiding ASC 470 Debt Modification Accounting

For some finance professionals, the pandemic brought their first experience with debt restructurings and Paycheck Protection Program (PPP) loans. Accountants note that the accounting for these transactions may seem relatively straightforward, but it is actually prone to errors.

Follow the flowchart guidance

The Financial Accounting Standards Board (FASB) issued its latest debt modification guidance last year, namely ASC Topic 470 (Debt): Accounting by Debtors for Debt Modifications, which contains numerous examples of accounting for debt modifications and exchanges.

The document includes a flowchart that serves as a good starting point for determining the appropriate accounting treatment. Essentially, it is a two-part decision:

If the debtor is experiencing financial difficulty as specified in Section 470-60-55 and the lender grants a concession under 470-60-55, then the debtor applies the troubled debt restructuring (TDR) guidance.

If neither of the above conditions is met, then the modification and exchange guidance in Section 470-50 applies, with the specific treatment depending on the type of debt.

Review debt covenants

Gino Scipione of Cohen & Company says it is important for companies to review and understand the covenants attached to their debt arrangements, as these often lead to exchanges, modifications, and restructurings.

"The economic and financial impact of the pandemic has hit or will hit companies at different times," he says. "When you have a covenant default or an anticipated default, depending on the nature of the issue and how the bank responds, this could cause the debt to be immediately classified as a current liability."

When debt is considered currently payable, companies need to address other accounting and presentation issues, such as going concern, Scipione says. "Therefore, we like to remind clients to proactively assess signs that a covenant default may occur. That way, if a covenant default does happen, you can address the matter in a timely manner and evaluate the impact on the financial statements and financial reporting."

Understand the fine print

Michael Poveda of UHY LLP says that certain more complex forms of debt can heighten accounting challenges and may affect the outcome of a debt exchange or modification. For example, if convertible debt is restructured into preferred stock, you need to know whether the company is dealing with debt or equity from an accounting perspective. You also need to understand whether there are embedded derivatives.

Poveda says that minor changes in the wording of new instruments can alter whether the instrument is reflected as debt or equity on the balance sheet, and further determine which accounting model should be followed for the exchange or modification.

Document PPP expenses

Pete Bible of EisnerAmper says that if your organization obtained a PPP loan, it is crucial to ensure you adequately document the acceptable expenses that will be used.

"These will be part of the forgiveness application and will determine the amount of forgiveness," he says. "Make sure you track expenditures and retain documentation for review. Hopefully, the SBA will accept it and notify your lender, who can then inform you that the loan has been forgiven."

Review PPP treatment options

John Confrey of Mazars says his firm is discussing treatment options with clients. He says most businesses will likely treat PPP loan forgiveness as consistent with a government grant or as debt that is subsequently forgiven, and that decision will determine the appropriate accounting treatment.

ASC 470 may apply, but there are also IAS 20 and grant accounting, and these considerations could lead to different treatments.

"ASC 470 does not delve deeply into this specific example, so some judgment is required," Confrey says.