For some finance staff, the pandemic ushered in their first exposure to debt-restructuring and Paycheck Protection Program (PPP) loans. Accounting for these transactions might appear to be relatively straightforward, but it’s easy to make mistakes, accountants say.
Follow the flowchart
The Financial Accounting Standards Board (FASB) published its latest debt modification guidance last year in “Topic 470 (Debt): Borrower’s Accounting for Debt Modifications,” a paper rich in examples on accounting for debt modifications and exchanges.
The document includes a flowchart that’s a good starting point for identifying the appropriate accounting treatment. Essentially, it’s a two-part decision:
If the borrower is experiencing financial difficulty in accordance with Section 470-60-55 and the lender grants a concession in accordance with 470-60-55, borrowers apply the troubled debt restructuring (TDR) guidance.
If neither of those conditions apply, the modifications and exchanges guidance in 470-50 will apply, with the specific treatment determined by the type of debt.
Review your debt covenants
It’s important for companies to review and understand the covenants attached to their debt arrangements which often can lead to exchanges, modifications and restructuring, according to Gino Scipione of Cohen & Company.
“The economic and financial impact of the pandemic hit or will hit companies at different times,” he says. “When you have a covenant failure or an expected covenant failure, depending on the nature of that issue and how the bank responds to it, that could immediately cause the debt to be considered current.”
When debt is considered currently payable, companies will need to deal with other accounting and presentation issues like going concern, Scipione says. “So, we like to remind our clients about being proactive in evaluating for indicators of a possible covenant failure. This way, if you in fact have a covenant failure, you can address how to resolve the matter timely and evaluate the impact to the financial statements and financial reporting.”
Know the fine print
Some forms of more complex debt can compound the accounting challenge and potentially affect the outcome of a debt exchange or modification, according to Michael Poveda of UHY LLP. For instance, if convertible debt is restructured into preferred stock, you need to know if the company is dealing with debt or equity from an accounting perspective. You also want to know if there are embedded derivatives.
A small change in the new instrument’s wording can alter whether an instrument is reflected on the balance sheet as debt or equity, and further what accounting model should be followed for the exchange or modification, Poveda says.
Document your PPP expenses
If your organization has taken out a PPP loan, the key is to make sure you've adequately documented the acceptable expenses that will be used, says Pete Bible of EisnerAmper.
“Those will be considered as part of the forgiveness application and will determine the amount of that forgiveness,” he says. “Make sure you track your spending and have the documentation if called upon. Hopefully the SBA will accept it and notify your lender that they can notify you that the loan is forgiven.”
Review PPP treatment options
John Confrey of Mazars says that his firm is discussing treatment options with clients. Most businesses likely will account for PPP loan forgiveness as either consistent with government grants or debt that was subsequently forgiven, and that decision will determine the appropriate accounting treatment, he says.
ASC 470 might apply but there is also IAS 20 and grant accounting, and those considerations may lead to different treatments.
“ASC 470 doesn't really dive into this specific example very well and so it requires a little bit of judgment,” Confrey says.