Question

You are a local CPA hired by Dru Company as a consultant on financial reporting under GAAP. Dru asks for your advice on the creditor's accounting for a troubled debt restructuring after (1) receipt of assets, (2) a modification of terms, or (3) a combination of the two. Write a memorandum explaining the nature of a troubled debt restructuring and the appropriate accounting.

Answer 1

1) Receipt of Asset

A creditor may receive either physical or intangible assets in full satisfaction of a troubled debt restructuring and may also receive in full satisfaction of debt if the debtor, in full satisfaction of a receivable, gives the creditor:

• Receivables from third parties
• Real estate or other assets
• Shares of stock and/or an equity interest in the debtor

The creditor would account for the asset at the fair value

Loss recognition is recorded as the recorded investment in the receivable minus the fair value of assets received.

2) Modification of Term

A creditor in a troubled debt restructuring involving only the modification of terms of a receivable accounts for the effects of the restructuring prospectively as:

• The recorded investment in the receivable at the time of the restructuring does not change unless that amount exceeds the total future cash receipts specified by the new terms
• The effects of changes in the amounts or timing (or both) of future cash receipts designated as interest or face amount is reflected in future periods
• Constant effective interest rate (interest method) is applied to the recorded investment in the receivable at the beginning of each period between restructuring and maturity to compute interest revenue
• The new effective interest rate is the discount rate that equates the present value of the future cash receipts specified by the new terms (excluding contingent receivable) with the recorded investment in the receivable

If the total future cash receipts under the new terms of the receivable (face amount and the interest) are less than the recorded investment in the receivable before restructuring, the creditor:

• Reduces the recorded investment in the receivable to an amount equal to the total future cash receipts specified by the new terms
• Recognizes the amount of the reduction as a loss
• Does not recognize any interest revenue on the receivable for any period between the restructuring and maturity of the receivable

c) Combination of Both

A troubled debt restructuring may involve receipt of assets (including an equity interest in the debtor) in partial satisfaction of a receivable and a modification of terms of the remaining receivable.

• A creditor:
  • Accounts for the assets received at its fair value
  • Reduces the recorded investment in the receivable by the fair value of the assets received
• Loss recognition applies if the remaining recorded investment in the receivable exceeds the total future cash receipts under the new terms of the receivable
• Future interest revenue, if any, is determined using the rules described above under Modification of Terms