Term debt has a specified term and coupon. The coupon may be fixed or based on a variable interest rate. Upon issuance, the issuer recognizes a liability equal to the proceeds (e.g., cash) received, less any allocation of proceeds to other instruments issued with the debt, other elements of the transaction, or features within the debt instrument itself. The proceeds generally approximate the present value of interest and principal payments of the debt. Debt should be recognized on the date the proceeds are received (settlement date) rather than on the trade date.
When the proceeds received are not the same as the amount due at maturity, a debt instrument has been issued at a discount or premium.
Definitions from ASC Master Glossary
Discount: The difference between the net proceeds, after expense, received upon issuance of debt and the amount repayable at its maturity.
Premium: The excess of the net proceeds, after expense, received upon issuance of debt over the amount repayable at its maturity.
A debt discount may reflect fees paid by a reporting entity to a lender as part of a debt issuance or the issuance of debt at a below market coupon. When a reporting entity issues debt at a discount, it receives less proceeds than it will repay; thus, the reporting entity is paying a higher effective interest rate than the coupon specified in the debt agreement (i.e., it is paying the coupon and the original issue discount). A debt discount is a reduction of the carrying amount of a debt liability.
A debt discount can also be created by the following:A debt premium typically reflects the issuance of debt at an above market coupon. A debt premium can also be created through an adjustment to the carrying amount of a debt instrument as a result of a fair value hedging relationship or through the separation of an embedded derivative that is an asset (e.g., a purchased option).
As discussed in ASC 835-30-45-1A, a debt discount or premium should be recorded as an adjustment to the carrying amount of the related liability.
When the proceeds received are not the same as the amount due at maturity, a debt instrument has been issued at a discount or premium.
Definitions from ASC Master Glossary
Discount: The difference between the net proceeds, after expense, received upon issuance of debt and the amount repayable at its maturity.
Premium: The excess of the net proceeds, after expense, received upon issuance of debt over the amount repayable at its maturity.
A debt discount may reflect fees paid by a reporting entity to a lender as part of a debt issuance or the issuance of debt at a below market coupon. When a reporting entity issues debt at a discount, it receives less proceeds than it will repay; thus, the reporting entity is paying a higher effective interest rate than the coupon specified in the debt agreement (i.e., it is paying the coupon and the original issue discount). A debt discount is a reduction of the carrying amount of a debt liability.
A debt discount can also be created by the following:A debt premium typically reflects the issuance of debt at an above market coupon. A debt premium can also be created through an adjustment to the carrying amount of a debt instrument as a result of a fair value hedging relationship or through the separation of an embedded derivative that is an asset (e.g., a purchased option).
As discussed in ASC 835-30-45-1A, a debt discount or premium should be recorded as an adjustment to the carrying amount of the related liability.
Issuance costs are specific incremental costs, other than those paid to the lender, which are incurred by a borrower and directly attributable to issuing a debt instrument. Issuance costs include the following.
Costs that do not qualify as issuance costs include bonuses paid to employees (even if attributed to the employees’ involvement in the financing), employee performance stock options with long-term debt issuance milestones, and premiums for Director’s and Officers’ insurance policies (even if mandated by the underwriters).
Like debt premiums and discounts, debt issuance costs should be reported as an adjustment to the carrying amount of the related liability as discussed in ASC 835-30-45-1A.
Excerpt from ASC 835-30-45-1A
Similarly, debt issuance costs related to a note shall be reported in the balance sheet as a direct deduction from the face amount of that note. The discount, premium, or debt issuance costs shall not be classified as a deferred charge or deferred credit.
See FG 1.2.3 for information on amortization of debt issuance costs.Question FG 1-1
A reporting entity pays a non-refundable commitment fee in connection with an underwriter’s agreement to provide bridge financing in the event the reporting entity’s debt offering is delayed or cannot be executed.
Should the commitment fee be included as a debt issuance cost of the debt offering?
PwC response No. ASC 340-10-S99-2 provides guidance on the accounting for costs related to a bridge financing.The commitment fee should be deferred and amortized over the commitment period. Any unamortized amount remaining upon the execution of the debt offering should be written off as the commitment has expired unused. Even if the reporting entity pays fees to the same underwriter in connection with the debt offering, ASC 340-10-S99-2 clarifies that the commitment fee and the underwriting fees should be distinguished for accounting purposes. We believe this guidance should also be applied by non-public companies.
Question FG 1-2
A reporting entity engages an investment bank to structure a loan syndication on a best efforts basis. Although the debt is not expected to be issued for several months, the bank is entitled to fees during the intervening period, based on milestones reached.
Presuming the fees incurred qualify as debt issuance costs, should the reporting entity defer these fees prior to the debt issuance?
PwC responseWe believe the guidance in ASC 340-10-S99-1 should be applied by analogy. If the reporting entity concludes that the likelihood of the syndicated loan being placed is probable, the fees should be accounted for as a deferred asset. If, on the other hand, the likelihood of the loan syndication being placed is considered remote, it may be more appropriate to expense the fees as they are incurred.
If the loan syndication’s prospects fall somewhere between probable and remote, judgment should be applied to determine which treatment is more appropriate. Some factors to consider in determining the appropriate accounting treatment include whether payment milestones have been and are expected to be achieved and the reporting entity’s history with respect to previous debt issuances.
With respect to a note for which the imputation of interest is required, the difference between the present value and the face amount shall be treated as discount or premium and amortized as interest expense or income over the life of the note in such a way as to result in a constant rate of interest when applied to the amount outstanding at the beginning of any given period. This is the interest method.
Although ASC 835-30-35-2 requires the use of the interest method for the amortization of debt discount and premium, ASC 835-30-35-4 indicates that other methods of amortization, including the straight-line method, may be used if the results obtained are not materially different from those that would result from use of the interest method. These differences should be analyzed each period for materiality.
With regard to the length of the amortization period, it is not clear whether ASC 835-30-35-2 is referring to the contractual life of an instrument or some shorter period. Although it is commonly understood to mean the contractual life, depending on a debt instrument’s terms and features, it may be appropriate to amortize any discount or premium over a shorter period.
We believe a shorter amortization period, such as the period from the issuance date to the date a put is first exercisable, is appropriate when a lender can demand repayment in circumstances outside of a reporting entity’s control. Using a shorter amortization period ensures that there will be no extinguishment gain or loss in the event a lender exercises its put option prior to the contractual maturity of the debt. However, amortization over the contractual life of a debt instrument is also permitted.
In most cases, debt issuance costs are amortized over the same period as debt discount or premium. This approach is supported by guidance in ASC 470, Debt, and other accounting literature. When a debt instrument is puttable by a lender at a price less than the par value, it may be appropriate to use a different amortization period for debt issuance costs than the debt discount and premium. See FG 1.2.3.1 for further information. When there is more than one amortization period that is acceptable, a reporting entity should elect a method, apply it consistently, and disclose it.
As discussed in ASC 835-30-35-5, the amount chargeable to interest expense pursuant to ASC 835-30 (e.g., amortization of debt discount or premium) is eligible for inclusion in the amount of interest cost capitalized in accordance with ASC 835-20.
If a debt instrument is accounted for at fair value under ASC 825, the issuance costs should be immediately expensed. If the debt was issued with other instruments (e.g., warrants) that are also measured at fair value, there may be occasions when the proceeds allocated to the debt instrument accounted for at fair value differ from the fair value of the debt instrument at issuance. To the extent the allocated proceeds received differ from the fair value of the debt instrument, the difference should be recorded in the income statement. See FG 1.5 for information on accounting for debt at fair value.
In general, a discount or premium should be amortized using the interest method over the same period used to amortize debt issuance costs. However, when debt is puttable at accreted value (the amount equal to the current basis of the debt, based on the discount or premium at issuance, less the amount of the discount or premium amortized to date based on an effective yield, but excluding the impact of debt issuance costs), it may be more appropriate to amortize a discount or premium over the contractual life of the debt because the reporting entity will “retain” the unamortized portion of the discount or premium if the lender puts the debt prior to maturity. The same is not true for debt issuance costs since these amounts are paid to third parties and are “lost” when the debt is redeemed at any price.
When a debt instrument is puttable at accreted value, we believe the discount or premium should be amortized over the contractual life of the debt such that the carrying amount of the debt is equal to the put price on the date the put is first exercisable. The discount or premium should continue to be amortized such that the carrying amount of the debt is equal to the put price on each subsequent put date as well. Because the carrying amount equals the price at which the debt can be put, there will be no gain or loss on extinguishment if the lender exercises its put option prior to maturity.
Debt issuance costs can either be amortized over the period from the issuance date to the date the put is first exercisable, or over the contractual life along with the debt discount or premium. A reporting entity should elect one of these amortization methods and apply it consistently. When the same period is used to amortize debt issuance costs and debt discount or premium (e.g., the contractual life), it results in one constant effective rate of interest for the debt instrument, consistent with the interest method. Although issuance costs will remain on the balance sheet after the date the lender can exercise its put option and demand repayment, the same is true any time a reporting entity amortizes issuance costs over the contractual life when the instrument is puttable at an earlier date.
Term debt that a reporting entity can call prior to its maturity date is similar to short-term debt that can be extended. Increasing rate debt is contractually short term with an embedded term-extending option that allows a reporting entity to make it long term; callable debt is contractually long term with an embedded call option that allows a reporting entity to make it short term. Therefore, we believe a reporting entity may elect to amortize debt issuance costs, discounts and premiums related to callable debt over either the contractual life of the debt instrument (consistent with term debt) or the estimated life of the debt instrument (by analogy to the guidance for increasing rate debt in ASC 470-10-35-2). A reporting entity should elect one of these methods and apply it consistently. See FG 1.4.1 for information on the accounting for increasing rate debt.
When the exercisability of a call option is subject to a contingency, the reporting entity should consider the effect of the contingency on the likelihood the reporting entity can exercise its call option. In circumstances where the contingency is remote, the estimated life of the debt instrument and its contractual maturity should be the same.
If a reporting entity elects the estimated life of the debt instrument as the amortization period, the life used should reflect the best estimate considering the reporting entity’s plans, ability and intent to service the debt as described in ASC 470-10-35-2, as well as economic factors affecting the desirability of calling the debt. There may be circumstances in which the economic factors affecting the desirability to exercise the call option indicate that the best estimate of the debt instrument’s life is its contractual life.
We believe that an accounting policy election should be made as to whether estimates will be updated for a specific debt instrument, and that policy should be applied consistently across similar instruments. A reporting entity may decide that the estimated life is established at the issuance date and should not be updated.
Debt agreements may contain covenants that the reporting entity must adhere to throughout the life of the agreement. Covenants are negotiated between a reporting entity and its lenders and may vary from agreement to agreement. Financial ratio covenants, which require the reporting entity to maintain various financial ratios, are included in nearly every debt agreement. A breach of a covenant triggers an event of default which may allow the lender to demand repayment (i.e., it becomes puttable).
When a covenant violation causes long-term debt to become puttable, the debt and related debt discount, premium, or issuance costs may need to be reclassified as current liabilities; however, we do not believe debt issuance costs, discounts, or premiums should be automatically amortized in full upon the reclassification of a long-term liability to a current liability.
ASC 470-10-45-7 indicates that the classification of the debt (and related contra accounts) does not have to be the same as the time frame used to amortize debt issuance costs, discount, and premium. A reporting entity should evaluate its specific facts and circumstances, including the following points, to determine whether it should amortize its debt issuance costs, discounts, or premiums in full.
If the preponderance of the evidence at the financial statement issuance date leads a reporting entity to conclude that there is a reasonable likelihood that it will be able to successfully negotiate a waiver with the lender, then amortization of debt issuance costs, discounts, and premiums should continue as before the violation, with adequate disclosure of the circumstances.
If a lender waives a covenant violation for no consideration (either explicit or implicit), no accounting is required under ASC 470-50-40 because there is no change in cash flows. A payment (of cash or other instruments) made to a lender to effect a waiver of a covenant violation is considered a modification of the terms of the debt instrument. When such a payment is made, the reporting entity should analyze the modification using the debt modification guidance discussed in FG 3.4.
Question FG 1-3
A reporting entity violates a covenant in its puttable debt instrument. The reporting entity restructures its debt agreement and obtains a debt covenant waiver. As a result of the waiver, the debt is classified as noncurrent in its period end financial statements. As part of the restructuring, the date the put option is first exercisable is accelerated; however, the contractual term remains the same as the original debt instrument.
Does the covenant violation or debt modification have an effect on the reporting entity’s amortization of debt issuance costs, discounts, or premiums?
PwC responseMaybe. The reporting entity should first determine whether the restructuring qualifies as a troubled debt restructuring (refer to FG 3.3). If the reporting entity determines this is not a troubled debt restructuring, it should apply the guidance in ASC 470-50-40-10 to determine whether the changes to the instrument should be accounted for as a modification or extinguishment. See FG 3.4 for information on accounting for a modification of a term loan or debt security. If the debt instrument is modified and the transaction is accounted for as a modification, the reporting entity should continue to account for the debt issuance costs, discounts or premiums based on its accounting policy election as of the original issue date.
If the reporting entity has elected an amortization period from the issuance date to the date the put is first exercisable, then, as of the modification date, any unamortized debt issuance costs, discounts, or premiums should be amortized to the new put date. If the reporting entity has elected an amortization period over the contractual life of the debt instrument, it should continue this policy.
If the modification is accounted for as an extinguishment, then any unamortized debt issuance costs, discounts, or premiums should be expensed as part of the extinguishment gain or loss.
If the reporting entity had not obtained a waiver as of the financial statement issuance date, and the preponderance of the evidence lead to a conclusion that it would not be able to negotiate a waiver, any debt issuance costs, discounts, or premiums would have been expensed as of the date that the debt became puttable (i.e., the covenant violation date), because the debt was, and would continue to be, demand debt notwithstanding any restructuring.
A reporting entity may enter into an agreement with a lender that allows the reporting entity to delay the funding of its debt, provided it is drawn within a specified time period (i.e., the reporting entity gets to choose the date that the debt funds within a specified time frame). This differs from a line of credit or revolving-debt agreement because once the debt is funded, it cannot be repaid and then borrowed again. Many agreements do not require that the reporting entity draw the full commitment amount at once; instead, a reporting entity can borrow a portion of the total debt commitment at different points in time.
When a reporting entity enters into a delayed draw debt agreement, it pays a commitment fee to the lender in exchange for access to capital over the contractual term. That is, the fees are paid whether or not the funds are ever drawn down. As such, we believe these costs meet the conceptual definition of an asset and should be recorded as such on the balance sheet. We believe that the subsequent accounting for deferred costs is based on the facts and circumstances. For instance, if a reporting entity is near certain that it will draw down/borrow the debt, the commitment fee is economically compensation for the borrowing, and we believe it would be appropriate for the commitment fee to remain as an asset on the balance sheet until the debt is drawn. Once the debt is drawn, the reporting entity should record the debt on its balance sheet, derecognize the commitment fee asset, and record the commitment fee as a component of the debt’s amortized cost basis. The adjustment to the amortized cost basis will be amortized over the term of the debt as component of the debt’s effective yield. If a reporting entity borrows a portion of the debt, only a proportionate amount of the commitment fee asset should be recognized as an adjustment to the amortized cost basis of the debt drawn.
In other instances, the reporting entity may have entered into the delayed draw simply to have access to the funds but without any current intention to draw down the debt. In this scenario, we believe it would be appropriate for the reporting entity to amortize the commitment fee on a straight-line basis over the access period. If it becomes probable that the debt (or a portion of the debt) will not be drawn during the access period, any remaining deferred costs (or portion of the costs) may be expensed.