Slide 1Loan Impairments & Troubled DebtsSlide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Creditor AccountingSlide 11Slide 12Loan Impairments & Troubled DebtsSequence of EventsLoanOriginationDebtorCreditorDebtor & creditor enter a debt arrangementEstimateLossPoor DebtManagementDebtor encountersdifficultyLoanImpairmentThis is a loanimpairmentCreditor realizes difficulty & estimateslossEstimateEffectInsolvency(Unable to Service Debt)Later, the debtorbecomes insolventModification of TermsCreditor & debtoragree to a modification of termsLoanOriginationDebtorCreditorPoor DebtManagementEstimateLossLoanImpairmentEstimateEffectInsolvency(Unable to Service Debt)Modification of TermsBankruptcyEconomicRecoveryWith altered agreement,maybe the debtor will make it & maybe not?Troubled debt restructure Troubled debt restructure provides for concession to provides for concession to debtor by creditor:debtor by creditor:•Transfer of assets or equity Transfer of assets or equity shares to settle all or part of shares to settle all or part of debt debt •Modification of terms of debtModification of terms of debtConcessions Granted to DebtorAssets/Equity used to settle debt Debt Terms ModifiedConcessions Granted to DebtorAssets/Equity used to settle debt Debt Terms ModifiedWhen assets or equity When assets or equity are used to settle are used to settle debt, there are effects debt, there are effects on debtor and creditoron debtor and creditorCreditor DebtorCreditors record ordinary loss (or Creditors record ordinary loss (or charge allowance account) for charge allowance account) for difference between carrying value difference between carrying value of debt and fair market value of of debt and fair market value of asset received.asset received.Loss equal to difference between carrying value of receivable and fair market value of compensation received.Concessions Granted to DebtorAssets/Equity used to settle debt Debt Terms ModifiedCreditor DebtorLoss equal to difference between carrying value of receivable and fair market value of compensation received.Debtors will recognize a Debtors will recognize a gain. Value of assets gain. Value of assets surrendered in surrendered in satisfaction of debt will satisfaction of debt will be less than carrying be less than carrying value of debt. That is value of debt. That is nature of concession nature of concession Gain on debt restructure equal to difference between book value of debt and FMV of compensation given.Book gain or loss on difference between book value and FMV of assets given. No gain or loss for securitiesDebtors must first Debtors must first update their books update their books to reflect the fair to reflect the fair value of assets value of assets surrenderedsurrenderedConcessions Granted to Debtor Debt Terms ModifiedAnother concession often Another concession often granted to debtors granted to debtors involves renegotiation of involves renegotiation of amounts due to creditor.amounts due to creditor.The modification of debt The modification of debt terms results in a terms results in a restructurerestructure of future of future cash flows.cash flows.Book value of debt <restructured cash flows?YES NOCan result in low or Can result in low or zero rate of interest on zero rate of interest on debt.debt.No gain is recognized by debtor. Debtor finds implicit rate that equates cash flows with book value of debt.Debtor recognizes gain on difference between book value of debt and restructured cash flows. No interest expense.0% interestLow interest rateConcessions Granted to DebtorAssets/Equity used to settle debt Debt Terms ModifiedLoss 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 securitiesBook value of debt <restructured cash flows?YES NOCreditor DebtorAccounting for Troubled Debt RestructuringPrepared by Jeff Harkins, edited by T GordonCreditor 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 fundsAre assets or an ownershipinterest transferred from debtor to creditor in settlement of debt?Is entitythe creditor?YesNoWhen the debt is settled, debtor and creditor accounting is basically parallel.Discount cash flows to be received undermodified terms usingoriginal interest rateDifference betweencarrying value ofreceivable and presentvalue is ordinary lossfor creditorFor a modification of terms, the creditor will generally recognize a LARGER loss (in comparison to gain recorded by debtor) because the creditor uses the original “historic” interest rate implicit in the loan.Record ordinary gain orloss on asset. Differencebetween fair value ofasset or equity interestand amount due ondebt is a gain for debtor and ordinary loss for creditorRecord ordinary gain orloss on asset. Differencebetween fair value ofasset or equity interestand amount due ondebt is ordinary gain for debtor and ordinary loss for creditorThe difference betweencarrying value of debtand total future cashflows is recorded as anordinary gain for debtor. No interest expense will berecorded in future years.Are cash flows to be made under the modified terms greater than the carrying value ofthe debt after transferof asset or equityinterest?No gain isrecorded by debtor. Find interest rate to equate cash flowsto carrying value of debt. Usethis interest rate to amortizerestructured debt overits termYesNoYesYesNoNoIs entitythe creditor?Discount cash flows to be received undermodified terms usingoriginal interest rateDifference betweencarrying value ofreceivable and presentvalue is ordinary lossfor creditorYesNoAre assets or an ownershipinterest transferred from debtor tocreditor in settlement of debt?Troubled Debt RestructuringTroubled Debt RestructuringAfter FAS 145After FAS 145Is the debt settledIn