Choosing the appropriate accounting for debt

The complexities of accounting for debt

Most companies use debt as an integral part of their capital structure to finance business operations and investments. Debt financing might take the form of loans from banks or other finance providers or the sale of debt securities to investors. Many companies have credit facilities that include lines of credit or revolving debt arrangements.

A company’s determination of the appropriate accounting for a debt transaction is often time-consuming and complex. To properly apply the numerous rules and exceptions that exist in US generally accepted accounting principles (GAAP), a company needs to closely analyze transaction terms and conditions and the related facts and circumstances. Terms that are significant to the accounting analysis may be buried deep within a contract’s fine print or in separate legal agreements. Even minor variations in the way contractual terms are defined could have a material effect on the accounting for a debt arrangement.

Let’s review five questions that need answering during the accounting for debt assessment and documentation.

Five key questions about accounting for debt

1. What are the units of account in a debt issuance?
While many debt contracts represent one unit of account, some debt agreements consist of two or more components that individually represent separate units of account. Conversely, two separate agreements might represent one combined unit of account. When a company enters into a debt transaction that includes items that can be legally detached or exercised separately from the debt, it must evaluate whether those items are required to be treated as separate units of accounting under GAAP.

2. What is the accounting for debt terms that could alter contractual cash flows?
Debt instruments often include contractual terms that that could affect the timing or amount of cash flows or other exchanges required by the contract. Under GAAP, an entity must evaluate such terms to determine whether they are required to be accounted for as derivatives at fair value separate from the debt in which they are embedded.

3. What is the accounting for a debt modification, exchange, conversion, or extinguishment?
If a company is experiencing financial difficulties and the creditor has granted a concession, the transaction must be accounted for and disclosed as a troubled debt restructuring (TDR), in which case special guidance limits the ability to recognize a debt restructuring gain. When a company modifies or exchanges outstanding debt in a transaction that does not qualify as a TDR, it must evaluate whether the transaction should be accounted for as a modification or extinguishment of the original debt instrument.

4. Should debt be classified as current or noncurrent?
The determination of whether debt should be presented as current or noncurrent on a classified balance sheet is governed by a variety of fact-specific rules and exceptions under GAAP. If a debtor violates an objectively verifiable debt covenant that makes an otherwise long-term obligation due on demand or payable on demand within one year of the balance sheet date, the debt might still qualify for noncurrent classification if the creditor grants a waiver before the financial statements are issued (or available to be issued) or a grace period applies and certain other conditions are met.

5. Have financing arrangements (e.g. supply chain financing arrangements) been properly presented and disclosed?
It has become increasingly popular for companies to provide their suppliers with access to arrangements in which a bank or other finance provider offers to purchase receivables held by the company’s suppliers. If a company has a trade payable arrangement involving an intermediary, it should consider how to appropriately present and disclose the amount payable.

The importance of getting it right

The outcome of your accounting for debt analysis could significantly affect the classification, measurement, and earnings impact of the debt arrangement and associated financial statement ratios. With such high stakes, a company might decide to involve accounting advisers with experience and knowledge of the complexities of debt accounting to help it arrive at appropriate accounting conclusions.

Looking for more?

Deloitte’s A Roadmap to the Issuer’s Accounting for Debt provides a comprehensive overview of the application of US GAAP to debt arrangements. It also includes our accounting guidance that applies as a company responds to the five debt accounting questions described above.