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What is Accounting For Troubled Debt Restructuring?

Accounting For Troubled Debt Restructuring

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Accounting For Troubled Debt Restructuring

Accounting for Troubled Debt Restructuring (TDR) involves the recognition and measurement of the effects of concessions given by creditors in situations where the debtor is experiencing financial difficulties. Both the debtor and creditor need to account for these restructurings in their financial statements.

Here’s an overview of how TDR is accounted for:

1. Accounting by the Creditor:

  • Impairment Measurement: If the present value of the estimated future cash flows (using the original effective interest rate) from the restructured debt is less than the carrying amount of the debt, an impairment has occurred. The creditor recognizes an impairment loss for the difference.
  • Interest Income Recognition: Subsequent to restructuring, the creditor will continue recognizing interest income based on the original effective interest rate applied to the new carrying amount of the debt (i.e., the loan’s original carrying amount adjusted for any impairment).

2. Accounting by the Debtor:

  • Gain on Restructuring: If the present value of the restructured cash flows (using the original effective interest rate) is less than the carrying amount of the debt, the debtor recognizes a gain on restructuring. This gain is essentially the difference between the original carrying amount of the debt and the present value of the restructured cash flows.
  • Interest Expense: After restructuring, the debtor recognizes interest expense based on the original effective interest rate applied to the new carrying amount of the debt (i.e., the debt’s original carrying amount adjusted for any gains recognized).

Example of Accounting For Troubled Debt Restructuring

Let’s delve into a detailed example for the accounting treatment of a Troubled Debt Restructuring (TDR).

Scenario:

“TechStart Inc.” took a $500,000 loan from “SafeBank” with an annual interest rate of 8%. Due to market downturns, TechStart Inc. struggles to make repayments. Recognizing the company’s financial distress, SafeBank offers to restructure the loan.

Restructured Terms:

  • Reduction of principal amount from $500,000 to $450,000.
  • Reduction in the annual interest rate from 8% to 6%.
  • Extension of the loan’s term by 2 years.

Accounting by SafeBank (Creditor):

  • Impairment Measurement:
    • Determine the present value of the restructured cash flows using the original interest rate of 8%.
    • Let’s assume the present value of the restructured cash flows is $420,000.
    • Impairment Loss = Carrying amount of the loan – Present value of restructured cash flows
    • Impairment Loss = $500,000 – $420,000 = $80,000
    • SafeBank will record an impairment loss of $80,000, reducing the carrying value of the loan to $420,000.
  • Future Interest Income Recognition:
    • Interest income is now recognized on the reduced carrying amount ($420,000) using the original effective interest rate of 8%.

Accounting by TechStart Inc. (Debtor):

  • Gain on Restructuring:
    • Gain = Carrying amount of the loan – Present value of restructured cash flows
    • Gain = $500,000 – $420,000 = $80,000
    • TechStart Inc. will recognize a gain of $80,000, reducing its liability to $420,000.
  • Future Interest Expense:
    • Interest expense is now recognized on the reduced liability amount ($420,000) using the original effective interest rate of 8%.

Journal Entries:

For SafeBank:

  • To record the impairment:
  Loss due to Impairment       $80,000
      Loan Receivable                $80,000

For TechStart Inc.:

  • To record the gain from restructuring:
  Loan Payable               $80,000
      Gain on Restructuring       $80,000

This example simplifies the accounting process, but it provides a framework to understand the basic entries and calculations involved. As always, the exact procedures might vary based on specific restructuring terms and applicable accounting standards.

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