ASC 470 Simplified: Debt Modifications and Extinguishments for Real Estate Entities
February 20, 2020
By Isaac Mansoura
In the normal course of business, and for a variety of reasons, real estate entities may choose to refinance their outstanding debt. While the reason might be of little consequence, the proper accounting for this is important and sometimes overlooked. As auditors charge through busy season, the question becomes: Was this properly accounted for in accordance with the applicable financial reporting framework?
A real estate entity’s debt structure is generally not complex (e.g., no discounts, premiums, call/put/conversion options, and so forth). When preparing financial statements in accordance with Generally Accepted Accounting Principles (“GAAP”), the first thing that should come to mind is the question of modification or extinguishment. The rules are promulgated in Accounting Standards Codification (“ASC”) 470. Keep in mind that they are complex and not the most intuitive. There is a similar calculation for those entities reporting on an income tax basis, but for the purposes of this discussion, the focus is on the required accounting in accordance with GAAP. The following is a simple guide assuming standard mortgage financing activities for real estate:
- Debt is often refinanced with a new lender, and the rules are quite simple. This refinance is deemed to be an extinguishment; all prior debt issuance costs should be written off, and any new costs incurred in connection with such refinancing should be capitalized and amortized over the new loan’s term. Unamortized debt issuance costs that were written off and any loan prepayment penalty incurred should be presented separately in the financial statements as a loss on debt extinguishment.
- In the case where debt is refinanced with the same lender, the entity must determine whether the refinanced debt is substantially different from the original debt. This is accomplished by comparing the present value of the cash flows of the outstanding original debt to the present value of the cash flows of the new debt, discounted at the effective interest rate of the original loan. A change of 10% or more is deemed to be an extinguishment.
The following table sets forth the treatment of new and previously incurred costs of financing activities with the same lender:
|Original Debt Issuance Costs||Fees Paid to Lender||Fees Paid to Third Parties|
|Extinguishment||Write off||Expense as part of loss on extinguishment||Capitalize and amortize|
|Modification||Continue amortizing over the term of modified loan||Capitalize and amortize over the term of the modified loan||Expense|
For the purposes of this example, we did not contemplate financing transactions with multiple lenders, put or call options, discounts or premiums, or troubled debt restructuring, etc. This is meant to serve as a simple guide for basic financing transactions relative to real estate entities (e.g., refinancing of a mortgage loan). In all instances, the real estate owner and the auditors should refer back to ASC 470 for proper treatment.