ASC 310-45: Former Rules for Troubled Debt Restructuring
Explore the superseded standard for troubled debt to understand how credit impairment measurement has evolved from an incurred to an expected loss approach.
Accounting Standards Codification (ASC) 310-40 was the former guidance from the Financial Accounting Standards Board (FASB) for Troubled Debt Restructurings (TDRs). This standard provided a framework for lenders modifying debt for borrowers facing financial hardship. While this guidance has been superseded, its principles are relevant for analyzing historical financial statements and understanding the evolution of credit loss accounting.
Identifying a Troubled Debt Restructuring
Under the former guidance, a loan modification was classified as a TDR if two criteria were met. The first was that the borrower had to be experiencing financial difficulty. Common signs included being in payment default on any debts, declaring or being in the process of declaring bankruptcy, or analysis showing a future default was probable without a modification.
The second criterion was that the creditor granted a concession due to the borrower’s financial distress. This meant the lender provided more favorable terms than the borrower could obtain elsewhere. Examples of concessions included reducing the interest rate, forgiving a portion of the principal, or extending the maturity date at a below-market interest rate. Both the borrower’s difficulty and the creditor’s concession had to be present for the modification to be a TDR.
Accounting for a TDR as a Creditor
Once a loan modification was identified as a TDR, the accounting approach depended on whether the restructuring involved modifying the loan’s terms or receiving assets to satisfy the debt. This determined how the creditor measured the impairment loss.
If a TDR involved modifying debt terms, the creditor measured the loan for impairment using one of three methods. The primary method was calculating the present value of expected future cash flows, discounted at the loan’s original effective interest rate. Alternatively, impairment could be based on the loan’s observable market price or the fair value of the collateral if the loan was collateral-dependent. Any shortfall between the loan’s recorded investment and the amount determined by one of these methods was recognized as a loss.
If the creditor received assets or an equity interest in the borrower, a different treatment was required. The creditor recorded the assets or equity received at their fair value at the time of the restructuring. A loss was recognized for any difference between the fair value of the assets received and the net carrying amount of the receivable. This process removed the original loan from the creditor’s books, replacing it with the new asset or equity.
Required Disclosures for TDRs
ASC 310-40 mandated disclosures in a creditor’s financial statement footnotes to provide transparency about TDRs. These requirements were designed to give investors insight into the volume and financial impact of these restructurings.
Creditors were required to disclose quantitative information about TDRs that occurred during the reporting period. This included the amortized cost basis of the modified receivables and the financial effects, such as the impact on interest income and any principal forgiveness. Creditors also had to provide information on any loans that defaulted within 12 months of being restructured.
The Transition to New Guidance
The accounting model for TDRs under ASC 310-40 was eliminated with the adoption of ASC 326, Financial Instruments—Credit Losses. This new standard introduced the Current Expected Credit Loss (CECL) model, which changed how financial institutions account for credit losses.
The transition moved from an “incurred loss” model to an “expected loss” model. Under the old rules, a loss was recognized only when it was probable. CECL requires entities to forecast and recognize all expected credit losses over the life of a financial instrument from origination. The FASB viewed this forward-looking approach as incorporating measurements already part of TDR analysis, making the separate TDR designation redundant.
With the adoption of CECL, the TDR classification and its specific accounting guidance were removed. Loan modifications for borrowers experiencing financial difficulty still occur, but they are now accounted for under the broader CECL framework. The focus is now on how changes in terms affect the overall estimate of expected credit losses for a loan, rather than applying a separate TDR accounting model.