What Replaced Troubled Debt Restructuring Under ASC 326-65?

When a lender and borrower agree to change a loan’s original terms, accounting rules dictate how the lender records the event. These modifications often occur when a borrower faces financial challenges and cannot adhere to the initial repayment schedule. This accounting process evaluates the modification’s nature and its impact on the loan’s value and expected cash flows.

Defining a Troubled Debt Restructuring

A loan modification has historically been classified as a Troubled Debt Restructuring (TDR) under a two-part test. First, the borrower must be experiencing financial difficulty. This is a determination made by the creditor based on available information, such as the borrower’s recent defaults or poor financial performance.

The second component is that the lender must have granted a concession. This means the lender has offered revised terms that it would not otherwise consider. Examples of concessions include a reduction of the loan’s principal balance, a decrease in the stated interest rate, or an extension of the maturity date with an interest rate below the current market rate for similar loans.

Original Accounting for Restructured Debt

Under the original accounting model, identifying a loan modification as a TDR triggered a specific impairment analysis. The creditor was required to measure the associated loss. This calculation involved comparing the loan’s recorded investment, which is the principal and any accrued interest, against the value of the newly agreed-upon payments.

The value of the revised payments was determined by calculating the present value of the expected future cash flows. These future cash flows were discounted using the loan’s original effective interest rate, not the new, modified rate. If the present value of these future payments was less than the loan’s recorded investment, the creditor had to recognize an impairment loss for the difference.

The Shift to a New Model

The accounting guidance for TDRs has been eliminated for entities that have adopted the Current Expected Credit Losses (CECL) model. The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2022-02, which eliminated the TDR recognition and measurement guidance previously found in ASC 310-40. This change alters how creditors account for modifications to loans with borrowers facing financial difficulty.

Instead of a separate TDR analysis, the modification is now viewed as one of many data points in estimating the lifetime expected credit losses for that loan. The CECL model, introduced by ASC 326-20, requires entities to forecast and reserve for the entire expected credit loss over the life of a loan from its origination. This makes the separate TDR impairment calculation redundant.

Under this new framework, the focus shifts from identifying a specific restructuring event to continuously assessing the overall credit risk. When a loan is modified for a borrower experiencing financial difficulty, the creditor updates its estimate of expected credit losses based on the new terms. While the TDR designation is gone, enhanced disclosure requirements for these types of modifications were introduced, ensuring financial statement users still have visibility into these activities.