This article is the first in a series of articles dedicated to issues that arise when accounting for debt modifications. This particular issue is addressed in Section 1.1 of our publication, A guide to accounting for debt modifications and restructurings (June 2023).
The two key parties to a loan are the borrower and its lender. Reading and understanding the terms of the agreements that underlie a loan and any related changes to the loan should clearly identify these and other relevant parties. Identifying the relevant parties factors into determining the accounting model that should be applied in a particular situation. For example, the accounting model would be different for an old term loan that was paid off with proceeds from a new term loan with a new lender as compared to being paid off with proceeds from a new term loan that is with the same lender.
Typically, determining whether the same lender is involved in a loan before and after any changes are made to the loan is a straightforward exercise, but sometimes it’s not. For example, if an affiliate of the old lender is the new lender, or if the old lender and new lender are two subsidiaries or two divisions within the same consolidated entity, making the determination as to whether the same lender is involved requires additional analysis. To determine whether the same lender is involved in a loan before and after any changes are made to the loan in these less-than-straightforward situations, such as when there are multiple funds in a private equity group acting as lenders, requires careful consideration of the relevant facts and circumstances, including but not limited to addressing the following questions:
- Are the new and old lenders separate legal entities?
- Are the new and old lenders not included in the same consolidated entity?
- Are management of the new and old lenders responsible as fiduciaries to manage the lenders solely for the benefit of the owners and equity holders of each individual lender?
If the answer to each of these questions is yes, there are indications that the old and new lenders operated separately and should not be considered the same lender for accounting purposes.
Alternatively, when the new and old lenders are part of the same consolidated entity and use the same representative to negotiate the debt modification with the borrower, there are indications that the old and new lenders operated together and should be considered the same lender for accounting purposes. This determination of the lender could impact whether the transaction is accounted for as the derecognition of a liability, a troubled debt restructuring a debt modification or a debt extinguishment.