Companies considering refinancing outstanding debt should pay close attention to a proposed update to accounting standards that could significantly ease the accounting treatment of debt exchanges. The proposal is open for public comment through May 30, 2025, and its implications are significant—particularly for companies that frequently engage in refinancing activity.
In a move aimed at reducing the complexity of debt modification accounting, the Financial Accounting Standards Board (FASB) has issued a proposed Accounting Standards Update (ASU): Debt-Modifications and Extinguishments (Subtopic 470-50) and Liabilities-Extinguishment of Liabilities (Subtopic 405-20): Accounting for Debt Exchanges. The proposed changes seek to align the accounting in this area by eliminating the current disparity in the application of the current guidance and reduce the ambiguity around whether a debt exchange should be treated as a modification or an extinguishment.
Current Practice: The Burden of the 10% Test
Under the existing framework, when a company exchanges debt with the same lender or lending group, it must perform an analysis—often called the “10% test”—to determine whether the new exchange should be treated as a modification or an extinguishment. If the present value of the new debt’s cash flows differs from the original by more than 10%, the transaction is considered an extinguishment. If the change in cash flows is less than that threshold, it’s a modification.
Why the distinction matters
Extinguishment accounting requires derecognition of the original debt, potential gain or loss recognition, and removal of unamortized fees; modification accounting does not. These decisions are complex, judgment-laden, and frequently scrutinized by auditors and regulators.
What’s Changing: A Path for Simplification
The FASB’s proposed ASU would create a simpler, more intuitive pathway to account for certain debt exchanges as separate transactions. Under the proposal, a company would account for the repayment of existing debt and issuance of new debt as independent transactions (and thus apply extinguishment accounting) if:
- The existing debt is repaid according to its contractual terms or repurchased at market terms, and
- The new debt is issued at market terms following the issuer’s customary marketing process.
The term “customary marketing process” is key
It implies the borrower has engaged with potential lenders beyond existing creditors, signaling that the new terms are market-based. If these conditions aren’t met—for example, if the lender group remains unchanged and no competitive process occurs—the borrower (company) would still need to apply the 10% test to determine the appropriate accounting treatment. If there is only a single creditor involved, the 10% must also be applied.
Why It Matters
This proposed change is a direct response to feedback from stakeholders who argue that the 10% test often fails to reflect the economic substance of a refinancing transaction. Many believe that in substance, these are separate transactions, even if the same lender is involved.
For companies, this shift could offer:
Reduced complexity and cost associated with evaluating transactions.
Greater clarity and consistency in accounting treatment.
Potential reduction in audit friction, particularly in complex refinancing scenarios.
We’ve seen firsthand through our extensive work in this area how intricate and heavily scrutinized these calculations can be. Even many experienced practitioners do not fully understand the nuances involved in accounting for debt exchanges. That’s where specialized expertise makes a difference. We don’t just understand the rules—we know how to apply them in ways that stand up to scrutiny from auditors and regulators.
What’s Next: Prepare Now
The FASB will begin deliberations once the comment window closes. Companies that are planning refinancing activity or those that participate in debt exchanges on a regular basis should begin evaluating how these changes might impact their accounting practices—and whether to provide feedback to the FASB.
In the meantime, get in touch if you’d like to discuss the potential implications of these proposed changes on your business and how our team can help you navigate this tricky area.
About the Author
Mike Vanscoy is a Principal in SolomonEdwards’ Transaction & Regulatory Advisory Services practice with over 25 years of national and international experience in various aspects of technical accounting and financial reporting, financial and accounting management, audit compliance, financial management standards and internal policies/controls and procedures.
To learn more, connect with Mike on LinkedIn, at mvanscoy@solomonedwards.com or call 610.902.0440.
