Troubled Debt Restructuring (TDR)

Troubled Debts Under U.S. GAAP

Troubled debts or more commonly known as troubled debt restructuring (TDR) is when a creditor restructures or modifies the terms of a loan when a debtor or borrower is financially incapable of paying the loan. Instead of the debtor filing for bankruptcy and leaving the creditor with the entire loan as a loss. In order to minimize the loss to the creditor while assisting the debtor in its financial crisis, can be accomplished by the restructuring of the loan. Now under U.S. GAAP, the location of the explanation for troubled debt restructurings is in ASC 470-60 for Debtors and ASC 310-40 for Creditors.

ASC 470-60 and ASC 310-40

According to ASC 470-60 and ASC 310-40, a troubled debt restructuring is allowable when certain events have happened. In order for a loan to be considered a TDR both creditor and debtor need to agree on the modification of the loan. The first step in doing so is the proof of the debtor absolute inability to pay the original debt. Once the creditor has come to the conclusion that the debtor will no longer be able to pay the loan, the creditor may allow the loan to be restructured. This is better known as concessions.

Several methods are given in ASC 310-40-15-9, such as the reduction or elimination of scheduled interest and principal payments. When the repaying schedule can be extended, a settlement between both parties for cash, other assets, or equity interest. On the other hand, not all reasons are allowed for troubled debt restructuring. ASC 310-40-15-11 considers changes in lease agreements, employment-related agreements, and changes in expected cash flows of a pool of loans not to be a valid reason for consideration for TDR.

Accounting of Modified Loans

The accounting of modified loans or TDR depends on the point of view of the creditor and debtor. The difference in journal entries will be different. Specifically when a loan has been restructured and the interest rate changes from the original rate onto a modified. On the debtor’s ledger, the original ledgers would be DR- Note Payable, Interest Payable, and CR Restructured not Payable. For the Creditor, DR Restructure note receivable, loss on receivable restructuring, CR Note receivable, Interest Receivable. However, these entries do not take into account the new interest rate.

If both parties would account for the change of interest rate in the same year, the debtor would show a loss of value in the loan while the creditor would show no loss in the carry note value. In order to account for the change of interest rate, the FASB mandates for both debtor and creditor to use both interest rate and journalize them for the next two years. This will allow the loan to match between books even though the book value will increase and be different from the initial book value.

Advantage Under U.S. GAAP for Troubled Debt Restructuring

There are advantages for U.S. GAAP guidance for troubled debt restructuring. It allows the creditor to mitigate losses and also allows debtors to continue doing business. By doing this, the market remains steady with no major losses for companies in the economy. Another advantage is that the guidance to use the two interest rates in the books. Using the conservative measurement method, it minimizes the confusion of the new modified interest rate. The conservative measurement method comes with some disadvantages. The most important disadvantage is the initial book value. It will change due to the modification of terms of the loan. The change between the initial book value and the value of the loan at the end of the modified loan will increase. If the loan is a long-term loan, then the difference will exponentially increase.


My recommendation is for U.S. GAAP to use a fair value approach to the valuation of a long term modified loan. Using this approach would minimize the difference between the initial book value and the book value at the end of the loan.

To learn more about Accounting for Securitization of Receivables Under U.S. GAAP, click here.