Troubled Debt Restructuring

Many companies carry long-term liabilities. Noncurrent or long-term liabilities are debt obligations the business is not required to pay back for at least a year from the date on the balance sheet. They are recorded at their present value, the principal and interest except future interest is not yet recorded. The principal that is due within the year is classified as a current liability.

When an investor reviews the financial statements in an annual report, it is vital he reads through the notes carefully. Often management will list any restrictions the business is under due to long-term debt covenants.

When a business is even slightly behind in its obligations, the amount can be called due at any time. In this case, the debt should be reclassified as a current liability unless it can be quickly repaid within the grace period allotted.

When a business has difficulty repaying its debts, the creditor may grant concessions to help the debtor refrain from defaulting the loan. This is called “troubled debt restructuring.”

  • Creditor settles debt for noncash assets or stock with less of a market value than the recorded value of the debt. If this occurs, the debtor must report a gain on the restructuring equal to the amount by which the debt exceeds the market value of the assets given the creditor. This amount falls on the income statement as an extraordinary item.
  • Creditor modifies terms of the debt. The debtor in turn agrees to pay more or less than the recorded value of the debt in addition to the interest due. A gain is recorded when the new payment is less than the recorded value which is noted as an extraordinary item.  If the new payment is more than the recorded value, the recorded value is entered as the principal of the restructured debt. The excess amount is labeled as the debtor’s interest expense.