Published Date:
June 8, 2025
Updated Date:
June 15, 2025
Introduction
On April 30, 2025, the Financial Accounting Standards Board (FASB) issued a
proposed Accounting Standards Update (ASU) on “Accounting for Debt Exchanges” to
simplify debt accounting in certain circumstances, making it less complex, less costly,
and more comparable. Specifically, the new guidance would apply to transactions
where a reporting entity pays off a loan using the cash proceeds from issuing new debt
to multiple creditors, with one of the creditors of the new debt being the same as the
creditor (or one of the creditors) of the old debt. The FASB’s new guidance could help
simplify the accounting process for these often-complex debt transactions while still
providing investors with decision-useful financial information.
The goal of this article is to explain debt exchanges, cover the FASB’s proposed
adjustments in greater depth, consider why debt accounting matters, and discuss
related financial reporting issues and implications.
What is a Debt Exchange?
A debt exchange is a transaction in which a reporting entity simultaneously settles an
existing debt with a creditor while issuing new debt to the same creditor. Current
accounting standards can make accounting for debt exchanges complex and expensive
in some situations because companies must complete a quantitative analysis to
determine how to account for the transaction. This is because companies that have a
debt exchange need to figure out which of two accounting methods applies to the
transaction:
1. Extinguishment, where the old debt is derecognized, resulting in a gain or loss,
and the newly issued debt is distinct from the old debt.
2. Modification, where the old debt remains on the books but has modified terms or
characteristics that are not materially different from the original instrument.
When a reporting entity repays an existing debt obligation using the proceeds from a
concurrent issuance of new debt to a different lender, the transaction is always a debt
extinguishment.
However, debt exchanges with multiple lenders can introduce more complexity. The
entity first needs to determine whether the loan issuance is a loan syndication (where
each lender has a separate loan) or a loan participation (where the lead lender
consolidates loans from several parties). If it is a loan syndication, the reporting entity must perform a quantitative analysis generally known as the 10 percent cash flow test
on a creditor-by-creditor basis. Under the 10 percent test, a company compares the
present value (PV) of the cash flows from the old debt with those of the new debt. If the
difference exceeds 10 percent, the transaction qualifies as a debt extinguishment;
otherwise, it is treated as a modification. While this framework works in many situations,
it becomes more challenging in cases involving multiple creditors or embedded features
(e.g., derivatives) because multiple loans may need to be assessed individually and
determining appropriate inputs for the test can be complicated.
How Will the Proposed Guidance Help?
The proposed guidance specifically addresses situations where the new debt has
multiple lenders (such as in a loan syndication) and one of the lenders is the same as
before. Under the proposed ASU, such debt exchanges would be accounted for as debt
extinguishments without further analysis if they meet the following requirements:
- The existing debt is repaid in accordance with its contractual terms (e.g., based
on an existing prepayment option) or repurchased at market terms. - The new debt has multiple lenders and is issued at market terms following the
issuer’s customary marketing process for new debt issuances. 1
The two conditions proposed by the FASB aim to ensure that a debt exchange is
treated as a debt extinguishment only when the repayment of old debt and issuance of
new debt are economically and substantively independent. The first condition helps
demonstrate that the old debt was not settled through a negotiated exchange linked to
the new debt. This helps prevent situations where the terms of repayment are
influenced by the terms of the new issuance. The second condition ensures the new
borrowing was subject to standard market discipline (road shows, etc.), inviting
participation from a broader base of potential lenders, and not structured to favor
existing creditors.2 Together, these conditions provide evidence that the two
transactions are independent, thereby supporting extinguishment accounting.
The proposed guidance simplifies the modification versus extinguishment assessment
process in a targeted way. It helps preparers by removing the burden of performing
complex present value calculations in certain transactions. It also benefits investors by
offering a clearer signal of when a company has meaningfully changed its debt
obligations. Additionally, public accounting and advisory firms that commented on the
proposed ASU supported the general direction of the proposal and suggested that
preparation costs could be lower and accounting outcomes more intuitive under the new
guidance.3
In summary, by clarifying how to treat debt exchanges when the new debt is issued to
multiple creditors, the FASB’s proposal makes the process more intuitive, less costly,
and more reflective of economic substance—without compromising the usefulness of
the resulting financial information.
See “The Story: A Company and Its Debt” for an illustrative example of a debt exchange
within the scope of the FASB’s proposed amendments.
How Debt Accounting Affects Credit Risk and Market Perception
Diversity in debt accounting can lead to diversity in financial reporting outcomes, which
in turn can affect how investors and analysts assess a company’s credit risk and
financial stability. These reporting differences can shape the market’s perception of a
company’s ability to manage its debt and overall financial health.
For example, when an entity accounts for a debt exchange as a modification, the
company simply adjusts the terms and recalculates the effective interest rate of the
existing debt without recognizing any gain or loss in the income statement. This method
may appear less disruptive and can suggest to stakeholders that the company
maintains stable creditor relationships and operates within its existing financing
framework. As a result, modifications often have less impact on the financial
statements, which can help preserve credit ratings and limit market concern.
However, this approach may obscure the economic reality of a transaction—particularly
when the company has effectively settled old debt and replaced it with new obligations.
In such cases, treating the transaction as a modification might understate the
significance of the change and reduce transparency for investors.
In contrast, when a transaction is accounted for as a debt extinguishment, the old debt
is derecognized and the new debt is recognized, with any gain or loss reflected in the
income statement. For investors, this can enhance transparency by clearly indicating
when a company has replaced one debt with another.
However, extinguishments can also signal financial distress to credit rating agencies
and analysts and potentially prompt a credit rating decrease. Similarly, the market may
interpret the debt restructuring as a sign of difficulty in managing debt obligations, which
could negatively affect investor confidence and the firm’s stock price.
Ultimately, the outcome of either extinguishment or modification accounting has real
implications—not just for how the entity records its transactions, but for how
stakeholders view the entity. By clarifying when and how an entity should apply debt
extinguishment, the FASB’s proposed guidance can help ensure that financial reporting
better reflects the underlying economics of debt transactions, while also improving
comparability and market understanding.
Is there a broader issue here?
Debt accounting is a perennial agenda item for the FASB because debt instruments
underpin a vast amount of corporate financing. Their features range from simple term
loans to complex hybrids that demand clear, consistent guidance. Recent proposals,
such as ASU 2024-04 which discussed accounting for convertible debt instruments, aim
to simplify the criteria for determining debt treatment. Debt instruments are not static. As
the financial landscape shifts, so do the ways companies structure their obligations.
Debt structures continually evolve and allow companies to adapt financing
arrangements to present a more favorable financial position. These structural changes
create a need for new financial reporting standards.
Historically, liability accounting has been complicated and required significate estimates
with some liabilities not fully recognized on Day 1. For example, consider the legacy
ASC 840 lease accounting standard. Under this standard, operating leases were treated
as off-balance sheet financing-lessees and recognized only straight-line rent expense
on the income statement while the underlying lease liability and corresponding right-of-
use asset never appeared on the balance sheet. Instead, companies disclosed future
lease payment obligations only in the footnotes or the commitments and contingencies
section, obscuring the full extent of their contractual debt from investors and creditors.
By 2015, the SEC estimated that U.S. companies had nearly $2 trillion in operating
lease commitments hidden off-balance sheet, substantially understating leverage ratios
and misleading those who relied on traditional debt measures. This lack of transparency
prompted calls, culminating in ASC 842, to bring virtually all leases onto the balance
sheet, thereby aligning reported liabilities with economic reality and restoring
comparability across companies and industries.
Throughout the 1990s and early 2000s, corporations created special purpose entities
(SPEs) primarily to isolate liabilities and make equity investments from these SPEs,
showing better liquidity and solvency away from their own financial statements. Enron’s
collapse in 2001 was the quintessential example: hundreds of SPEs (e.g., Chewco,
Raptors) held debt and hedging losses, while Enron guaranteed or funded these entities
off-balance sheet. Synthetic leases were another off-balance sheet device that were
structured as sale-and-leaseback transactions with qualifying accounting terms. They
enabled companies to retain the economic benefits of an asset without recording the
associated liability.
Another example comes from banks and non-financial firms securitizing loans and
receivables—such as mortgages, credit card debt, or trade receivables—by selling them
to SPEs and issuing asset-backed securities. This removed the underlying debt from
the originator’s balance sheet, freeing capital and improving leverage ratios. While legal
and beneficial for liquidity, securitization also masked the concentration of credit risk, as
seen in the 2007–08 financial crisis, where risk-trenching of mortgage-backed securities
obscured the true indebtedness and credit quality of underlying loans.
This ongoing evolution in debt structures presents significant challenges for the FASB.
As companies introduce increasingly innovative and complex financing arrangements,
the boundaries between debt and equity, extinguishment and modification, and other
classifications can blur. This makes consistent classification and measurement more
difficult.
Ambiguities create pressure for the FASB to issue timely guidance that addresses both
the technical details and broader economic substance of financial instruments.
However, the FASB’s ability to respond is constrained by the need for extensive due
process, stakeholder feedback, and alignment with broader accounting objectives such
as comparability and transparency. As a result, the FASB must carefully balance
responsiveness with deliberation to develop guidance that can accommodate innovation
without sacrificing clarity.
These challenges have made it increasingly difficult for companies to apply current debt
accounting rules clearly and consistently. As financial instruments grow more
customized, guidance often falls short, forcing companies to rely on judgment and which
results in inconsistent reporting. Areas like convertible debt, revolving credit facilities,
and debt with performance-based features are especially unclear under existing rules.
These gaps highlight the need for future revisions that offer more straightforward,
principle-based guidance to keep pace with evolving financial practices.
Conclusion
As companies continue to use creative and complex financing strategies, clear and
practical debt accounting guidance is essential. The FASB’s proposed update on
accounting for debt exchanges represents a step forward in reducing unnecessary
complexity while enhancing consistency and transparency in financial reporting. By
targeting specific scenarios that often create confusion—like multi-creditor debt
exchanges—the guidance aims to make accounting more intuitive without sacrificing the
quality of information available to investors. While challenges remain and further
revisions may be needed, the FASB’s work in this space helps ensure that debt
accounting keeps pace with the world.
References
1 Proposed ASU, Accounting for Debt Exchanges
2 Proposed ASU, Accounting for Debt Exchanges—Bases for Conclusions ; Deloitte Heads Up, FASB Proposes Guidance on Accounting for Debt Exchanges
3 FASB Comment Letters on Accounting for Debt Exchanges Exposure Draft
Current Projects Page on Debt Exchanges
FASB PCC Debt Modifications and Extinguishments Memo
ASC 470, Debt
KPMG EITF Agenda Request – Issuance of New Debt to Repay Old Debt
Proposed ASU, Accounting for Debt Exchanges
FASB Board Meeting, Wednesday November 20, 2024
Deloitte Heads Up, FASB Proposes Guidance on Accounting for Debt Exchanges
PwC Viewpoint: Chapter 3, Debt Modification and Extinguishment
PwC In Brief, FASB proposes to simplify accounting for certain debt restructurings
Footnotes
June 8, 2025