Example 3.11 and Example 3.12 provide comprehensive illustrations of this guidance.
2.3.2.3. Treatment of a warrant or other sweetener or enhancement in the 10% cash flow test
Relevant guidance: ASC 470-50-40-12A and ASC 470-50-40-17A
Commentary: In some situations, a sweetener might be added to or removed from a loan agreement as
a result of a modification or exchange of the loan. In other situations, the terms of a sweetener included in
the original terms of the loan agreement might be changed. The question that arises in these situations is
how adding, changing or removing a sweetener affects the conclusion about whether there is a
substantial difference between the old loan and the new loan (and, therefore, whether the extinguishment
or modification accounting model should be applied to account for the modification or exchange of the
loan). While GAAP does not explicitly answer this question for sweeteners as a whole, GAAP does
address the treatment of changes in the fair value of freestanding equity-classified written call options that
are modified together with the related debt, stating that the fair value of those changes should be
reflected in the 10% cash flow test. Further, when determining whether a concession has been granted in
a TDR (see Section 2.2.2.2), GAAP requires the effects of any new, revised or removed sweeteners to be
included in the projected cash flows required under the debt after the changes are made even though
adding, revising or removing a sweetener may not always have a direct effect on cash flows. As such,
when performing the analysis as to whether a concession has been granted, the day-one projected cash
flows required under the debt after the changes are made includes the new sweetener’s fair value or the
change in a revised sweetener’s fair value. Based on this guidance, we believe it would also be
appropriate to take this approach when assessing whether there is a substantial difference between the
old loan and new loan when a modification or exchange occurs. In other words, we believe that it would
be appropriate to include a new sweetener’s fair value in the cash flows of the new loan for purposes of
the 10% cash flow test used to determine whether there is a substantial difference between the old loan
and new loan. In addition, if the terms of a sweetener have changed, we believe it would be appropriate
to include the change in the fair value of the sweetener in the new loan’s cash flows for purposes of the
10% cash flow test.
The accounting for the fair value or the change in fair value of a sweetener (e.g., warrant) that is added,
revised or removed depends on whether the extinguishment or modification accounting model should be
applied to the modification or exchange itself. For example, if a loan agreement is modified to include a
warrant and the fair value of that warrant is $1 million, then $1 million would be included in the new loan’s
cash flows for purposes of the 10% cash flow test. In addition, if the modification accounting model is
applicable, the fair value of the warrant would be recognized as a debt discount. In contrast, if the
extinguishment accounting model is applicable, the fair value of the warrant would be taken into
consideration in determining the gain or loss on extinguishment (i.e., it would increase what would
otherwise be a loss or decrease what would otherwise be a gain). The accounting for any equity-linked
sweetener or enhancement, including whether it should be classified as a liability or equity, is addressed
in our debt and equity guide.
2.3.2.4 Reference rate reform
Relevant guidance: ASC 848-10-05, ASC 848-10-15, ASC 848-10-65, ASC 848-20-05, ASC 848-20-15,
ASC 848-20-35-3 to 35-5, ASC 848-20-35-10 and ASC 848-20-55-1
The publication of the London Interbank Offered Rate (LIBOR), which is referenced in approximately
$350 trillion of contracts, is expected to cease after June 30, 2023. In the U.S., the Secured Overnight
Financing Rate (SOFR) has been identified as the preferred alternative to LIBOR as part of reference rate
reform. Reference rate reform will affect entities that have assets, debt instruments, interest rate swap
agreements or other contracts that reference LIBOR or another rate that is expected to be discontinued.
The FASB issued ASU 2020-04 to provide temporary optional expedients and exceptions to the guidance
in GAAP regarding contract modifications, hedge accounting and other transactions to ease the expected