Debt Modification Accounting (ASPE)
4. In addition to the 10 percent test, the borrower should apply judgment to assess whether qualitative
factors indicate that a modification is substantial. Some factors to consider may include significant
change in the collateral or a significant change in covenants.
5. If the modifications are substantial, the original liability is removed from the financial statements and a
new liability is recorded at fair value. (Paragraph 3856.27) Any difference between the fair value of
the new liability and the carrying value of the old liability is recognized as a gain or loss in net income.
(Paragraph 3856.A54)
6. If the modifications are non-substantial, the carrying value of the existing liability is adjusted to reflect
the new terms. If there are any costs associated with the new agreement, these are added to the
carrying amount of the liability and amortized over the remaining life of the debt. (Paragraph
3856.A55)
Assessing compliance with covenants and considerations for breach of covenants
7. Some private enterprises may have breached their debt covenants arising from the sudden and
unexpected change in market conditions due to COVID-19.
8. If a covenant has been breached, management should first review lending contracts to assess the
remedies available. For example, there may be a grace period during which the covenant breach can
be remedied. Management should also assess how the breach of covenants on long-term debt may
affect the debt classification on the balance sheet.
9. When a debt covenant is breached, the debt must be classified as a current liability on the balance
sheet unless:
(a) the creditor waives its right to demand repayment for more than a year from the balance sheet
date; or
(b) the debt agreement contains a grace period to remedy the violation, and contractual
arrangements are made to remedy the covenant breach during the grace period. (
Paragraph
1510.14)
10. These remedies could be in the form of revised covenants on the existing loan agreement or
exceptions from meeting certain covenants for a period of time.
11. If a private enterprise has more than one debt facility, it should consider how a covenant violation on
one debt facility affects its other debt facilities. Debt agreements often have cross-default provisions
whereby a breach on one debt facility will trigger a breach on another debt facility. In these situations,
the enterprise would need to remedy the breach by obtaining a waiver for all affected debt facilities, to
classify the debt as non-current.
12. In some cases, a breach on debt covenants can be so significant to the borrower that it creates
uncertainties about the borrower’s ability to continue as a going concern. For example, if the lender
calls its loan and the borrower has no alternative sources of financing, it may be forced to declare
AcSB COVID-19 Resource, May 2020 2