Updated April 2023

CFOs have found themselves in uncharted territory recently. For many, the thought of restructuring in some capacity might have seemed worlds away just a few years ago. But, lo and behold, between a global pandemic, a sideways labor market, skyrocketing inflation and interest rates, and stretched supply chains, many once rock-solid companies have found themselves struggling just to tread water.

Of course, a rampant lack of experience with restructuring accounting only exasperates these challenges. And if you happen to fall into that camp – or maybe just want to put a few insights in your pocket in case you need them down the road – then came to the right place. So join us as we dive into accounting for restructuring, what to look for, and a few tips to set you on the right path.

The Restructuring Spectrum

The term restructuring is one of the most pliable in accounting, encompassing everything from lease contracts and debt modifications for distressed companies to more dire processes like Chapter 11 filings. Put another way, restructuring occurs across a spectrum of circumstances and needs, and can mean different things to different companies at different times.

Obviously, the coronavirus pandemic and litany of other issues we mentioned up top have driven the bulk of the restructuring trend as of late. But in the future, it could be any number of forces, both micro and macroeconomic, that make companies look for ways to shore up their cash flow, revisit their obligations and workforce, and refine their operations. In other words, restructuring has been top-of-mind since 2020, but is in no way relegated to these particular times.

Therefore, whether it's COVID-19, a half-empty manufacturing plant, inflation, an industry-specific change in demand, or something else, restructuring is an evergreen need. Here at Embark, we look at the topic as a spectrum of different processes and actions, where the further a company finds itself along that spectrum, the more severe and far-reaching the restructuring will likely be.

If you're a CEO, CFO, or controller, then the critical first step is identifying where you fall on the restructuring spectrum based on your company's needs, financial circumstances, and future viability. From least severe to most, the following restructuring actions each involve a unique set of accounting considerations that your team will have to address:

• Debt restructuring
• Lease modifications
• Employee terminations
• Pre-bankruptcy actions and reporting
• Formal bankruptcy filing

Contract Modifications & Creditor Negotiations

This highest, least aggressive form of restructuring really stems from two different factors:

• The availability of liquidity, driving debt modification or expanding your borrowing capacity
• Deteriorating financial conditions, leading to an inability to satisfy certain debt covenants and risk default

Naturally, these two factors aren't mutually exclusive of each and typically work hand-in-hand. Other factors – like the interest rate environment, for example – could also be involved but, particularly when there's an economic shock to the system, liquidity and default prevention are the two primary drivers, both directly involved in helping you simply meet your operating expenses – both short-term and long-term – and survive.

Debt Restructuring

A while back, we discussed accounting for debt restructuring due to the impact of COVID-19. However, since the topic is pertinent to an overall look at restructuring and helping leadership hit the ground running, we still want to cover the high-level points in these insights.

When it comes to the financial reporting implications of debt restructuring, it's critical you take into account the different considerations of debt covenant waivers for violations – or potential violations – as well as evaluate the troubled debt restructuring criteria.

Covenant Waivers

First and foremost, remember that covenant waivers don't necessarily constitute a full restructuring of your debt agreement. If there's a particularly restrictive covenant that is the primary source of potential default, then you can request a waiver from your lender specifically on reducing that individual burden.

From an accounting perspective, if you have a covenant violation at the balance sheet date and the lender could demand repayment, then how you account for that violation depends on the circumstances. For instance, if you don't obtain a covenant waiver and the debt agreement provides no grace period, then the debt is obviously current. However, if you receive a waiver after the balance sheet date for a current violation that relaxes the requirement for 12 months, then the debt is noncurrent.

There are other possible scenarios as well, so we urge you to review our previous summary on accounting considerations for debt covenant waivers for a more granular look. Just remember, before you even request a waiver, make sure it extends far enough into the future so you can address the issues at hand and avoid potential issues around going concern. Otherwise, you might find yourself in the same boat soon after the waiver expires.

Troubled Debt Restructurings (TDRs)

A debt modification is considered a TDR when a lender grants you a concession due to financial difficulties that it wouldn't otherwise consider. This will require borrowers to assess their situation both quantitatively and qualitatively to determine if the restructuring qualifies as a TDR. As you might guess, the accounting considerations from a TDR can be quite burdensome and require expertise, experience, and a whole lot of high-octane coffee.

For obvious reasons, there has been a sudden and dramatic rise in such financial difficulties recently, primarily from severe cash flow restraints.

Lease Modifications

Once again, back in the COVID-19 days, we discussed many of the lease accounting considerations that should be on a company's radar. But given the enduring attention on rent concessions since then, it only makes sense to quickly revisit the subject as it pertains to restructuring.

Long story short, you’ll want to consult the lease accounting gospel – ASC 842 – for the overall lease modification process. And that begins by determining if you have an enforceable right to a rent concession under your lease contract. If you don't, then account for the concession as a modification of the original lease.

If you do have such an enforceable right, you must then determine if other changes or amendments to the original lease terms were made during your negotiations. If they were, then consider it a modification of the original lease. If not, then consider the concession a variable lease payment under the original contract. In this case, you would account for it as a negative lease payment.

Other Contract Modifications

Debt restructuring and lease modifications might be the most timely and relevant contract modifications in recent years, but they certainly aren't the only ones. For modifications not specifically addressed under US GAAP, then ASC 420, Exit or Disposal Cost Obligations, is close to the guidance catch-all.

The accounting standards under ASC 420 are pretty straightforward, where you measure any liability associated with other contract terminations at fair value and as you incur it. Our advice is to avoid recognizing such liabilities too early. Even if you have a restructuring plan in place and intend on canceling various contracts with termination penalties and other costs, the guidance states that you don't account for them until the event that actually gives rise to the corresponding liability occurs.

Granted, aside from debt and leases, other potentially tricky line items like contractual termination benefits, asset retirement obligations, and impairment-related items are outside the scope of ASC 420. Still, for the most part, the vast majority of contract modification issues outside of those specific topics will fall under ASC 420.

Employee Termination Benefits

We mentioned termination benefits, which, of course, have been very top-of-mind lately with layoffs and, later, a topsy-turvy labor market driving headlines. But it's a complex topic that veers in different directions, depending on the circumstances. So before we proceed to other forms of restructuring, we wanted to provide a bit of detail on the accounting for various termination costs and employee benefits.

ASC 420 does, in fact, provide guidance on one-time termination benefits given to current employees that are involuntarily terminated. The key here – those benefits are not part of an ongoing benefit arrangement. A typical severance payment is the most obvious example of this type of restructuring charge.

Alternatively, the termination benefits could be contractual, either stated explicitly in an employee's contract, part of an overarching severance policy, or mutually understood – generally based on consistent past practices warranting a “substantive plan.” In these cases, you would then account for these restructuring costs according to ASC 712, Compensation, Nonretirement Postemployment Benefits.

Pre-Bankruptcy Reporting

Let's say you've implemented some – maybe even all – of the restructuring actions we've discussed thus far, but cash flow remains tight and finances shaky. While you haven't passed the point-of-no-return yet, it's time to start making some preparations if Chapter 11 now seems more likely. And that process begins with your financial reporting.

As you know, management is obligated to keep a constant eye on the road ahead, most notably by performing interim and annual going concern assessments. This is where management evaluates events or conditions that may give rise to substantial doubt within twelve months of the expected issuance date of your financial statements.

Given the amount of uncertainty of late, most SEC companies included some sort of risk factor disclosure in some of their filings, at least going back three years or so. However, a simple risk factor disclosure is a far cry from disclosure requirements around going concern.

In other words, if you initially raised substantial doubt around going concern but created a plan to mitigate the risk, there are disclosure requirements to provide the financial statement users with essential details on what gave rise to the initial doubt along with your actions to alleviate the doubt.

Likewise, if your plan is unsuccessful and substantial doubt festers, then you're still going to face significant disclosure requirements, just from the other side of the going concern coin. In this scenario, you must include language stating that substantial doubt about the reporting entity’s ability to continue as a going concern exists. Either way, ASC 205-40 provides the guidelines you'll need.

Formal Bankruptcy Filing

Obviously, you would prefer things not to get this far, but, depending on the environment and circumstances, formal bankruptcy is sometimes inevitable. But that's not to say Chapter 11 is the death knell for your company. In fact, if you emerge from the process with a clear understanding of your responsibilities going forward and a promising exit plan, bankruptcy really could be a springboard to a brighter future.

From an accounting perspective, your team must be well acquainted with fresh start accounting, if you even qualify for it, the considerations and exit activity involved, and what it entails for your company emerging from bankruptcy. And just as before, although we have provided in-depth insights on fresh start accounting, we still want to review it at a high level to demonstrate how it fits into our restructuring discussion.

Fresh Start Accounting: An Overview

As you emerge from Chapter 11, the FASB allows you – in most cases – to essentially create a new reporting entity that, for the most part, is completely separate from the entity you've left behind. You establish and work from a new reorganization value that becomes the starting point for your financial accounting going forward.

However, as beneficial as a "fresh start" is to the future viability of your company, the severity of Chapter 11 means that you shouldn't confuse a fresh start with a simple one. Your reorganization – which is essentially a massive restructuring – will likely affect everything from your capital structure and asset valuations to your obligations and taxes. And as you would expect, your disclosures will play an instrumental role in helping the public make sense of the significant changes occurring within your financial reporting.

While we urge you to read over our specific thoughts on Chapter 11 and fresh start accounting, most companies find it best to bring in third-party experts to help with the process, particularly regarding asset valuations and tax considerations.

Remember, as a distressed company that isn't necessarily familiar with these new surroundings, the critical first step is to get your bearings and identify a game plan that works best for you. Restructuring could be as simple as modifying a debt obligation or two, but it could also mean a complete reorganization in bankruptcy court.

However, as we discussed, there are several nuanced levels between those two polar opposites. Wherever you find yourself on the restructuring spectrum, just be sure to enter into it fully informed of your requirements and don't hesitate to bring in specialists if needed. The stakes are simply too high to cut any corners.