MHM is an independent CPA firm that is a member of Kreston International, a global network of accounting firms. The accounting standard change that required debt issuance costs to be presented as a direct deduction from the principal debt balance rather than as a prepaid asset could impact financial ratios used in debt covenants. This is because it reduces the amount of debt reported on the balance sheet. Companies with debt covenant ratios close to the prescribed thresholds should examine how the standard change may affect those ratios and consider addressing any potential issues with lenders as debt agreements are renewed or refinanced to avoid the risk of default.

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MHM (Mayer Hoffman McCann P.C.) is an independent CPA firm that is a member firm of Kreston International Limited, a global network of independent accounting firms.
A publication of the Professional Standards Group
July 2018
How to Prepare Debt Covenants for Recent Changes to the Accounting for Debt Issuance Costs
Sometimes a revision to an accounting standard will
have an impact that takes a while to become apparent
to the financial reporting community. Accounting
standard changes tend to affect financial statements,
and so changes to the financial statements may affect
the business operations that rely on them, such as
lending arrangements.
Much has been said already about how the major
changes to revenue recognition released under ASC
Topic 606 and the changes to leasing affect the financial
ratios that inform debt covenants. With the focus
on revenue recognition and leasing, however, other
accounting standard changes that could affect financial
reporting may have been overlooked. Such may be the
case with ASU No. 2015-03, Interest – Imputation of
Interest (Subtopic 835-30): Simplifying the Presentation
of Debt Issuance Costs (ASU 2015-03).
What has Changed with Presentation of Debt
Issuance Cost?
The Financial Accounting Standards Board (FASB)
issued ASU 2015-03 to remove inconsistencies with the
treatment of debt issuance costs. Prior to the issuance
of ASU 2015-03, debt discounts and premiums were
presented on the balance sheet differently than debt
issuance costs. With the issuance of ASU 2015-
03, the FASB required that debt issuance costs be
presented as a direct deduction of the principal debt
balance. In other words, the new standard clarifies
that debt issuance costs can no longer be treated as
a prepaid asset. They must be presented in the same
manner as debt discounts and premiums. It went into
effect for fiscal years beginning after Dec. 15, 2015
(generally 2016). Private companies implemented for
interim fiscal periods after Dec. 15, 2016 (generally
2017). Entities retroactively adopted the standard and
adjusted financial statements to account for the effects
of adopting the new standard
Debt Issuance Cost Changes’ Impact on Loan
Covenants
While ASU 2015-03 does not change the amount of
debt issuance costs recognized on the balance sheet,
the new presentation requirements have the potential
to change the amount of debt presented on an entity’s
balance sheet. Many companies had debt issuance
cost that was a prepaid asset, so the change to
presenting debt issuance costs as a direct deduction of
the principal debt balance reduces the amount of debt
and the amount of assets, with the potential to affect the
computation of the related debt covenant ratios.
It is extremely common for financial covenants related to
debt to contain a covenant that relies on a U.S. Generally
Accepted Accounting Principles (GAAP)-compliant
balance sheet. This so-called “rolling” debt covenant
requires debt agreement ratios to be computed based
on the U.S. GAAP in effect at each reporting date.
Companies will need to closely examine their ratios to
determine how they may be affected by the standard,
particularly if they have debt ratios near the prescribed
threshold specified in their financial covenants. Entities
should also examine their agreement terms. Some
agreements may include language that would allow
lending arrangements to be amended should GAAP
affect debt covenant ratios, but others may not, which
could put the borrower at risk of being in default. If a
borrower goes into default, it would need a waiver from
the lender and go back through the time and expense

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Copyright ©2018, Mayer Hoffman McCann P.C. All rights Reserved.
MHM (Mayer Hoffman McCann P.C.) is an independent CPA firm that is a member firm of Kreston International Limited, a global network of independent accounting firms.
877-887-1090 | www.mhmcpa.com | @mhm_pc Mayer Hoffman McCann P.C.
of working with the loan committee.
Considering experiences from this recent change,
and the upcoming significant financial reporting
changes (revenue recognition, leasing and financial
instruments), borrowers may be able to avoid the hassle
of renegotiating lending arrangements if they prepare
projections of the impact of all the changing accounting
standards to gauge just how the changes affect their
financial covenant calculations and work with their
lender to address these changes as debt agreements
are renewed or refinanced.
For More Information
An experienced accounting professional may be able
to assist your organization in understanding the full
ramifications of accounting standard changes. For
more information, please contact James Comito of
MHM’s Professional Standards Group. James can be
reached at jcomito@cbiz.com.