India's external debt has increased steeply year-on-year to $334.91 billion as at end-December 2011 This is because of a sharp increase in commercial borrowings, export credits and short-term debts.

A large part of the debt — approximately 43 per cent or $137 billion (as of June 2011) is classified as short-term (based on the residual maturity) and is coming up for repayment.

Given the prevailing economic uncertainty, companies may face some issues in negotiating extensions or roll-overs from the lenders. At the same time, it would be important to assess the impact of refinancing from a financial reporting perspective.

In the absence of comprehensive guidance under Indian GAAP, the implications may vary from simple replacement of one debt with another, to potential direct impact into equity, depending upon the accounting followed for existing debt instruments. For companies reporting or evaluating impact under IFRS, the following will be relevant:

Modification of existing debt

Companies may choose to extend or modify or replace existing debt (“revised debt arrangement”) instead of settling it in full.

In case that happens, the terms of the revised debt arrangement should be carefully studied to determine whether the revised debt arrangement is (1) a modification of the existing debt or (b) considered as a new debt. This is determined based on whether the change in terms is considered substantial or not and some of the factors that are considered include:

Differences in the present value of the cash flows under the new and old terms;

Currency of the debt;

Interest rates;

Conversion features.

A substantial modification in the revised debt arrangement will mean that the existing debt has been replaced with a new one and the company would record a gain or loss for the settlement of the old debt.

The unamortised cost of the existing debt will also be considered in calculating the gain or loss on settlement.

A less than substantial modification in the revised debt arrangement with the same lender(s) will mean that the existing debt has been modified; and the unamortised cost associated with the existing debt, along with the incremental cost associated with the revised debt arrangement, will be accounted over the term of the revised debt arrangement using the effective interest rate method.

Term extending options

Sometimes, clauses are included in debt instruments that allow the issuer to extend the debt's term beyond its original maturity.

An automatic provision to extend the remaining term-to-maturity of the loan, without adjusting the interest rate, could result in the interest rate being different from the then prevailing market rate and may need to be accounted for as a derivative instrument. When the revised debt arrangement is considered as a new debt, as opposed to modification of the existing debt, some other implications that require evaluation include:

Debt versus equity classification : Each new debt needs to be evaluated between debt or equity classification, considering the terms of the instrument, especially in structured instruments like foreign currency convertible bonds.

Debt issuance costs : Incremental costs associated with the revised debt arrangement should be deferred and amortised over the new debt's loan term using the effective interest rate method.

Prepayment options : Prepayment options could be embedded derivatives that need to be accounted separately in the financial statements, with few exceptions. These exceptions could be on prepayment with market adjusted value or covering loss of interest to the lender, etc.

Foreign currency debts : Implications of these debts include re-measurement at each balance-sheet date and related characterisation of such loss between interest expense and forex fluctuation.

Compliance with covenants

As banks get more stringent and creative with covenants, companies must study them carefully to ensure that they will be and are compliant.

(The author is Associate Director, Price Waterhouse.)

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