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Financing Fees

Financing Fees are NOT treated as an Amortizing Asset (US GAAP Convergence with IFRS)

Last Updated April 20, 2023

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What are Financing Fees?

When a company borrows money, either through a term loan or a bond, it usually incurs third-party financing fees (called debt issuance costs). These are fees paid by the borrower to the bankers, lawyers and anyone else involved in arranging the financing.

Prior to April 2015, financing fees were treated as a long-term asset and amortized over the term of the loan, using either the straight-line or interest method (“deferred financing fees”).

In April 2015, FASB issued ASU_2015-03, an update that changes how debt issuance costs are accounted for. Effective December 15, 2015, an asset will no longer be created, and the financing fee will be deducted from the debt liability directly as a contra-liability:

To simplify presentation of debt issuance costs, the amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.

– Source: FAS ASU 2015-03

Debt Issuance Costs

Companies will thus report debt figures on their balance sheet, net of debt issuance costs, as you see below for Sealed Air Corp:

Financing Fees Example

This does not change the classification or presentation of the related amortization expense, which over the term of borrowing will continue to be classified within interest expense on the income statement:

Amortization of debt issuance costs shall be reported as interest expense

Source: FAS ASU 2015-03

The update impacts both private and public companies and applies to term loans, bonds and any borrowing that has a defined payment schedule. Below is an example of debt issuance costs treatment pre- and post-ASU 2015-03.

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Financing Fees Calculation Example

A company borrows $100 million in a 5-year term loan and incurs $5 million in financing fees. Below is the accounting at the borrowing date:

Financing Fees ASU

Financing Fees: Accounting Journal Entry (Debit and Credit)

Below are the journal entries laid out explicitly over the next 5 years:

FASB Financing Fees

Revolver Commitment Fees are Still Treated as a Capital Asset

The changes prescribed under ASU 2015-03 for debt issuance costs associated with term loans and bonds do not apply to commitment fees paid to revolving credit lenders and are still treated as a capital asset. That’s because FASB views the commitment fee as representing the benefit of being able to tap the revolver in the future, as opposed to a third-party related fee with no discernible long-term benefit. That means that commitment fees continue to be capitalized and amortized as they have been in the past.

Purpose of the Accounting Rule Change

The purpose of the change is part of a broader effort by FASB to simplify its accounting rules. The new rules now align with FASB’s own rules for debt discounts (OID) and premiums (OIP) as well as with IFRS treatment of debt issuance costs. Prior to the update, debt issuance costs were treated as an asset while debt discounts and premiums directly offset the associated liability:

The Board received feedback that having different balance sheet presentation requirements for debt issuance costs and debt discount and premium creates unnecessary complexity.

– Source: FAS ASU 2015-03

Conceptually, since debt issuance fees provide no future economic benefit, treating them as an asset prior to the update conflicted with the basic definition of an asset:

Additionally, the requirement to recognize debt issuance costs as deferred charges conflicts with the guidance in FASB Concepts Statement No. 6, Elements of Financial Statements, which states that debt issuance costs are similar to debt discounts and in effect reduce the proceeds of borrowing, thereby increasing the effective interest rate. Concepts Statement 6 further states that debt issuance costs cannot be an asset because they provide no future economic benefit.

– Source: FAS ASU 2015-03

The change also aligns US GAAP with IFRS in this regard:

Recognizing debt issuance costs as a deferred charge (that is, an asset) also is different from the guidance in International Financial Reporting Standards (IFRS), which requires that transaction costs be deducted from the carrying value of the financial liability and not recorded as separate assets. – Source: FAS ASU 2015-03

Financing Fees in M&A and LBO Models

Those that are involved in modeling M&A and LBO transactions will recall that prior to the update, financing fees were capitalized and amortized while transaction fees were expensed as incurred.

Going forward, transaction professionals should take note that there are now three ways that fees will need to be modeled:

  1. Financing fees (term loans and bonds): Directly lower the carrying value of the debt
  2. Financing fees (for revolvers): Capitalized and amortized
  3. Transaction fees: Expensed as incurred

So much for simplifying things.  For what it’s worth, FASB did consider expensing the financing fees, aligning the treatment of financing fees with transaction fees, but decided against it:

The Board considered requiring that debt issuance costs be recognized as an expense in the period of borrowing, which is one of the options to account for those costs in Concepts Statement 6. …The Board rejected the alternative to expense debt issuance costs in the period of the borrowing. The Board concluded that this decision is consistent with the accounting treatment for issuance costs associated with equity instruments as noted in the preceding paragraph.

– Source: FAS ASU 2015-03

Financing Fee Treatment in Financial Modeling

Effective December 15, 2015, FASB changed the accounting of debt issuance costs so that instead of capitalizing fees as an asset (deferred financing fee), the fees now directly reduce the carrying value of the loan at borrowing. Over the term of the loan, the fees continue to get amortized and classified within interest expense just like before. The new rules don’t apply to commitment fees on revolvers. As a practical consequence, the new rules mean that financial models need to change how fees flow through the model. This particularly impacts M&A models and LBO models, for which financing represents a significant component of the purchase price. While ignoring the change has no cash impact, it does have an impact on certain balance sheet ratios, including return on assets.

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John
January 1, 2023 3:49 am

Hi,

Would the Amort of DFF or OID be added back to EBITDA and is it included in EBIT? I believe it is not because it is not an operating expense / not core to business.

Thanks – John

Brad Barlow
January 2, 2023 3:00 pm
Reply to  John

Hi, John,

That’s correct! Amortization of this sort is included in interest expense, so it is part of neither EBIT nor EBITDA.

BB

Sarah
December 31, 2021 12:36 am

Assume an investor bought a note (face value of $1,000) at $950 AND paid $200 fees for legal opinions. Further assume the $200 is not expenses immediately, then what is the book value/carrying value of the debt investment on the investor’s balance sheet? Is it $970? What are the journal… Read more »

Jeff Schmidt
December 31, 2021 10:49 am
Reply to  Sarah

Sarah:

I believe the carrying value on the balance sheet would be the face value, less the discount ($50) less the debt underwriting/legal fees. Those fees would be amortized over the life of the debt.

Best,
Jeff

Sarah
December 31, 2021 11:52 am
Reply to  Jeff Schmidt

Jeff, Thank you very much for your response. First of all I apologize for a number error in my example, I meant to say the investor incurred $20 (not $200) fees for legal opinions. So on the investor’s balance sheet, I would think the $20 should be added to the… Read more »

Jeff Schmidt
December 31, 2021 12:31 pm
Reply to  Sarah

Sarah:

Financing fees and arrangements reduce the carrying value of the debt so it should $930 on the balance sheet.

Best,
Jeff

Sarah
December 31, 2021 12:37 pm
Reply to  Jeff Schmidt

Jeff, I understand that the financing fees incurred by the borrower/bond issuer are essentially treated as bond discount, i.e., reduce the carrying value of the liability on the borrower’s balance sheet. Are you saying this is also the case when the investor incurs such fees, i.e., the fees reduce the… Read more »

Jeff Schmidt
December 31, 2021 2:35 pm
Reply to  Sarah

Sarah: Sorry, I assumed that since this was written on an article about debt financing fee treatment I assumed that was what you were asking about. An individual investor would carry the bond at its market value. A corporation has different ways to account for this investment. In my mind… Read more »

Fernando Garcia
July 8, 2020 7:03 am

As of 2020, if the debt is refinanced or repaid before maturity, what’s the treatment of the previous financing fee that have been amortized over the period? How does it flow on the three statements?

Jeff Schmidt
July 8, 2020 7:50 am

Fernando:

It would be removed and hit the income statement, usually as a loss on early extinguishment of debt (assuming the refinancing qualifies as an extinguishment… the accounting for this is well beyond our scope but essentially depends on the differences between the new and old debt).

Best,
Jeff

Fernando Garcia
July 8, 2020 11:17 pm
Reply to  Jeff Schmidt

Would the line item be called Financing Fees Write-down? Then it is added back on cash flow statements? Hence, on B/S, it would be Cash – increased by tax benefit of the write-down Financing fees – reduced to zero (it is an add-back to debt since it is contra-liability) Retained… Read more »

Jeff Schmidt
July 9, 2020 8:14 am

Fernando: No, it would be embedded in the loss on early extinguishment of debt. Also, write-downs by and large are not tax deductible (although I’m sure there are exceptions) so I wouldn’t ascribe a tax shield to this. But, as always, consult with a professional tax advisor before doing this.… Read more »

Juan Manuel
June 13, 2020 9:23 pm

Hello,

I am confused as to what the different accounting entries would be in the case that the term loan was amortized annually (say 20% each year). Could you please shed some color on that?

Thanks!

Jeff Schmidt
June 14, 2020 1:20 pm
Reply to  Juan Manuel

Juan:

Debit Term Loan
Credit Cash

Best,
Jeff

Juan Manuel
June 14, 2020 3:58 pm
Reply to  Jeff Schmidt

But with regards to the financing fees, could you tell me if the following entries are correct? The company takes out a 5-year, $100 term loan, which amortizes 20% annually and the company incurs in $5 of financing fees securing the loan. In year 0, Cash goes up by $95,… Read more »

Jeff Schmidt
June 14, 2020 4:20 pm
Reply to  Juan Manuel

Juan: Your journal entries are correct. Don’t forget that with a declining debt balance interest expense will go down. The financing fees are amortized over the life of the debt, in this case five years, and are typically included in interest expense. But to your point, the financing fees don’t… Read more »

Juan Manuel
June 14, 2020 5:13 pm
Reply to  Jeff Schmidt

Understood, thanks so much!

Carlos Melgarejo
June 9, 2020 11:00 pm

I assume that there won’t be any change on the IS meaning that those 1 million per year will still have a negative impact on a per-year basis? Is that right?

Jeff Schmidt
June 10, 2020 10:29 am

Carlos:

That is correct. The I/S impact is essentially the same; it’s the B/S that has the change.

Best,
Jeff

Matt
May 2, 2020 1:55 pm

Dear all, I’m really wondering how the amortization is adjusted once the principal gets repaid annually – is the treatment similar to OIDs, where one has to adjust “loss on unamortized OID”? It would make sense in my opionion, otherwise the financing fees would be just based on a theoretical… Read more »

Jeff Schmidt
May 2, 2020 6:26 pm
Reply to  Matt

Matt:

Yes, that is correct… the treatment is the same.

Best,
Jeff

Eugene
September 7, 2021 6:41 pm
Reply to  Matt

Matt, I also wanted to raise this topic for a long time because I didn’t really understand why this happens , this loss on umortized OID occurs, could you please tell me conceptually why this occurs? Maybe with examples or in some more detail, I would be very grateful to… Read more »

Jeff Schmidt
September 8, 2021 11:20 am
Reply to  Eugene

Eugene:

This really gets beyond our scope but the basic idea is that deferred financing fees are tax deductible over the life of the debt and if the debt is refinanced then the remaining unamortized debt issuance costs are immediately deductible.

Best,
Jeff

Joe
January 9, 2020 7:25 pm

Just curious, when calculating Firm Value (i.e. Equity Value + net debt + Prefered sec + NCI), do you used the actual principal that is due ( I.e. principal not principal less issuance costs)?? Also, should weights for calculating cost of debt be based around the actual principal, not principal… Read more »

Jeff Schmidt
January 10, 2020 6:05 pm
Reply to  Joe

Joe:

Great question. Yes, it is technically more proper to use the actual principal amounts that are to be paid. Having said that, in my experience, most analysts tend to use the balances net of issuance costs as the difference is usually pretty small.

Gig Em,
Jeff

Kay Lu
October 6, 2019 7:46 pm

For commitment fee on revolver, what should the useful life of amortization be? For example, if, from Year 1 to Year 5, the company pays $100k commitment fee, then what should be the amount of amortization for each year? Is Year 1 amortization = $100k / 5, Year 2 amortization… Read more »

Jeff Schmidt
October 7, 2019 3:55 pm
Reply to  Kay Lu

Kay: So our reading has a typo. Revolver financing fees are still treated as assets and amortized over the life of the revolver. However, commitment fees are what the bank charges on the unused revolver balance and is aggregated into interest expense. There is no useful life for the commitment… Read more »

Kay Lu
October 9, 2019 12:03 am
Reply to  Jeff Schmidt

Thank you so much Jeff!

Jeff Schmidt
October 9, 2019 3:51 am
Reply to  Kay Lu

Kay:

Thanks!

Best,
Jeff

FrancesD
September 12, 2019 5:48 pm

If you prepay a lump-sum of a term loan, but do not pay it all off, by taking out new debt at a lower interest rate in order to use those funds to pay off the term loan that was at a higher interest rate, what do you do with… Read more »

Jeff Schmidt
September 16, 2019 2:12 pm
Reply to  FrancesD

Frances:

This is definitely beyond our curriculum but it would depend on the size of the paydown and if cash flows change by 10%. If post-paydown cash flows change by 10% it should sounds like an extinguishment. If less than 10%, it would likely be a modification.

Best,
Jeff

JP Leonard
September 5, 2019 11:22 pm

If a prepayment fee is incurred in order to refinance debt at a lower rate, can the prepayment fee be treated as a financing fee and deferred over the life of the new debt? Thought being that the prepayment fee was only incurred to obtain new lower rates. ASU 2016-15… Read more »

Jeff Schmidt
September 8, 2019 4:54 pm
Reply to  JP Leonard

JP:

Based on a cursory review there seems to be some debate about the proper treatment. I think for financial modeling purposes the amount should be fairly minor so I would probably just expense it.

Best,
Jeff

Phyu
August 22, 2019 11:55 pm

How should treat payment of bank loan commitment fees on cash flow statement? I am not so sure whether operating or financing activities. Can someone assist me?
Thanks

Jeff Schmidt
August 27, 2019 8:00 pm
Reply to  Phyu

That is usually included in interest expense so it would be an operating activity.

Best,
Jeff

bev
May 25, 2019 8:44 am

When a loan is prepaid, with a fund raise. What is the offset for the debt discount?
Debit Loan Payable 10M
Credit Debt Discount 1.2M
Credit Cash 10.3M . (loan valude 10M, prepaid penalty 200k, 100k legal cost)
thanks

Jeff Schmidt
May 25, 2019 3:24 pm
Reply to  bev

Bev:

Your journal entries are almost correct. You would need to debit Loss on early extinguishment of debt by 1.2mm plus the penalty and legal costs of $300k.

Best,
Jeff

Ben Bryer
January 8, 2019 1:13 pm

Using the post-2015 accounting treatment of financing fees, would the incremental annual amortization of the contra liability account that is recognized in interest expense need to be added back to net income to compute cash flow from operations? thank you

Haseeb Chowdhry
January 8, 2019 1:37 pm
Reply to  Ben Bryer

Ben,

Yes – correct, b/c the amortization is non-cash.

– Haseeb

Ben Bryer
January 8, 2019 1:40 pm

also, can you please review how the OID is treated? I believe it is essentially amortized over the tenor of the debt, and shown as a cash outlay each year. is that correct?

Haseeb Chowdhry
January 8, 2019 3:19 pm
Reply to  Ben Bryer

Ben, We go into this accounting treatment in detail on the Advanced Accounting course. There’s an implied IRR calculation based on the initial price and amount due at maturity. Based on that IRR, you calculate the implied interest expense amortization that in included (non-cash) within interest expense, and then gets… Read more »

Jim Tse
August 23, 2018 2:13 am

If the debt is refinanced or repaid before maturity, what’s the treatment of the financing fee? How does it flow on the three statements?

Haseeb Chowdhry
October 17, 2018 3:16 pm
Reply to  Jim Tse

Jim, The financing fee would be written off immediately. As such, the unamortized fees would be immediately recognized as interest expense on the I/S, you would see a non-cash add-back on the CFS, and the ending balance of unamortized fees (the contra liability account) would be brought to 0. Hope… Read more »

Brian Myers
December 19, 2018 11:15 am

Jim – would the amortized deferred financing cost be written of as interest expense on the P&L, or as “Loss on debt extinguishment”?

Thanks,
Brian

Haseeb Chowdhry
December 19, 2018 5:26 pm
Reply to  Brian Myers

Brian, My apologies – this would be booked as a gain or loss on debt extinguishment within the income statement. They used to exclusively be booked as extraordinary items on the I/S. In fact, FASB ASC 470-50-45: Debt-Modifications and Extinguishments-Other Presentation Matters now states that they are classified as an… Read more »

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