Financing Fees: Debt Issuance Costs in M&A

When a loan is refinanced with the same lender on market terms, the changes in terms are more than minor, and a troubled debt restructuring is not involved, then the refinanced loan is considered a new loan. Any deferred fees and costs on the old loan are written off and new deferred fees and costs are deferred and amortized over the term of the new loan, assuming the loan is held for investment.

• Debt issuance fees refer to expenses that the government or public companies incur in selling bonds.
• If a reporting entity borrows a portion of the debt, only a proportionate amount of the commitment fee asset should be recognized as an adjustment to the amortized cost basis of the debt drawn.
• A payment from a third party to a lender may be characterized as made from the third party to the borrower followed by a payment in the same amount from the borrower to the lender.
• Some troubled thrift institutions were doing this in theS&L Crisisin the 1980s.

This makes it is possible to buy goods or services from a supplier on credit rather than paying cash up front. Bank OverdraftOverdraft is a banking facility that offers short-term credit to the account holders by allowing them to withdraw money from their savings or current account even if their account balance is or below zero.

What is Weighted Marginal Cost?

The usual shortcut for calculating EBITDA is to start with operating profit, also calledearnings before interest and taxes , then add back depreciation and amortization. EBITDA, or earnings before interest, taxes, depreciation, and amortization, is an alternate measure of profitability to net income.

• Operating profit is the total earnings from a company’s core business operations, excluding deductions of interest and tax.
• EBITDA can be used to track and compare the underlying profitability of companies regardless of their depreciation assumptions or financing choices.
• EBITDA is not a metric recognized under generally accepted accounting principles .
• For a $10,000 loan two hundred to six hundred dollars in fees will not greatly affect the income statement results.
• The straight-line method, however, results in a lower rate during the first part of a debt term and higher rate towards the end of the debt term.
• See Debits and Credits in Parenthesis on the Balance Sheet for further guidance.

EBITDAR—an acronym for earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs—is a non-GAAP measure of a company’s financial performance. Working capital trends are an important consideration in determining amortization of deferred financing costs how much cash a company is generating. If investors don’t include working capital changes in their analysis and rely solely on EBITDA, they may miss clues—for example, such as difficulties with receivables collection—that may impair cash flow.

Seed Financing

There are several principles the reader needs to understand to properly calculate and assign these costs to the financial statements. This lesson explains the basic business principlesof amortization of financing costs, organization of information, reporting and interpretation. It is written for bookkeepers, novice accountants and small business owners.

Sometimes the stamp cost is merely a tax and can be written off as an immediate expense. The balance of these costs all relate to the actual loan processing and are accumulated as one summed amount called loan financing costs. If the reporting entity has elected an amortization period from the issuance date to the date the put is first exercisable, then, as of the modification date, any unamortized debt issuance costs, discounts, or premiums should be amortized to the new put date. If the reporting entity has elected an amortization period over the contractual life of the debt instrument, it should continue this policy. A debt discount may reflect fees paid by a reporting entity to a lender as part of a debt issuance or the issuance of debt at a below market coupon. A debt discount is a reduction of the carrying amount of a debt liability. The debt issuance costs should be amortized over the period of the bond using the straight-line method.

Examples of Negative Net Income & Cash Gain in the First Year

Don’t forget, either way it will be expensed over time to the income statement; if aggregated with the fixed asset, depreciation is the method; if included with financing costs, amortization is the tool. The two prepaid items are merely regular costs that are advanced by the borrower and recorded as prepaid expenses in the current assets section of the balance sheet.

EBITDA is a measure of a company’s profitability, so higher is generally better. From an investor’s point of view, a “good” EBITDA is one that provides additional perspective on a company’s performance without making anyone forget that the metric excludes cash outlays for interest and taxes as well as the eventual cost of replacing its tangible assets. Amortization Of Discounts And PremiumsWhen a company issues bonds to investors with a coupon rate that is higher than the market rate of interest, the investors may bid higher than the face value of the bond. The excess premium received is amortized by the company over the bond term, and the concept is known as Amortization of Bond Premium . Equity FinancingEquity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. The money raised from the market does not have to be repaid, unlike debt financing which has a definite repayment schedule. Potentially, then, the IRS would consider these expenses interest for purposes of Sec. 163.

The cable industry pioneer came up with the metric in the 1970s to help sell lenders and investors on his leveraged growth strategy, which deployed debt and reinvested profits to minimize taxes. EBITDA is net income with interest, taxes, depreciation, and amortization added back. EBITDA can be used to track and compare the underlying profitability of companies regardless of their depreciation assumptions or financing choices. EBITDA lets investors assess corporate profitability net of expenses dependent on financing decisions, tax strategy, and discretionary depreciation schedules.

Even if the arranger is a lender, an arrangement fee is not generally required to reduce the issue price of the loan under Regs. The nature of the debt has a big impact on how to account for expenses related to loans. We need to recalculate the interest expense base on effective interest rate (7.23%) rather than old rate.

What is amortization in EBITDA?

When purchasing a loan, either a whole loan, or a participation, the initial investment in the loan should include amounts paid to the seller or other third parties as part of the acquisition. While not technically loan origination costs, they can essentially be treated as such since the treatment of a discount or premium is similar. Since the purchase is not an origination, any internal costs should be expensed as incurred. The basic idea for deferring loan fees is to prevent lenders from writing loans with below market coupon rates and high loan origination fees and front-loading the fee income. Some troubled thrift institutions were doing this in theS&L Crisisin the 1980s. The FASB stepped in and prohibited that practice and at the same time, required lenders to defer some of the origination costs as well.

Cash includes, but is not limited to, currency on hand, demand deposits with banks or financial institutions, and other accounts with general characteristics of demand deposits. Cash equivalents include, but are not limited to, short-term, highly liquid investments that are both readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Amount of cash and cash equivalents, and cash and cash equivalents restricted to withdrawal or usage. On the other hand, Sec. 162 only allows deductions for ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. Generally, payment by one taxpayer of the obligation of another taxpayer is not ordinary and necessary and as such may not be claimed as a deduction under Sec. 162 (Welch v. Helvering, 290 U.S. 111 ). When one taxpayer pays an expense that is properly treated as the obligation of another taxpayer, there is often a recharacterization as first, a payment from the original payer to the proper taxpayer and second, a payment from the proper taxpayer to the payee. Includes commitment fees as an example of a payment for services provided by the lender .