ASC

ASC 470-30

Participating Mortgage Loans

470 Debt

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In brief

IntermediateRecognitionSubsequent measurementDisclosureFair value

ASC 470-30 governs how a *borrower* accounts for a participating mortgage loan — a mortgage in which the lender is entitled to share in appreciation in the fair value of the mortgaged real estate project, in its results of operations, or both. If the lender participates in fair value appreciation, the borrower recognizes a participation liability at the fair value of the participation feature at loan inception with an offsetting debt discount, remeasures the liability to current fair value each reporting period (adjusting the discount), and amortizes the discount to interest expense using the interest method. Participations in results of operations are charged to interest expense in the period incurred with a credit to the participation liability.

Key points (7)
  • A participation liability with a corresponding debit to a debt discount account is recognized when the lender is entitled to participate in appreciation in the market value of the mortgaged real estate project (470-30-25-1).
  • The participation feature is measured at fair value (per Subtopic 820-10) at inception of the loan (470-30-30-1).
  • Interest expense has three components: stated interest, amounts for the lender's participation in results of operations, and amortization of the debt discount related to participation in fair value appreciation (470-30-35-2); the discount is amortized by the interest method using the effective interest rate (470-30-35-1).
  • At the end of each reporting period the participation liability is adjusted to the current fair value of the participation feature, with the offsetting debit or credit to the debt discount account (470-30-35-4A), and the revised discount is amortized prospectively at the effective interest rate (470-30-35-5).
  • Amounts due for participation in results of operations are charged to interest expense in the corresponding reporting period with a credit to the participation liability (470-30-35-4); stated interest is charged to income as incurred, based on the index/rate as it changes, and is subject to Subtopic 835-20 capitalization rules, with capitalized amounts not adjusted for reversals of appreciation (470-30-35-3).
  • Early extinguishment produces a gain or loss equal to the difference between the recorded amount of the debt (including unamortized discount and the participation liability) and the amount exchanged, reported as required by 470-50-40-2 (470-30-40-1; 470-30-45-2).
  • Borrowers must disclose the aggregate amount of participating mortgage obligations at the balance sheet date, separately showing aggregate participation liabilities and related debt discounts, plus the terms of the lender's participations (470-30-50-1).

For students. Exam traps: this Subtopic applies only to borrowers (not lenders) and excludes participating leases, lender-option equity-convertible debt, and participations arising from troubled debt restructurings. Remember the participation liability is remeasured to fair value every period through the debt discount (not through earnings directly) — earnings are affected only via prospective amortization of the revised discount.

participating mortgage loanparticipation liabilitydebt discountinterest methodeffective interest ratefair value appreciation participationparticipation in results of operationsdebt extinguishment gain or loss

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470-30-00Status

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470-30-05Overview and Background

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470-30-05-1
This Subtopic establishes the borrower's accounting for a participating mortgage loan if the lender is entitled to participate in any of the following:
  1. a
    Appreciation in the fair value of the mortgaged real estate project
  2. b
    The results of operations of the mortgaged real estate project.
470-30-05-2
The desire for instruments in which the return to the lenders was tied more closely to the performance of the property led to the introduction of participating mortgage loans.
470-30-05-3
Participating mortgage loans and nonparticipating mortgage loans share all of the following characteristics:
  1. a
    Debtor-creditor relationships between those who provide initial cash outlays and hold the mortgages, and those who are obligated to make subsequent payments to the mortgage holders
  2. b
    Real estate collateral
  3. c
    Periodic fixed-rate or floating-rate interest payments
  4. d
    Fixed maturity dates for stated principal amounts.
470-30-05-4
However, unlike a nonparticipating mortgage loan arrangement, in a participating mortgage loan, the lender participates in appreciation in the fair value of the mortgaged real estate project or the results of operations of the mortgaged real estate project, or in both.
470-30-05-5
The terms and economics of participating mortgage loan agreements vary by agreement. The terms and economics of one agreement may create a circumstance in which any participation payment is remote. In another agreement, the terms and economics may transfer many of the risks and rewards of property ownership.
470-30-05-6
A lender may be entitled to participate in appreciation in the fair value of a project at any one of the following times:
  1. a
    Upon the sale of the project
  2. b
    At a deemed sale date
  3. c
    At the maturity or refinancing of the loan.
470-30-05-7
In agreements in which lenders participate in results of operations, the definition of the results of operations may vary among agreements. Examples of these definitions include, but are not limited to, the following:
  1. a
    Revenue
  2. b
    Income
  3. c
    Cash flows before or after debt service.
470-30-05-8
The participation terms of a participating mortgage loan agreement usually are negotiated concurrently with the other terms of the underlying mortgage loan. A borrower agrees to participation rights generally because of market conditions, or in exchange for concessions granted by the lender on some other term(s) of the loan, such as a lower interest rate or a higher loan-to-value ratio.
470-30-05-9
The lender's participation reduces the borrower's potential realization of operating results or gain on the sale of the real estate. However, the participation also may reduce any of the following:
  1. a
    The contract interest the borrower is required to pay
  2. b
    The risk that the borrower will be unable to pay interest at the stated or floating rate in the loan agreement and, consequently, the risk that the borrower will default on the loan and need to sell the property
  3. c
    The amount of capital the borrower has at risk, because the loan-to-value ratio normally is higher.
Further, the obligation to pay the lender a share of the property appreciation does not increase the current exposure of the borrower to loss in its investment, because the participation payments are made only if the fair value of the property appreciates.

470-30-15Scope and Scope Exceptions

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Entities

470-30-15-1
The guidance in this Subtopic applies to the following entities:
  1. a
    All borrowers in participating mortgage loan arrangements.
470-30-15-2
The guidance in this Subtopic does not apply to the following entities:
  1. a
    Creditors in participating mortgage loan arrangements.

Transactions

470-30-15-3
The guidance in this Subtopic does not apply to the following transactions and activities:
  1. a
    Participating leases
  2. b
    Debt convertible at the option of the lender into equity ownership of the property
  3. c
    Participating loans resulting from troubled debt restructurings.

470-30-25Recognition

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470-30-25-1
If a lender is entitled to participate in the appreciation of the market value of a mortgaged real estate project, the borrower shall recognize a participation liability with a corresponding debit to a debt discount account.

470-30-30Initial Measurement

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470-30-30-1
If the lender is entitled to participate in appreciation in the fair value of the mortgaged real estate project, the borrower shall determine the fair value (see Subtopic 820-10) of the participation feature at the inception of the loan (see paragraph 470-30-25-1 for guidance on how to recognize the participation feature).

470-30-35Subsequent Measurement

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470-30-35-1
The debt discount shall be amortized by the interest method, using the effective interest rate.
470-30-35-2
Interest expense on participating mortgage loans consists of the following three components:
  1. a
    Amounts designated in the mortgage agreement as interest
  2. b
    Amounts related to the lender's participation in results of operations
  3. c
    Amortization of debt discount related to the lender's participation in the fair value appreciation of the mortgaged real estate project.
470-30-35-3
Amounts designated in the mortgage agreement as interest shall be charged to income in the period in which the interest is incurred. If the loan's stated interest rate varies based on changes in an independent factor, such as an index or rate (for example, the prime rate, the London Interbank Offered Rate [LIBOR], or the U.S. Treasury bill weekly average rate), the calculation of the interest shall be based on the factor (the index or the rate) as it changes over the life of the loan. Interest recognized pursuant to this guidance is subject to the requirements of Subtopic 835-20. Once capitalized, amounts shall not be adjusted for the effects of reversals of appreciation.
470-30-35-4
Amounts due to a lender pursuant to the lender's participation in the real estate project's results of operations (as defined in the participating mortgage loan agreement) shall be charged to interest expense in the borrower's corresponding financial reporting period, with a corresponding credit to the participation liability.
  1. a
    Subparagraph superseded by Accounting Standards Update No. 2015-10.
  2. b
    Subparagraph superseded by Accounting Standards Update No. 2015-10.
470-30-35-4A
If a lender is entitled to participate in the appreciation of the market value of a mortgaged real estate project, both of the following are required at the end of each reporting period:
  1. a
    The balance of the participation liability shall be adjusted to equal the current fair value of the participation feature.
  2. b
    The corresponding debit or credit shall be recorded in the related debt-discount account.
470-30-35-5
The revised debt discount shall be amortized prospectively, using the effective interest rate.

470-30-40Derecognition

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470-30-40-1
If the participating mortgage loan is extinguished before its due date, the difference between the recorded amount of the debt (including the unamortized debt discount and the participation liability) and the amount exchanged to extinguish the debt is a debt extinguishment gain or loss.

470-30-45Other Presentation Matters

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470-30-45-1
The amortization of the debt discount relating to the participation liability shall be included in interest expense.
470-30-45-2
If the participating mortgage loan is extinguished before its due date, the debt extinguishment gain or loss shall be reported as required by paragraph 470-50-40-2.

470-30-50Disclosure

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470-30-50-1
The borrower's financial statements shall disclose both of the following:
  1. a
    The aggregate amount of participating mortgage obligations at the balance sheet date, with separate disclosure of the aggregate participation liabilities and related debt discounts
  2. b
    Terms of the participations by the lender in either the appreciation in the fair value of the mortgaged real estate project or the results of operations of the mortgaged real estate project, or both.

470-30-55Implementation Guidance and Illustrations

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Illustrations

470-30-55-1
This Example illustrates the guidance in this Subtopic.
470-30-55-2
Assume that on January 1, 19X1, Borrower Co. purchased a property for $10 million. On that date, Borrower paid $1 million cash and entered into a participating mortgage loan agreement with Lender Co. in the amount of $9 million.
470-30-55-3
The loan agreement has the following terms:
  1. a
    15 year term
  2. b
    Interest-only periodic payments, principal to be repaid at end of term
  3. c
    5% stated interest rate
  4. d
    20% participation in appreciation in the value of the property above $10 million, payable at maturity (or earlier if the asset is sold or the loan is refinanced).
470-30-55-4
Assumptions related to the fair value of the participation feature are as follows.
  • Date Fair Value Estimated Payment Years in Future 1/1/X1 " $25,055 " " $300,000 " 15 12/31/X1 " 40,063 " " 320,000 " 14 12/31/X2 " 54,122 " " 333,000 " 13
470-30-55-5
Based on the preceding assumptions, Borrower Co. should make the following journal entries for this participating mortgage loan.
  • "a. On January 1, 19X1, the following journal entries should be recorded:" Cash " $9,000,000 " Loan discount " 25,055 " Mortgage loan payable " $9,000,000 " Participation liability " 25,055 " To record participating debt and estimate of participation liability (based on fair value of participation feature). Property " $10,000,000 " Cash " 10,000,000 " To record purchase of property. "b. By the end of 19X1, entries to record interest expense and amortization of discount throughout the year would have taken the following form:" Interest expense " $451,159 " Interest payable " 450,000 " Loan discount " 1,159 " To record interest expense and amortization of debt discount using the interest method and an effective rate of 5.03 percent (rounded). Loan discount " $15,008 " Participation liability " 15,008 " To adjust balance of participation liability to fair value at end of period. The adjustment is calculated as follows: Fair value at 12/31/X1 " $40,063 " Fair value at 1/1/X1 " 25,055 " Adjustment " $15,008 " "Note: For purposes of this illustration, the fair value of the participation feature at 12/31/X1 is based on a revised estimate of the equity participation that would be payable in fourteen years of $320,000." "c. At the end of 19X2, entries to record interest expense and amortization of discount throughout the year would have taken the following form:" Interest expense " $451,979 " Interest payable " 450,000 " Loan discount " 1,979 " "To record interest expense and amortization of debt discount, using the interest method and an effective rate of 5.04 percent (rounded)." Loan discount " $14,059 " Participation liability " 14,059 " "To adjust recorded participation liability of $40,063 to fair value at 12/31/X2 of $54,122."

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