Negative Amortization of Deferred Financing Costs on CFS
I am having trouble with how the line item "amortization of deferred financing costs" can be negative. To illustrate, say in at year 0 company XYZ issued a 2-year (or 8 quarters) $100,000 bond with a 5% interest rate and it costed the company $8,000 to do so. In this case, the interest expense recorded on the income statement after the first quarter would be comprised of the $5,000 in cash interest and ($8,000/8=) $1,000 in deferred financing costs, or $6,000 total on IS.
To find cash interest, we would take $6,000 from IS and subtract $1,000 to get $5,000, and the $1,000 would show up as a positive number on the CFS. However, I am currently looking at a company where the deferred financing cost is negative. I know that the company issued new debt in this period and refinanced old debt, but I do not understand why it would be negative. Say they were refinancing our bond from above after 2 quarters, wouldn't they just amortize the remaining $7,000 all in one quarter and the line item be positive? Please help!
With refinancing, you can have either debt extinguishment or debt modification. Extinguishment happens when the terms of the new and old debt are substantially different. Modification happens when they are not substantially different.
In the case of modification, you do not extinguish the old debt and as a result you reallocate the unamortized DFC over the new period of the modified debt (as opposed to writing all remaining DFC off immediately with extinguishment). When this occurs, DFC will shrink since the period extends and in a model the difference may show up as a negative in the transition year.
Here’s a quick chat gpt example if it helps:
Starting point: $2M deferred financing costs left, 2 years remaining.
Old Schedule (before refinance)
• Year 1 amortization: $1,000,000
• Year 2 amortization: $1,000,000
New Schedule (after refinance, 7 years total)
• Amortization each year: $285,714
Adjustment in Year 1
• Old plan said: $1,000,000
• New plan says: $285,714
• Difference: –$714,286 (negative amortization / true-up)
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