Frozen GAAP

Loan documentation - financial covenants.

The financial model used to set initial financial covenant levels will be based on the accounting principles in use by the borrower at the time of negotiation, usually referred to as generally accepted accounting principles ('GAAP').

However accounting standards change over time, and consequently financial covenant ratios can be affected.

In general loan documentation is worded such that covenants are tested assuming GAAP at the date the loan was negotiated, as this gives both parties the greatest certainty.

This is called 'frozen' GAAP, because the initially prevailing GAAP is frozen for the purposes of covenant testing.