FAR-F5-M6-Troubled Debt Restructuring Flashcards
What constitutes a troubled debt restructuring?
Troubled debt restructuring is when the creditor grants the debtor a concession that they wouldn’t normally consider, based on 2 conditions:
1. The debtor must be experiencing financial difficulties.
2. The creditor must grant a concession as a result of the debtor’s financial difficulties.
Essentially, the creditor modifies the debt in a way that results in less overall money being paid back then before the restructure, indicating the creditor has made a concession.
When assets are transferred in a troubled debt restructuring, there are 2 transactions involved in which either a gain or loss can be recognized. What are those 2 transactions?
When assets are transferred in a troubled debt restructuring, there are 2 transactions that occur.
Step 1. Recognize the ORDINARY gain or loss on the disposition of the asset which is
Fair Value of the asset transferred
Less NBV of asset transferred aka the carrying amount
Equals the ordinary gain or loss on disposal
Step 2: Recognize the gain on the troubled debt restructure
Carrying amount of the payable
Less the fair value of the asset transferred
Equals gain aka the amount of debt discharged.
In a troubled debt restructuring, where is the only area that a loss can be recognized?
In a troubled debt restructuring, a loss is only possible in the transaction involving the disposal of the asset, whereby the FV of the asset less the carrying value of the asset results in a loss on disposal of the asset.
A loss is not possible in the discharge of the troubled debt since the troubled company is paying less than what it owes, therefore a gain will always be recognized.
Other than assets, can a transfer of equity resolve a troubled debt restructuring, and if so, how is a gain recognized?
Yes, a transfer of equity can be used to settle a troubled debt restructuring.
Carrying amount of the note payable
LESS the fair value of the assets and/or equity transferred
EQUALS gain on troubled debt restructuring.
The total increase in stockholder’s equity would be the Gain on troubled debt restructuring (because the gain is reported as part of income from continuing operations on the income statement which is eventually closed to retained earnings in the b/s ) and the fair value of the equity transferred is also included in the equity section of the b/s as par of issuance of common stock at par value and APIC which includes the difference between the par and fair value of the common stock)
What is a modification of terms and how does it differ from a troubled debt restructuring?
A restructuring that does not involve the transfer of assets or equity will often involve the modification of the terms of the debt. Under a modification of terms, the debt has not been extinguished, the terms have been adjusted so that the debtor has a greater ability to fulfill its obligation.
Could be either a lower interest rate or a longer period to pay back the loan.
Is the following statement true or false. The debtor does not change the carrying amount UNLESS the carrying amount exceeds the future cash payments specified by the new terms in a modification of terms”
True. The debtor does not change the carrying amount UNLESS the carrying amount exceeds the future cash payments specified by the new terms in a modification of terms”
When the total undiscounted future cash payments that continue to be payable by the modification of terms is LESS than the carrying value of the debt, should the debtor reduce the carrying amount? Should a gain be recognized?
Yes, when the total undiscounted future cash payments (principal and any accrued interest at the time of the restructuring continues to be payable by the new terms) are less then the carrying amount, the debtor should reduce the carrying amount and recognize the difference as a gain on restructuring of debt.
Carrying amount of note payable
LESS the total undiscounted future cash payments of debt under new terms
EQUALS gain on debt restructuring
When is a loan considered to be impaired?
A loan is impaired when it is probable that a creditor will be unable to collect all amounts due (including both principal and interest) according to the contractual terms of the loan agreement.
When a loan is impaired and foreclosure is NOT probable, how should the creditor measure the impairment?
When a loan is impaired and foreclosure is not probable, the creditor should measure impairment based on the present value of expected future cash flows discounted at the loans POST RESTRUCTURING EFFECTIVE INTEREST RATE.
However, as a practical expedient, the creditor may measure impairment based on the loans observable market price or the fair value of the collateral.
If foreclosure of the loan is probable, then impairment must be measured based on the fair value of the collateral.
When a loan is impaired and foreclosure is probable, how should the creditor measure impairment?
If foreclosure of a loan is probable, impairment must be measured based on the fair value of the collateral.
should the historical rate or the post restructuring effective interest rate be used as the discount rate when calculating the present value of future cash flows?
The new rule is that POST RESTRUCTURING EFFECTIVE INTEREST RATE should be used. If the question does not offer this rate, then use the historical rate.
If a bond payable is extinguished before maturity, is a gain or loss recorded?
If a bond is extinguished before maturity, a gain or loss is generally recorded.
Reacquisition Price
LESS net carrying value of the bond (which includes the Face amount of the bond Less unamortized discount or plus unamortized premium AND less unamortized issuance costs)
EQUALS gain on bond retirement.
Where is a gain or loss on extinguishment of debt recognized?
The gain or loss on extinguishment of debt is recognized as income from continuing operations.
