Troubled Debt Restructuring and Extinguishment Flashcards
What is troubled debt restructuring?
the creditor allows the debtor certain concessions to improve the likelihood of collection that would not be considered under normal circumstances; concessions include items such as reduced interest rates, extension of maturity dates, reduction of the face amount of the debt, and reduction of the amount of accrued interest; the concessions must be made in light of the debtor’s financial difficulty, and the objective of the creditor must be to maximize recovery of he investment; troubled debt restructurings are often the result of legal proceedings or of negotiation between parties
How does a debtor account for troubled debt restructuring?
transfer of assets - the debtor will recognize a gain in the amount of the excess of the carrying amount of the payable over the fair value of the assets given up; the gain or loss on disposition of the asset is reported in income of the period
transfer of equity interest - the difference between the carrying amount of the payable and the fair value of the equity interest is recognized as a gain under U.S. GAAP
**whether transfer of assets or transfer of equity interest, once the transfer has taken place, the debt has been extinguished
modification of terms - a restructuring that does not involve the transfer of asses or equity will often involve the modification of the terms of the debt; in a modification, the debtor usually accounts for the effects of the restructuring prospectively; the debtor does not change the carrying amount unless the carrying amount exceeds the total future cash payments specified by the new terms
**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
combination of type - when a restructuring involves a combination of asset or equity transfers and modifications of terms, the fair value of any asset or equity is used first to reduce the carrying amount of the payables; the difference between the fair value and the carrying amount of any assets transferred is recognized as gain/loss; no gain on restructuring can be recognized unless the carrying amount of the payable exceeds the total future cash payments (all gains are aggregated and included in net income for the period, usually as part of continuing operations
How does a creditor account for troubled debt restructuring?
a loan is considered impaired if it is probable (likely to occur) that the creditor will be unable to collect all amounts due under the original contract when due; normal loan procedures should be used to judge whether a loan is impaired; a loan restructured in a troubled debt restructuring is an impaired loan
receipt of assets or equity - when the creditor receives either assets or equity as full settlement of a receivable, these are accounted for at their fair value at the time of the restructuring; the fair value of the receivable satisfied can be used if it is more clearly determinable than the fair value of the asset or equity acquired; in a partial payment, the creditor must use the fair value of the asset or equity received; the excess of the recorded receivable over the fair value of the asset received is recognized as a loss; the creditor accounts for these assets as if they were acquired for cash
modification of terms - impairment should be captured as part of an entity’s overall assessment of credit losses; any losses with troubled debt restructuring should be incorporated into a creditor’s estimate of its allowance for credit losses
What is extinguishment of debt?
corporations issuing bonds may call or retire them prior to maturity; callable bonds can be retired after a certain date at a stated price; refundable bonds allow an existing issue to be retired and replaced with a new issue at a lower interest rate
a liability cannot be recognized in the financial statements until it has been extinguished; a liability is considered extinguished if the debtor pays or the debtor is legally released
debtor pays - a liability is considered extinguished if the debtor pays the creditor and is relieved of its obligation for the liability; if a bond is paid at maturity, the carrying value of the bond is equal to the face amount of the bond and no gain/loss is recorded; if a bond is extinguished before maturity, a gain/loss is generally recorded; the gain/loss is the difference between the carrying value of the bond (face value less unamortized discount or plus unamortized premium) and the cash paid to extinguish the bond
debtor legally released - a liability is considered extinguished if the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor; a troubled debt restructuring would result in the extinguishment of debt only if the debt were forgiven by the creditor as the result of a transfer of assets or the transfer of equity interest; a modification of terms is not extinguishment
What is in-substance defeasance?
an arrangement in which a company places purchased securities into an irrevocable trust and pledges them for the future principal and interest payments on its long-term debt; because the company remains the primary obligor while there is outstanding debt, the liability is not considered extinguished
Gain/loss on bond extinguishment before maturity
in any bond reacquisition, the following items must be accounted for adjusted in the financial statements: any related unamortized bond issuance costs, any related unamortized discount or premium, and the difference between the bond’s face value and the reacquisition proceeds
gain/loss on extinguishment of debt is the difference between the reacquisition price and the net carrying amount of the bond at the date of extinguishment; any gain/loss on extinguishment of debt is recognized as income from continuing operations (gross of tax) in the income statement
gain/loss = reacquisition price - net carrying amount
