Debt extinguishment accounting

ASC 405-20-40-1 provides guidance on when a reporting entity should extinguish a liability. This guidance does not apply to convertible debt with a cash conversion feature. See FG 9.6.5 for information on the derecognition (conversion or extinguishment) of such instruments.

Excerpt from ASC 405-20-40-1

A debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met:

a. The debtor pays the creditor and is relieved of its obligation for the liability.

Paying the creditor includes the following:

1. Delivery of cash

2. Delivery of other financial assets 3. Delivery of goods or services

4. Reacquisition by the debtor of its outstanding debt securities whether the securities are cancelled or held as so-called treasury bonds.

b. The debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor.

A reporting entity should also extinguish a debt instrument (and recognize a new one) when a debt modification or exchange is deemed an extinguishment. See FG 3.4 for information on modifications and exchanges of term loans and debt securities, and FG 3.6 for information on modifications and exchanges of loan syndications and

participations.

ASC 470-50-55-9 provides guidance on situations that do not result in a debt extinguishment.

ASC 470-50-55-9

The following situations do not result in an extinguishment and would not result in gain or loss recognition under either paragraph 405-20-40-1 or this Subtopic:

a. An announcement of intent by the debtor to call a debt instrument at the first call date

b. In-substance defeasance

c. An agreement with a creditor that a debt instrument issued by the debtor and held by a different party will be redeemed.

An extinguishment should not be recognized prior to its occurrence; therefore, a debtor’s announcement of its intent to call its debt should not result in an extinguishment.

See FG 3.8 for information on debt defeasance.

3.7.1 Measuring the gain or loss on debt extinguishment

ASC 470-50-40-2 provides guidance on how to calculate a gain or loss on debt extinguishment.

ASC 470-50-40-2

A difference between the reacquisition price of the debt and the net carrying amount of the extinguished debt shall be recognized currently in income of the period of extinguishment as losses or gains and identified as a separate item. Gains and losses shall not be amortized to future periods. If upon extinguishment of debt the parties also exchange unstated (or stated) rights or privileges, the portion of the consideration exchanged allocable to such unstated (or stated) rights or privileges shall be given appropriate accounting recognition. Moreover, extinguishment transactions between related entities may be in essence capital transactions.

The ASC Master Glossary defines the reacquisition price of debt and the net carrying amount of debt.

Definitions from ASC Master Glossary

Reacquisition Price of Debt: The amount paid on extinguishment, including a call premium and miscellaneous costs of reacquisition. If extinguishment is achieved by a direct exchange of new securities, the reacquisition price is the total present value of the new securities.

Net Carrying Amount of Debt: Net carrying amount of debt is the amount due at maturity, adjusted for unamortized premium, discount, and cost of issuance.

The reacquisition price includes the fair value of any assets transferred or equity securities issued. It also includes fees (which may include noncash fees) the reporting entity pays the original lender in connection with the extinguishment. Typically, accrued interest payable is settled in cash upon extinguishment (i.e., the issuer pays the investor the accrued interest in cash). However, if accrued interest payable is not paid in cash upon extinguishment, it should be deducted from the reacquisition price (i.e., a portion of the reacquisition price should be treated as payment of interest).

The net carrying amount of debt includes an unamortized premium, discount, and debt issuance costs.

See FG 3.3.5 for information on the recognition of a debt extinguishment gain when a lender also holds equity securities of the reporting entity. Extinguishment losses are typically charged to earnings unless the loss is in substance a dividend (i.e., a pro-rata distribution to all equity holders).

See FSP 12.10.1 for information on the classification of a gain or loss on debt extinguishment.

The following example illustrates how the gain or loss on a debt extinguishment is measured.

EXAMPLE 3-8

Calculating a gain or loss on debt extinguishment

J&N Corp reacquired its term loan for cash of $50,000,000. It paid $500,000 in fees to its lender in connection with the extinguishment.

The carrying amount of the debt at the date of reacquisition was $50,000,000, and J&N Corp had unamortized debt issuance costs of $1,000,000. There is no

unamortized debt discount or premium and no accrued interest payable associated with the debt.

What is J&N Corp’s gain or loss on extinguishment of its debt?

Analysis

The reacquisition price is the carrying amount of the debt and the fees paid to the lender to extinguish the debt.

The gain or loss on extinguishment is calculated as follows:

Term loan carrying amount $50,000,000

Less: unamortized debt issuance costs (1,000,000)

Net carrying amount 49,000,000

Reacquisition price 50,500,000

Loss on extinguishment $1,500,000

J&N Corp should recognize a loss on extinguishment of $1,500,000 in net income.

3.7.2 Debt extinguishment as a subsequent event

An extinguishment occurring subsequent to the end of a fiscal period but prior to the issuance of the financial statements should be accounted for as a nonrecognized subsequent event, which is not recorded in the financial statements, but may require disclosure. See FSP 28 for information on subsequent events.