Chapter 4 — Foreign Currency Transactions

4.17 Debt-for-Equity Swap

The implementation guidance in ASC 830-20-55-1 through 55-3 describes a transaction in which a U.S. entity purchases dollar-denominated debt due from a foreign government, or an entity that operates in that foreign country, for less than its face value. The U.S. entity then exchanges that debt with the foreign country’s government in a transaction denominated in the foreign currency and is required to invest that money in its subsidiary operating in that foreign country. The foreign government’s intent in this transaction is generally to induce the U.S. entity to invest in long-lived assets in the foreign country (through its subsidiary in that country). The graphic below illustrates this transaction.

Debt-for-equity swap programs may be in place in financially troubled countries, since the intent of the above transaction is to induce the U.S. entity to invest in the foreign country (by purchasing long-lived assets through its foreign subsidiary). In practice, debt-for-equity swaps are complicated transactions that can involve several brokers and are subject to both domestic and international currency regulations.

In general, the U.S. entity will receive more proceeds from the foreign government than it paid to acquire the debt. Under ASC 830-20-55-2, the cost basis of any long-lived assets acquired or constructed should be reduced by the amount by which the foreign currency proceeds (received from the government) translated at the official exchange rate exceed the purchase cost of the debt. The example below illustrates this concept.

Example 4-9

Debt-for-Equity Swap

Parent Co, a U.S. registrant whose functional and reporting currency is the USD, has a subsidiary, Sub Co, that operates in Brazil. Parent Co purchases USD-denominated debt with a principal amount of $5 million from a Brazilian bank for $2 million (the debt’s price in the secondary market). Immediately after acquiring the debt, Parent Co sells the debt to the Brazilian government for 15 million BRL, the local currency. The official exchange rate in effect on the date Parent Co sold the debt to Brazil was BRL 1 = $0.3. Therefore, the USD value of the proceeds received from the Brazilian government is $4.5 million ($15 million × 0.3).

In this example, the excess of the amount received from the Brazilian government over the amount paid to acquire the debt is $2.5 million ($4.5 million proceeds – $2 million purchase price). Assume that in accordance with the terms of the sale to the government, Parent Co is required to contribute the proceeds to Sub Co and that Sub Co must use the proceeds to acquire long-lived assets in Brazil. Under ASC 830-20-55-2, the carrying value of the long-lived assets acquired must be reduced by the $2.5 million of excess proceeds received from the Brazilian government.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.