9.2 Extinguishment Conditions

9.2.1 Background

ASC 405-20-40-1 identifies the two circumstances in which a liability should be considered extinguished:

“The debtor pays the creditor and is relieved of its obligation” (see Section 9.2.3). For instance, a debtor may settle all or a portion of a liability by delivering cash, other financial assets, its own equity shares, goods, or services to the creditor.
“The debtor is legally released [as] the primary obligor . . . either judicially or by the creditor” (see Section 9.2.4). For instance, debt may be extinguished through a court order, the creditor forgiving the debt, or the assumption of the debt obligation by a third party.

9.2.2 Scope

ASC 405-20

05-1 This Subtopic addresses extinguishments of liabilities. This Subtopic does not address debt conversions or troubled debt restructurings. The accounting guidance for those areas is addressed in Subtopics 470-20 and 470-60.

05-2 An entity may settle a liability by transferring assets to the creditor or otherwise obtaining an unconditional release. Alternatively, an entity may enter into other arrangements designed to set aside assets dedicated to eventually settling a liability. Accounting for those arrangements has raised issues about when a liability should be considered extinguished. This Subtopic establishes standards for resolving those issues.

15-2 The guidance in this Subtopic applies to extinguishments of all liabilities, including both financial and nonfinancial liabilities, unless derecognition of a financial or nonfinancial liability is addressed in another Topic (for example, the derecognition guidance for gaming chips in Subtopic 924-405 on casinos or the breakage guidance in Topic 606 on revenue from contracts with customers). Derivative instruments that are nonfinancial liabilities (for example, a written commodity option) are included in the scope of this Subtopic.

ASC 470-50

05-1 This Subtopic discusses the accounting for all extinguishments of debt instruments, except debt that is extinguished through a troubled debt restructuring (see Subtopic 470-60) or a conversion of debt to equity securities of the debtor pursuant to conversion privileges provided in terms of the debt at issuance (see Subtopic 470-20).

15-3 The guidance in this Subtopic does not apply to the following transactions and activities:

Conversions of debt into equity securities of the debtor pursuant to conversion privileges provided in the terms of the debt at issuance. Additionally, the guidance in this Subtopic does not apply to conversions of convertible debt instruments pursuant to terms that reflect changes made by the debtor to the conversion privileges provided in the debt at issuance (including changes that involve the payment of consideration) for the purpose of inducing conversion. Guidance on conversions of debt instruments (including induced conversions) is contained in paragraphs 470-20-40-13 and 470-20-40-15.
Extinguishments of debt through a troubled debt restructuring. (See Section 470-60-15 for guidance on determining whether a modification or exchange of debt instruments is a troubled debt restructuring. If it is determined that the modification or exchange does not result in a troubled debt restructuring, the guidance in this Subtopic shall be applied.)
Transactions entered into between a debtor or a debtor’s agent and a third party that is not the creditor.

Pending Content (Transition Guidance: ASC 470-20-65-4)

15-3 The guidance in this Subtopic does not apply to the following transactions and activities:

Conversions of debt instruments pursuant to conversion privileges provided in the terms of those instruments. Additionally, the guidance in this Subtopic does not apply to conversions of convertible debt instruments pursuant to terms that reflect changes made by the debtor to the conversion privileges provided in the existing terms of those debt instruments (including changes that involve the payment of consideration) for the purpose of inducing conversion. Guidance on conversions of debt instruments (including induced conversions) is contained in paragraphs 470-20-40-4, 470-20-40-13, and 470-20-40-15.
Extinguishments of debt through a troubled debt restructuring. (See Section 470-60-15 for guidance on determining whether a modification or exchange of debt instruments is a troubled debt restructuring. If it is determined that the modification or exchange does not result in a troubled debt restructuring, the guidance in this Subtopic shall be applied.)
Transactions entered into between a debtor or a debtor’s agent and a third party that is not the creditor.

15-4 The general guidance for the extinguishment of liabilities is contained in Subtopic 405-20 and defines transactions that the debtor shall recognize as an extinguishment of a liability.

ASC 405-20 applies to financial liabilities, such as debt, and nonfinancial liabilities, except for liabilities that are subject to specific derecognition requirements. For example, liabilities resulting from prepaid stored-value products are subject to different derecognition guidance (see Section 9.4).

As discussed in Chapter 10, ASC 470-50 contains guidance on the accounting for modifications and exchanges of debt instruments in which the identity of the creditor has not changed. Under that guidance, a debt modification is accounted for as an extinguishment if the modified terms are substantially different from the original terms even if the original debt has not been legally extinguished (see Section 10.4.2). Extinguishment accounting is not applied to an exchange of debt instruments whose terms are not substantially different regardless of whether the original debt has been legally extinguished (see Section 10.4.1). Debt may or may not be considered extinguished when there is a change in the creditor (see Section 10.2.8).

Although ASC 405-20 does not apply to debt conversions, extinguishment accounting does apply to certain exchanges of debt into the issuer’s equity shares. Examples include:

The settlement of debt through the issuance of equity shares if the issuer is using its own shares as a means of currency to settle the debt’s value (e.g., the number of shares delivered is determined to have a value equal to the monetary amount of the debt obligation; see Section 9.3.3).
A conversion that occurs upon the issuer’s exercise of a call option if the instrument did not contain a substantive conversion feature as of its issuance date (see Section 12.3.3).
A conversion that occurs in accordance with changed conversion privileges that do not meet the criteria for induced conversion accounting (see Section 12.3.4).
A conversion that occurs in accordance with the original terms of a conversion feature that represents a share-settled redemption or indexation feature (e.g., the number of shares delivered is determined to have a fair value equal to the redemption amount; see Section 8.4.7.2.5).

Further, it may be appropriate to apply extinguishment accounting to conversions of convertible debt for which the conversion feature was separated as a derivative instrument under ASC 815-15 (see Section 12.4).

The accounting for TDRs is addressed in ASC 470-60 (see Chapter 11).

9.2.3 Condition 1 — Settlement

9.2.3.1 General Considerations

ASC 405-20

40-1 Unless addressed by other guidance (for example, paragraphs 405-20-40-3 through 40-4 or paragraphs 606-10-55-46 through 55-49), 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:

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. . . .

As noted in Section 9.2.1, one scenario in which debt is extinguished under ASC 405-20 is when the debtor is relieved of its obligation through a debt repayment. Examples include:

The debtor repays the principal amount and any accrued interest at the debt’s contractual maturity date.
The debtor settles the debt after exercising a call or prepayment feature embedded in the debt.
The debtor settles the debt after the investor exercises a put feature embedded in the debt.
The debtor settles the debt after a contingent redemption or acceleration feature is triggered.
The debtor repurchases outstanding debt securities in a public market for the debt.
The entity’s stockholders or other related parties repay the debt (see Section 9.3.7).

Although not specifically stated in ASC 405-20-40-1, debt might be extinguished by the delivery of the debtor’s equity shares (see the next section). When debt is settled by the delivery of noncash financial assets, the debtor should consider whether the conditions for sale accounting in ASC 860 are met for the transferred financial assets (see Section 9.2.3.3). Debt that has been settled should be accounted for as extinguished even if the debtor expects or intends to reissue the debt (see Section 9.2.3.4). However, an intention or commitment to settle debt does not represent a debt extinguishment (see Sections 9.2.3.5 and 9.2.3.6). Special considerations are necessary if a debtor acquires a participating interest in its own debt (see Section 9.2.3.7). The settlement of debt after the balance sheet date represents a nonrecognized subsequent event (see Section 9.2.3.8).

9.2.3.2 Settlement in Equity Shares

Under certain GAAP (such as ASC 470-50-40-3), debt can be extinguished by the issuance of common or preferred stock (see Section 9.3.3). For example, an entity might settle debt by issuing equity shares to the creditor that have a value that is equal to the amount due. As discussed in Chapter 12, however, the accounting guidance on debt extinguishments does not apply to certain conversions of debt into the issuer’s equity shares.

9.2.3.3 Settlement Involving Transfer of Noncash Financial Assets

ASC 405-20

55-5 A cash payment or conveyance of noncash financial assets from a debtor to a creditor results in full or partial settlement of the creditor’s receivable from the debtor. Whether or not that settlement is an extinguishment is governed by paragraph 405-20-40-1. However, if a noncash financial asset was conveyed to the creditor in full or partial settlement of a creditor’s receivable, it would be rare to conclude that debt has been extinguished if the criteria of paragraph 860-10-40-5 were not also met.

The extinguishment conditions in ASC 405-20-40-1 apply irrespective of whether the consideration transferred to repay the debt is in the form of cash or noncash assets. For example, a debtor’s transfer of noncash financial assets (e.g., debt or equity securities) to settle all or a portion of the debt should be evaluated under those conditions.

If, however, a debtor conveys noncash financial assets to a creditor to settle debt and the transferred financial assets do not meet the conditions for sale accounting in ASC 860-10-40-5 (see Deloitte’s Roadmap Transfers and Servicing of Financial Assets), the debtor would be unable to derecognize those transferred assets. As a result, the debtor would either not meet the extinguishment conditions in ASC 405-20-40-1 or would have to recognize another similar liability in accordance with the secured borrowing accounting guidance in ASC 860-30 (see also Section 9.2.4.2).

9.2.3.4 Debt Held for Resale

Under ASC 405-20-40-1(a)(4), debt is considered extinguished if the debtor or its agent buys it back such that the debtor no longer has an obligation to another party. Repurchased debt (or so-called “treasury bonds”) does not qualify as an asset even if it (1) has not been formally retired, (2) is held in treasury and the entity expects to resell it on a future date, (3) is part of a debt issuance that is trading in a public market, or (4) will be held for only a short period.

9.2.3.5 Intention, Commitment, or Offer to Extinguish Debt

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:

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

A debtor’s expectation, intention, offer, or firm commitment to settle debt on a future date does not satisfy either extinguishment condition in ASC 405-20-40-1. (However, if the creditor commits to settle debt on terms different from those in the original terms of the debt, the issuer should consider whether the commitment represents a modification to the debt terms that should be accounted for as an extinguishment under ASC 470-50 [see Section 10.2.3].) A debtor should not write off any remaining unamortized premium, discount, or debt issuance costs before debt is considered extinguished for accounting purposes.

Although an extinguishment gain or loss should not be recognized before the extinguishment of debt, the debtor should disclose the terms of the redemption transaction and the anticipated gain or loss in the notes to any interim or annual financial statements issued for periods before the extinguishment. Further, an irrevocable notice to repay the debt before its maturity date may affect the debt’s classification as current or noncurrent under ASC 470-10 (see Chapter 13).

9.2.3.6 Exercise of Contractual Redemption Feature

An intention or commitment to exercise a contractual redemption feature does not represent a debt extinguishment under ASC 405-20. For instance, a debt agreement may contain a redemption provision that permits the issuer to redeem the debt on specified terms (e.g., at a price equal to 110 percent of par value plus accrued and unpaid interest) before the debt’s contractual maturity date. Often, such a provision requires the debtor to give notice of legally binding and irrevocable redemption sometime before the actual redemption date. However, the redemption notice would not represent an extinguishment of the debt because it does not legally relieve the debtor of its obligation to pay the debt.

Example 9-1

Irrevocable Notice of Debt Redemption

Entity A has issued, and has outstanding, $500 million of senior secured notes with a stated maturity of December 31, 2020. The original terms permit A to redeem the notes at a price equal to 113 percent of par value plus accrued and unpaid interest. During the second quarter of 2012, A decides to redeem the notes in accordance with the redemption provisions in the original terms of the debt. On June 30, 2012, A exercises its right under the original terms of the notes to redeem the notes on July 30, 2012. Entity A provides an irrevocable notice of the early redemption to the debt holders on June 30, 2012. Entity A’s early redemption is expected to generate an extinguishment loss of approximately $65 million. The redemption notice is legally binding and irrevocable. Since A exercised its right to redeem the notes early, it reclassified the carrying amount of the notes from long-term to short-term liabilities.

Entity A’s fiscal year-end is December 31, 2012, and its second quarter financial reporting period ended on June 30, 2012, the date of the irrevocable notice to redeem the notes.

Entity A should record an extinguishment gain or loss when the debt has been extinguished for accounting purposes (i.e., in July 2012). The notes are considered extinguished on the date A pays the debt holders and is legally relieved of its obligation. Although the extinguishment loss should not be recognized in the interim financial statements for the second quarter ended June 30, 2012, A should disclose the terms of the redemption transaction and the expected or actual loss, as applicable, in the notes to those interim financial statements.

The exercise of an early redemption provision is not considered a modification or exchange of a debt instrument that should be evaluated under ASC 470-50-40 since such redemption occurs under the debt instrument’s original contractual terms (see Section 10.2.7).

9.2.3.7 Debtor Purchases a Participating Interest in Its Own Debt

Sometimes, a debtor acquires a participating interest in its own outstanding debt. In such circumstances, the debtor should evaluate whether it should derecognize an equivalent portion of the debt.

Example 9-2

Participating Interest in an Entity’s Own Debt

On January 1, 20X1, Entity B enters into a note payable with Bank C that contains the following terms:

The principal amount of $500 million is repayable in full on December 31, 20X6.
Interest is payable quarterly at the three-month U.S. Treasury rate plus 100 basis points.
Entity B has the option to prepay the note at any time, in full or in part, without penalty.
The note is collateralized by a retail office property owned by B.

On June 15, 20X2, the net carrying amount of the note payable on B’s balance sheet is $500 million. Entity B has excess cash of $100 million that is available for investment. If B uses this cash to partially prepay the note, there are no prepayment penalties payable to C; however, there is a local transfer tax that becomes payable. Entity B can avoid this transfer tax by purchasing a participating interest in the note from C. Therefore, in lieu of partially prepaying its note payable, B pays C $100 million in return for a participating interest in the note. For simplicity, assume that there are no fees or costs incurred by B to acquire the participating interest.

Entity B has concluded that the conditions in ASC 210-20-45-1 for offsetting the participating interest with the note payable on the balance sheet are not met.

Bank C has concluded that the transfer of the participating interest qualifies for derecognition under ASC 860-10-40-5 and 40-6A. As a result, C recognizes the receipt of the $100 million as a partial sale of its $500 million note receivable from B.

Entity B cannot recognize the $100 million payment to C for a participating interest in its own debt as an asset. Entity B’s purchase of a participating interest in its note payable to C is addressed by ASC 405-20-40-1(a)(4). That is, the participating interest transaction represents the reacquisition by B of a portion of its outstanding debt. Therefore, B must treat the payment of $100 million as a partial extinguishment of its liability for the note payable. This results in B’s reporting a $400 million obligation on its balance sheet. Since B paid $100 million to “extinguish” $100 million of its previously recognized liability, and the carrying amount of that liability is equal to its principal amount (i.e., there are no unamortized premiums, discounts, or issuance costs), there is no gain or loss to be recognized. For income statement reporting purposes in periods after the purchase of the participating interest, B should reflect the interest “earned” on the participating interest as a reduction of the interest “paid” on the note payable. Accordingly, B will recognize interest expense on the net $400 million obligation.

The accounting by B will be symmetrical to the accounting by C. That is, after the participating interest transaction, B reflects a $400 million note payable and C reflects a $400 million note receivable. This symmetry in accounting is consistent with the symmetrical accounting for the transferor and transferee under ASC 860.

The above example discusses a transaction that involves a participating interest in an issuer’s own debt and is not intended to address a similar transaction that does not meet the definition of a participating interest in ASC 860-10-40-6A (see Deloitte’s Roadmap Transfers and Servicing of Financial Assets). For instance, an entity could purchase an interest in its own debt that pays an interest rate that is lower than the interest rate on the debt itself. Such a scenario may occur for various reasons (e.g., the rate differential might reflect a financing of the fees imposed by the creditor to enter into the transaction or a financing of the premium that would otherwise be payable because of a decline in market rates of interest since the origination date of the note).

9.2.3.8 Subsequent Events

An extinguishment of debt after the balance sheet date but before the financial statements are issued (or available to be issued; see Section 13.3.4.9) is a nonrecognized subsequent event under ASC 855. Accordingly, the debt is treated as outstanding in the financial statements. The debtor should consider whether disclosure of the subsequent event is required under ASC 855-10.

9.2.4 Condition 2 — Legal Release

9.2.4.1 General Considerations

ASC 405-20

b. The debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor. For purposes of applying this Subtopic, a sale and related assumption effectively accomplish a legal release if nonrecourse debt (such as certain mortgage loans) is assumed by a third party in conjunction with the sale of an asset that serves as sole collateral for that debt.

As noted in Section 9.2.1, the second scenario in which debt is considered extinguished under ASC 405-20-40-1 occurs when the debtor is legally released as the primary obligor on the debt. Circumstances that may qualify as debt extinguishments under this guidance include those in which:

The debtor is judicially released, such as the cancellation of debt in a bankruptcy.
The debtor is legally released by the creditor, such as legal defeasances involving the establishment of a trust that will repay the debt (see Section 9.2.4.2). Since creditors rarely forgive debt without a reason, the debtor should consider whether a debt forgiveness was due to the debtor’s financial difficulties (see Chapter 11) or whether other rights or privileges were exchanged that should be given accounting recognition.
A third party assumes the debtor’s nonrecourse debt when the debtor sells an asset that serves as sole collateral for that debt (e.g., certain mortgage loans).
The debtor becomes secondarily liable as a guarantor (see Section 9.2.4.4).

The determination of whether a debtor has been legally released as the primary obligor under ASC 405-20-40-1(b) is a legal determination that may need to be made on the basis of a legal opinion (see Section 9.2.4.2).

The following do not qualify as debt extinguishments because the debtor has not been legally relieved of its obligation:

In-substance defeasances of debt involving the establishment of a trust that will repay the debt if the debtor is not legally released of its obligation (see Section 9.2.4.3).
The issuer’s intention, expectation, or offer to repay the debt (see Section 9.2.3.5).
The issuer’s irrevocable notice to the holder that it will repay debt in accordance with its contractual terms (see Section 9.2.3.6).
The debtor’s extinguishment of the debt after the balance sheet date but before the financial statements are issued (see Section 9.2.3.8).

9.2.4.2 Legal Defeasance

ASC 405-20

55-9 In a legal defeasance, generally the creditor legally releases the debtor from being the primary obligor under the liability. Liabilities are extinguished by legal defeasances if the condition in paragraph 405-20-40-1(b) is satisfied. Whether the debtor has in fact been released and the condition in that paragraph has been met is a matter of law. Conversely, in an in-substance defeasance, the debtor is not released from the debt by putting assets in the trust. For the reasons identified in paragraph 405-20-55-4, an in-substance defeasance is different from a legal defeasance and the liability is not extinguished.

Sometimes, a creditor agrees to release a debtor from being the primary obligor under a debt arrangement even though the debtor has not repaid the creditor. For example, the creditor might agree to release the debtor from its obligation if the debtor (1) sets up an irrevocable trust for the benefit of the creditor (a “defeasance trust”) and (2) the debtor transfers a sufficient amount of cash or other high-quality assets to the trust so that the trust will be able to repay the principal and interest payments on the debt. Further, sometimes debt indentures permit the debtor to legally defease the debt by transferring to a trust either (1) enough cash to purchase Treasury securities that will mature on or before each remaining payment date (interest and principal) in an amount necessary to service those remaining payments or (2) such securities directly. The trust irrevocably pledges the cash flows from the securities to retire the debt.

In these scenarios, debt extinguishment accounting applies if (1) the debtor is not required to consolidate the trust and (2) the arrangement legally releases the debtor from being the primary obligor under the debt, which means that another party has become the primary obligor on the obligation. However, if the debtor’s transfer of assets to the trust does not qualify for derecognition under ASC 860-10 (see Deloitte’s Roadmap Transfers and Servicing of Financial Assets), the debtor would be required to recognize another similar liability to the defeasance trust under the ASC 860-30 accounting requirements for transfers of financial assets that do not qualify for sale accounting. If the debtor is required to consolidate the trust, the debt would continue to be reported in the debtor’s consolidated financial statements (see Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).

ASC 405-20-40-1(b) specifies that in a transfer of noncash financial assets, the debtor would derecognize the liability if the debtor “is legally released from being the primary obligor under the liability.” Accordingly, the debtor would need to obtain a legal opinion indicating that it, as well as any of its consolidated affiliates, has been released as the primary obligor. The debtor would need to obtain such an opinion even if (1) the debt indenture contains provisions that legally release the obligor if the defeasance trust is properly structured or (2) the debt indenture does not require a legal opinion to be obtained.

Example 9-3

In 20X0, Entity X issued notes with a maturity date of September 15, 20X5 (the “20X0 notes”). On July 10, 20X5, X issues new notes to new lenders (the “20X5 notes”) and plans to use the proceeds from the 20X5 notes to settle the 20X0 notes. To facilitate this repayment, X deposits cash with a trustee the same day in amounts sufficient to fund the payment of the principal and accrued but unpaid interest through September 15, 20X5. On or before September 15, 20X5, the trustee will transfer the cash to the creditor(s) of the 20X0 notes, settling the debt. The 20X0 notes contain provisions (often referred to as “satisfaction and discharge” provisions) outlining the process that X will use to discharge the notes.

In accordance with ASC 405-20-40-1(a) and (b), an entity has extinguished outstanding debt only if it either (1) has paid the creditor and is relieved of the obligation or (2) is legally released from being the primary obligor. In this example, although X has transferred cash that is intended to be sufficient to satisfy the debt obligation, it has not actually paid the creditor (i.e., the requirement in ASC 405-20-40-1(a) is not met). For X to conclude that it can derecognize the 20X0 notes on July 20, 20X5, it would need to determine that in accordance with ASC 405-20-40-1(b), it is legally released from being the primary obligor of such notes. As discussed throughout Section 9.2.4, meeting this condition is a legal determination. Entity X cannot derecognize the 20X0 notes unless it can obtain a legal opinion at the “would” level (i.e., the highest standard of assurance an attorney can give on a legal matter; note that the legal opinion should also identify the new primary obligor since, as discussed above, the noteholders have not been paid cash to satisfy the debt). In practice, attorneys generally will not provide a legal opinion that an entity needs to derecognize debt in accordance with satisfaction and discharge provisions.

If a debtor transfers cash to a defeasance trust, the cash is typically derecognized because transfers of cash are not subject to the sale accounting requirements in ASC 860-10-40-5.

Connecting the Dots

Entities often finance acquisitions, fixed-asset additions, and renovations with long-term debt issued through municipal or industrial revenue bonds. Typically, a qualified governmental agency (the issuer) issues the bond and lends the proceeds to the entity (the obligor). Although the conduit bonds are in the issuer’s name, the obligor is solely responsible for repaying the bonds. Obligors sometimes benefit from defeasing the debt before its scheduled retirement. In a defeasance, the bond obligor or its agent purchases securities to deposit into a trust that irrevocably pledges the cash flows from the securities to retire the conduit bonds. The obligor has no continuing involvement with the transferred assets and is not required to consolidate the trusts.

In such circumstances, the debtor would derecognize both (1) its bond obligations and (2) the securities that it has deposited into the trust to service the bonds if the transaction satisfies the derecognition criteria in both ASC 405-20 for liabilities and ASC 860 for financial assets. ASC 405-20-40-1(b) states that in a transfer of noncash financial assets, the obligor can derecognize the bond liability if the obligor “is legally released from being the primary obligor under the liability.” Accordingly, the debtor should obtain a legal opinion even if (1) the municipal bond indentures contain provisions that legally release the obligor if defeasance is properly structured or (2) the bond indenture does not require a legal opinion to be obtained. The debtor also needs to consider the derecognition criteria in ASC 860-10-40-5 for the transfer of a financial asset. Like ASC 405-20-40-1, ASC 860-10-40-5 calls for a legal conclusion — in this instance, regarding whether the transfer isolates the noncash financial assets from the obligor.

In practice, most defeasance transactions represent in-substance defeasances that do not qualify for extinguishment accounting (see the next section).

9.2.4.3 In-Substance Defeasance

ASC Master Glossary

In-Substance Defeasance

Placement by the debtor of amounts equal to the principal, interest, and prepayment penalties related to a debt instrument in an irrevocable trust established for the benefit of the creditor.

ASC 405-20

55-3 In an in-substance defeasance transaction, a debtor transfers essentially risk-free assets to an irrevocable defeasance trust and the cash flows from those assets approximate the scheduled interest and principal payments of the debt being extinguished.

55-4 An in-substance defeasance transaction does not meet the derecognition criteria in either Section 405-20-40 for the liability or in Section 860-10-40 for the asset. The transaction does not meet the criteria because of the following:

The debtor is not released from the debt by putting assets in the trust; if the assets in the trust prove insufficient, for example, because a default by the debtor accelerates its debt, the debtor must make up the difference.
The lender is not limited to the cash flows from the assets in trust.
The lender does not have the ability to dispose of the assets at will or to terminate the trust.
If the assets in the trust exceed what is necessary to meet scheduled principal and interest payments, the transferor can remove the assets.
Subparagraph superseded by Accounting Standards Update No. 2012-04.
The debtor does not surrender control of the benefits of the assets because those assets are still being used for the debtor’s benefit, to extinguish its debt, and because no asset can be an asset of more than one entity, those benefits must still be the debtor’s assets.

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: . . .

b. In-substance defeasance . . . .

In an in-substance defeasance, a debtor establishes an irrevocable trust for the benefit of the creditor and transfers to the trust an amount of cash or other assets that is sufficient for repayment of the debt. Unlike a legal defeasance, an in-substance defeasance does not legally release the debtor as the primary obligor under the debt and therefore the debt cannot be treated as extinguished in accordance with ASC 405-20-40-1(b). In the absence of legal release, extinguishment accounting is not appropriate even if the issuer has notified the holder that the third party has assumed the obligation.

ASC 405-20

50-1 See paragraph 470-50-50-1 for a disclosure requirement for debt considered to be extinguished by in-substance defeasance. In addition, see paragraph 860-30-50-1A for disclosure requirements for assets that are set aside solely for the purpose of satisfying scheduled payments of a specific obligation.

ASC 470-50

50-1 If debt was considered to be extinguished by in-substance defeasance under the provisions of FASB Statement No. 76, Extinguishment of Debt, before the effective date of FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a general description of the transaction and the amount of debt that is considered extinguished at the end of each period that debt remains outstanding shall be disclosed.

ASC 860-30

50-1A An entity shall disclose all of the following for collateral: . . .

b. As of the date of the latest statement of financial position presented, both of the following:

1. The carrying amount and classifications of both of the following:

i. Any assets pledged as collateral that are not reclassified and separately reported in the statement of financial position in accordance with paragraph 860-30-25-5(a)

ii. Associated liabilities.

2. Qualitative information about the relationship(s) between those assets and associated liabilities; for example, if assets are restricted solely to satisfy a specific obligation, a description of the nature of restrictions placed on those assets. . . .

If an in-substance defeasance trust does not have the right to sell or repledge assets that a debtor has set aside to satisfy a specific obligation, ASC 860-30-50-1A requires the debtor to disclose the carrying amount and classification of those assets and the associated liabilities as well as a description of the nature of the restrictions placed on the assets. ASC 470-50-50-1 requires an entity to disclose a general description of an in-substance defeasance transaction that occurred before December 31, 1996 (i.e., the effective date of certain legacy U.S. GAAP guidance), that the entity was allowed to recognize as an extinguishment before such date. This disclosure would only be required if the related debt was still outstanding (i.e., has not been legally extinguished).

9.2.4.4 Original Debtor Becomes Guarantor

ASC 405-20

40-2 If a creditor releases a debtor from primary obligation on the condition that a third party assumes the obligation and that the original debtor becomes secondarily liable, that release extinguishes the original debtor’s liability. However, in those circumstances, whether or not explicit consideration was paid for that guarantee, the original debtor becomes a guarantor. As a guarantor, it shall recognize a guarantee obligation in the same manner as would a guarantor that had never been primarily liable to that creditor, with due regard for the likelihood that the third party will carry out its obligations. The guarantee obligation shall be initially measured at fair value, and that amount reduces the gain or increases the loss recognized on extinguishment. See Topic 460 for accounting guidance related to guarantees.

Sometimes, another entity assumes primary responsibility for an issuer’s debt instrument and the original issuer becomes legally obligated to make payments on the debt only if the party that has assumed primary responsibility for the debt fails to make payments. In this circumstance, the debtor applies extinguishment accounting to the debt and recognizes a new financial liability for the guarantee obligation at fair value in accordance with ASC 460. The initial fair value amount recognized for the guarantee obligation adjusts the debt extinguishment gain or loss. Subsequently, the guarantee is accounted for in accordance with ASC 460-10-35. See Chapter 5 of Deloitte’s Roadmap Contingencies, Loss Recoveries, and Guarantees for further discussion of the recognition and measurement of guarantee liabilities.

Example 9-4

Primary Obligor on Debt Becomes Secondarily Liable

Entity C issues debt to Entity E. Subsequently, Entities C, E, and F execute an agreement under which (1) F assumes primary responsibility for C’s obligation to E, (2) C is relieved of that responsibility, and (3) C becomes secondarily liable to E if F fails to pay E. Further, C transfers nonmonetary assets with a fair value of $9.8 million to F as consideration for assuming primary responsibility for the debt obligation. As of the date of the agreement, the current carrying amount of the debt is $10 million and the fair value of C’s new obligation is $300,000. The asset transfer qualifies for derecognition under ASC 860-10. Because the fair value of the transferred assets equals their carrying amount, there is no gain or loss on the asset transfer. In this scenario, C would recognize the following accounting entry:

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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.