Chapter 9 — Debt Extinguishments

9.1 Background

A debtor accounts for debt as extinguished when the debt has been repaid or the debtor is legally released from its repayment obligation (see Section 9.2). The debtor generally recognizes a gain or loss for the difference between the reacquisition price and the net carrying amount of the debt upon an extinguishment (see Section 9.3.1). However, not all extinguishments are accounted for in the same manner (see Sections 9.3.2 through 9.3.8). In certain circumstances, financial liabilities for prepaid stored-value products are derecognized even though they have not been legally extinguished (see Section 9.4). Further, some debt modifications are accounted for as debt extinguishments even though the debt is still outstanding (see Section 10.4.2).

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.

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 a per annum rate of LIBOR 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. 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.

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.

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 9-3

Primary Obligor on Debt Becomes Secondarily Liable

Entity D issues debt to Entity E. Subsequently, Entities D, E, and F execute an agreement under which (1) F assumes primary responsibility for D’s obligation to E, (2) D is relieved of that responsibility, and (3) D becomes secondarily liable to E if F fails to pay E. Further, D 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 D’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, D would recognize the following accounting entry:

9.3 Extinguishment Accounting

9.3.1 General

9.3.1.1 Background

ASC 470-50

40-1 As indicated in paragraph 470-50-15-4, 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.

40-2 A difference between the reacquisition price of 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.

Under ASC 470-50-40-2, any difference between the debt’s reacquisition price (see the next section) and its net carrying amount (see Section 9.3.1.3) is recognized as an extinguishment gain or loss in earnings. It is not appropriate to defer recognition of such gain or loss to a future period. For example, a debtor cannot amortize the gain or loss over the remaining life of the extinguished debt or replacement debt issued to fund the proceeds of the extinguishment.

In addition, ASC 470-50-40-2 requires entities to identify debt extinguishment gains and losses as a separate item. Because a debt extinguishment gain or loss is akin to a financing activity, it generally should be classified as part of nonoperating income in the income statement.

9.3.1.2 Reacquisition Price

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.

The debt’s reacquisition price is the fair value of the consideration transferred to the creditor (e.g., the amount of cash paid or the fair value of any instruments, goods, or services transferred) to extinguish the debt as well as any reacquisition costs (e.g., third-party fees paid). As an exception, the reacquisition price is the fair value of the debt if common or preferred stock is used to settle the debt and the fair value of the debt is more clearly evident than the fair value of the stock (see Section 9.3.3). If the debtor issues new debt to the same creditor to settle debt or modifies existing debt, it should evaluate the transaction under the guidance on debt modifications and exchanges in ASC 470-50 (see Chapter 10). If the modification or exchange is accounted for as an extinguishment, the reacquisition price is the fair value of the new debt adjusted for the fair value of any other consideration paid to, or received from, the creditor and issuance costs (see Section 10.4.2).

If a debt extinguishment is part of a larger transaction that includes elements not related to the debt extinguishment, those other elements should be given separate accounting recognition. If a portion of the consideration paid by the debtor is related to an asset acquisition or the repurchase of the debtor’s outstanding equity shares, for example, that portion does not form part of the debt’s reacquisition price. In this scenario, the consideration paid is allocated between the debt extinguishment and the other items purchased in the transaction. Similarly, the debtor would need to allocate the consideration paid if it reacquires both debt and outstanding equity shares or contracts on its own equity (e.g., warrants) in the same transaction. The debtor should apply an allocation method, such as relative fair value or a with-and-without method, as appropriate (see Sections 3.4 and 3.5 for analogous guidance).

If an entity extinguishes debt by transferring a noncash asset, the debt’s reacquisition price is the asset’s fair value as of the date of extinguishment. The debt extinguishment gain or loss is calculated on the basis of the difference between the asset’s fair value and the debt’s net carrying amount. The difference between the net carrying amount and the fair value of the asset transferred to extinguish the debt is recognized as a realized gain or loss in earnings. For example, if an entity transferred available-for-sale debt securities to extinguish debt, it would remeasure those securities immediately before the transfer and then reclassify any unrealized gain or loss in OCI to earnings in the same manner as if it sold those securities to third parties. (Note, however, that when noncash financial assets are transferred to extinguish debt, the debtor must ensure that derecognition of those assets is appropriate under other applicable GAAP; see also Sections 9.2.3.3 and 9.2.4.2.)

The gain or loss on an extinguishment of debt in which the debtor transfers its own equity shares is generally calculated on the basis of a comparison of the fair value of the equity shares transferred and the net carrying amount of the debt; however, there is one exception that applies in certain situations (see Section 9.3.3 for further discussion).

9.3.1.3 Net Carrying Amount

ASC Master Glossary

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 net carrying amount of debt that is accounted for at amortized cost equals the amount due at maturity adjusted for any remaining unamortized premium or discount or debt issuance costs as of the extinguishment date as determined by using the interest method. It includes any accrued interest to the extinguishment date even if such interest is forfeited upon settlement (i.e., accrued interest is not reversed). Further, the net carrying amount reflects any adjustment to the debt resulting from the application of fair value hedge accounting (see Section 14.2.1.2). If debt contains a bifurcated embedded derivative (e.g., a bifurcated conversion option or bifurcated share-settled put option; see Chapter 8), an entity remeasures the embedded derivative to fair value as of the extinguishment date and includes such fair value in the net carrying amount before calculating the extinguishment gain or loss. Special considerations are necessary if the debt is accounted for at fair value under the fair value option (see Section 9.3.2).

Example 9-4

Loss on Early Extinguishment of Debt

On January 1, 20X0, Entity G borrowed $10 million from Bank H for 20 years at an interest rate of 6 percent per annum, which is accounted for at amortized cost. As part of the borrowing transaction, G paid lender fees of $50,000 to H and attorney fees of $20,000 to third parties. Entity G is permitted to prepay the debt at any time for $10.5 million. Entity G determined that the prepayment did not require bifurcation as an embedded derivative under ASC 815-15. Upon issuance, G recognized the following accounting entry:

On January 1, 20X5, G exercised its prepayment option and repaid the debt for $10.5 million. Under the interest method (see Section 6.2), the debt’s net carrying amount as of the extinguishment date was $9,986,528, consisting of the stated principal amount of $10 million less $9,623 of remaining unamortized discount and $3,849 of remaining unamortized debt issuance costs. Because G paid an amount in excess of the debt’s net carrying amount, the difference caused a debt extinguishment loss of $513,472 ($10,500,000 – $9,986,528). Entity G recognized the following accounting entry:

If only a portion of an outstanding issue of debt is extinguished, any remaining unamortized discount or premium or issuance costs is allocated between the portion of the debt extinguished and the portion that remains outstanding. Such allocation is typically made on the basis of the relative net carrying amounts. The calculation of the gain or loss on the portion of the debt extinguished reflects the amount of remaining unamortized discount or premium or issuance costs allocated to that portion. The amount of the remaining unamortized discount or premium or issuance costs allocated to the debt that remains outstanding continues to be amortized over the remaining life of that debt.

Example 9-5

Gain on Early Extinguishment of Debt

On January 1, 20X0, Entity J issued debt with a principal amount of $100 million in a public offering for proceeds of $102 million, which is accounted for at amortized cost. The debt has a term of 6 years and pays interest at 8 percent per annum. Upon issuance, J makes the following accounting entry:

On January 1, 20X2, J repurchases half of the debt for $50.5 million. The remaining unamortized debt premium on the entire debt issuance is $1,427,964. Accordingly, J allocates that amount between the portion extinguished and the portion that remains outstanding. The difference between the reacquisition price and the net carrying amount of the extinguished portion results in an extinguishment gain of $213,982 ($101,427,964 ÷ 2 – $50,500,000 = $213,982). Entity J recognizes the following accounting entry:

9.3.2 Extinguishments of Debt for Which the Fair Value Option Has Been Elected

ASC 470-50

40-2A In an early extinguishment of debt for which the fair value option has been elected in accordance with Subtopic 815-15 on embedded derivatives or Subtopic 825-10 on financial instruments, the net carrying amount of the extinguished debt shall be equal to its fair value at the reacquisition date. In accordance with paragraph 825-10-45-6, upon extinguishment an entity shall include in net income the cumulative amount of the gain or loss previously recorded in other comprehensive income for the extinguished debt that resulted from changes in instrument-specific credit risk.

ASC 825-10

45-6 Upon derecognition of a financial liability designated under the fair value option in accordance with this Subtopic, an entity shall include in net income the cumulative amount of the gain or loss on the financial liability that resulted from changes in instrument-specific credit risk.

If an entity accounts for debt at fair value by using the fair value option in ASC 815-15 (see Section 8.5.6) or in ASC 825-10 (see Section 4.4), the debt’s net carrying amount is its fair value on the reacquisition date as long as the extinguishment is not a TDR. Upon the debt’s extinguishment, the debtor is required to include in net income the cumulative amount of any changes in fair value that are attributable to instrument-specific credit risk and that have been recognized in accumulated other comprehensive income (AOCI). If the debt is repaid at its principal amount at maturity, there would typically not be any remaining component in AOCI related to the cumulative changes in fair value of the financial liability attributable to instrument-specific credit risk (see Section 6.3.2). However, if the debt is extinguished before its stated maturity, there will generally be a component in AOCI that must be reclassified to earnings upon debt extinguishment.

9.3.3 Extinguishments Effected Through the Issuance of Shares

ASC 470-50

15-2 The guidance in this Subtopic applies, in part, to the following transactions and activities:

Extinguishments of debt effected by issuance of common or preferred stock, including redeemable and fixed-maturity preferred stock, that do not represent the exercise of a conversion right contained in the terms of the debt at issuance.

40-3 In an early extinguishment of debt through exchange for common or preferred stock, the reacquisition price of the extinguished debt shall be determined by the value of the common or preferred stock issued or the value of the debt — whichever is more clearly evident.

Extinguishment accounting applies if a debtor settles outstanding debt by delivering equity-classified shares of common or preferred stock and such settlement is not accounted for as a conversion (see Chapter 12). However, if the shares issued must be classified as liabilities under ASC 480 (e.g., they meet the definition of a mandatorily redeemable financial instrument and are not exempt from the scope of ASC 480; see Deloitte’s Roadmap Distinguishing Liabilities From Equity), the existing debt should be accounted for as extinguished only if the instruments have substantially different terms, as determined under ASC 470-50 (see Section 10.4.2).

If extinguishment accounting applies, the reacquisition price of the extinguished debt is whichever is more clearly evident of either the fair value of the shares issued or the fair value of the debt at the time of the extinguishment. However, under the original terms of some debt instruments, the debtor may deliver a variable number of shares whose value is computed to equal a fixed monetary amount that is based on an average stock price as of a determination date that precedes settlement (e.g., the most recent 20-day volume-weighted average price) rather than the stock price on the settlement date. In such circumstances, in accordance with ASC 480-10-55-22, the debtor should not recognize a gain or loss for a difference between (1) the settlement-date fair value of the shares delivered and (2) the fixed monetary amount. However, an extinguishment gain or loss would still exist for any difference between the fixed monetary amount and the net carrying amount of the debt. The guidance in ASC 480-10-55-22 may not be applied when the settlement does not occur in accordance with the contractual terms of the debt instrument.

For discussion of the accounting for an extinguishment of convertible debt, see Section 9.3.5.

9.3.4 Extinguishments of Hedged Debt

If a debtor extinguishes debt that has been designated as a hedged item in a fair value hedge (e.g., a fair value hedge of fixed-rate debt), the debt’s net carrying amount would have been adjusted for the change in the debt’s fair value attributable to the hedged risk (see Section 14.2.1.2). Further, the debtor would have been permitted or, if hedge accounting had ceased, required to amortize such fair value adjustments (see ASC 815-25-35-9 and 35-9A). Fair value hedge accounting adjustments are accounted for in the same manner as other components of the debt’s carrying amount (see ASC 815-25-35-8). Upon the debt’s extinguishment, therefore, the extinguishment gain or loss is calculated on the basis of the net carrying amount as of the extinguishment date after the application of fair value hedge accounting.

If a debtor extinguishes debt that has been designated in a cash flow hedge (e.g., a cash flow hedge of floating-rate debt), the debtor may have deferred amounts in AOCI related to the change in the fair value of the designated hedging instrument that was included in the assessment of hedge effectiveness (see Section 14.2.1.3). Such amounts must be reclassified to earnings if the debt is extinguished (i.e., the debt is settled before maturity); however, such reclassification gain or loss is not classified as part of the debt extinguishment gain or loss (see ASC 815-30-35-44).

9.3.5 Extinguishments of Convertible Debt

9.3.5.1 Background

The accounting for extinguishments of convertible debt (e.g., the repurchase of convertible debt for cash or the settlement of a share-settled redemption feature) depends on whether the debt contains a separately recognized equity component.

9.3.5.2 Convertible Debt Without a Separately Recognized Equity Component

ASC 470-50

40-4 The extinguishment of convertible debt does not change the character of the security as between debt and equity at that time. Therefore, a difference between the cash acquisition price of the debt and its net carrying amount shall be recognized currently in income in the period of extinguishment as losses or gains.

If a debtor extinguishes convertible debt that does not contain a separately recognized equity component, the extinguishment gain or loss is calculated as the difference between the debt’s net carrying amount (including the fair value of any bifurcated embedded derivative as of the extinguishment date) and the reacquisition price (see Section 9.3.1.2). This accounting applies even if the debtor pays an amount significantly in excess of the debt’s net carrying amount as a result of the fair value of the conversion feature.

Example 9-6

Redemption of Convertible Debt

Entity K has outstanding convertible debt with a net carrying amount of $1,000. The conversion feature is deeply in-the-money because of an increase in K’s stock price after the debt was issued. Entity K pays $2,200 to repurchase the debt, which is also the current fair value of the debt. Entity K recognizes the following accounting entry:

9.3.5.3 Convertible Debt With a Separately Recognized Equity Component

ASC 815-15

40-4 If a convertible debt instrument with a conversion option for which the carrying amount has previously been reclassified to shareholders’ equity pursuant to the guidance in paragraph 815-15-35-4 is extinguished for cash (or other assets) before its stated maturity date, the entity shall do both of the following:

The portion of the reacquisition price equal to the fair value of the conversion option at the date of the extinguishment shall be allocated to equity.
The remaining reacquisition price shall be allocated to the extinguishment of the debt to determine the amount of gain or loss.

A convertible debt instrument will have a separately recognized equity component only in the following circumstances:

The convertible debt instrument was issued at a substantial premium (see Section 7.6.3).
The convertible debt instrument was modified or exchanged in a transaction that did not result in an extinguishment but increased the fair value of the embedded conversion option (Section 10.4.3).
The embedded conversion option in a convertible debt instrument was previously reclassified from a derivative liability to equity (Section 8.5.4.3).

In these circumstances, any extinguishment of the convertible debt instrument includes settlement of both the liability for the convertible debt instrument and the separate amount recognized in equity. Therefore, the total reacquisition price must be allocated between these two components.

If the equity component is the result of the reclassification of an embedded conversion feature from a derivative liability to equity, the amount allocated to the reacquisition of the equity component equals the fair value of the conversion option on the date of the extinguishment, in accordance with ASC 815-15-40-4. Although not specifically addressed in the Codification, if the separately recognized equity component resulted from (1) a modification or exchange that increased the fair value of the conversion option or (2) a substantial issuance premium, a portion of the reacquisition price equal to the amount that was previously recognized for that separate equity component is allocated to the reacquisition of such equity component, and the remaining portion of the reacquisition price is allocated to the liability for the convertible debt instrument.1 The amount allocated to the equity component does not result in a gain or loss because ASC 260-10-S99-2 does not apply to the settlement of the equity component if the convertible debt instrument permitted conversion into the issuer’s common stock. However, the amount allocated to the equity component will indirectly affect the extinguishment gain or loss since it reduces the amount allocated to the extinguished debt component.

9.3.6 Debt Tendered Upon Exercise of Detachable Warrants

ASC 470-50

40-5 The guidance in this Subtopic does not apply to debt tendered to exercise detachable warrants that were originally issued with that debt if the debt is permitted to be tendered towards the exercise price of the warrants under the terms of the securities at issuance. The tendering of the debt in such a case would be accounted for in the same manner as a conversion.

When debt is tendered upon the exercise of detachable warrants, the transaction is accounted for as a conversion (see Chapter 12) and not as an extinguishment if (1) the warrants were originally issued with that debt, (2) the original terms permit the debt to be tendered toward the exercise price of the warrants, and (3) the warrants are classified in equity.

Example 9-7

Debt Tendered Upon Exercise of Detachable Warrants

Entity M issues debt with detachable warrants for total proceeds of $10 million, which equals the par amount of the debt, and it elects not to apply the fair value option to the debt. Entity M determines that the warrants qualify as an equity instrument because they are exercisable by the holder into 150,000 shares of M’s common stock (par value of $1 per share) for $20 per share, payable in cash or by tendering an equivalent principal amount of the debt. Upon the debt’s issuance, M allocates the proceeds between the debt and warrants on a relative-fair-value basis in accordance with ASC 470-20-25-2 (see Section 3.4.2.2). It allocates $8.5 million to the debt and $1.5 million to the warrants and recognizes the following accounting entry:

Three years later, the holder exercises all of the warrants in return for tendering the debt. The remaining unamortized debt discount is $1 million. Entity M recognizes the following accounting entry:

9.3.7 Extinguishments Involving Related Parties

9.3.7.1 Background

Special considerations are necessary for certain debt extinguishment transactions involving related parties, including extinguishments of debt owed to related parties, an affiliated entity’s acquisition of the entity’s debt from a third party, and the repayment of debt by a related party.

9.3.7.2 Extinguishments of Debt Owed to Related Parties

ASC 470-50

40-2 . . . [E]xtinguishment transactions between related entities may be in essence capital transactions.

The guidance in ASC 470-50-40-2 has generally been interpreted to suggest that there is a rebuttable assumption that debt extinguishment “gains” in transactions with related parties (e.g., the investor is a significant shareholder, part of management, or an affiliate of the issuer) should be recognized as equity contributions (i.e., in APIC and not in earnings) unless there is substantive evidence that the entity would have obtained the same economic outcome in an arm’s-length transaction. For example, if an entity’s outstanding debt is forgiven by a related party, the credit recognized to reflect the forgiveness should be reflected as an addition to equity. However, the guidance in ASC 470-50-40-2 does not apply when debt issued to a related party is settled in accordance with its contractual terms. In these situations, if there is an equity transaction associated with the debt issuance, it would be recognized upon issuance, not settlement, of the debt.

If a subsidiary’s debt is forgiven by its parent for no consideration, the subsidiary should record that forgiveness as a capital contribution from its parent. Evidence that an extinguishment transaction was at arm’s length includes a debt settlement that involves related parties and significant third-party investors that receive the same settlement terms (e.g., same reacquisition price).

Generally, debt extinguishment losses in transactions with related parties are recognized in earnings. However, a loss may be recognized in equity as an in-substance dividend if it represents a pro rata distribution to all shareholders.

Example 9-8

Extinguishment of Debt Owed to a Related Party

Entity N has outstanding debt with a net carrying amount of $100 that is owed to Investor O, which is a significant shareholder. Entity N settles the debt with O for $95. Entity N would not have been able to obtain the same terms from an unrelated party. Accordingly, it records the following accounting entry to reflect the forgiveness of a portion of the debt and a corresponding capital contribution from O:

In his remarks at the 2010 AICPA Conference on Current SEC and PCAOB Developments, then SEC Professional Accounting Fellow Sagar Teotia addressed how the SEC staff expects issuers to determine whether an extinguishment transaction with a related party represents a capital transaction. He noted that “the staff has not formed any bright line views on these types of transactions and analyzes these questions individually on a specific facts and circumstances basis.” Mr. Teotia provided the following example (footnote omitted):

A Company has non-convertible debt outstanding to a related party (An executive of the Company who is also a significant shareholder). [At] a later date the related party accepts an offer from the Company to exchange the debt for the Company’s common stock. At the date of exchange, . . . the value of the common stock that was accepted by the related party was significantly lower than the carrying value of the Company’s debt.

At issue is whether the Company’s exchange of common stock for the debt held by the related party should be accounted for as an early extinguishment gain or as a capital contribution. . . .

Based on its analysis, which included the information provided in response to [the] questions [below], the staff believed the substance of the transaction was in essence a capital contribution from a related party.

Further, Mr. Teotia provided the following examples of questions the SEC staff has asked registrants related to this analysis:

What was the role of the related party in the transaction?
Why would the related party accept the Company’s offer which resulted in the related party accepting common stock that was significantly lower in value than the carrying value of the debt?
Was the substance of the arrangement a forgiveness of debt that was owed to a related party?

Mr. Teotia emphasized that the “staff believes that a full analysis is required in assessing the substance of these types of transactions. Accordingly, the staff would expect that registrants consider all of the facts and circumstances and related party relationships in a particular transaction when making its accounting assessment.”

9.3.7.3 Debt Acquired by Affiliated Entity

In consolidated financial statements, an entity’s debt is extinguished if it is held by another member of the same consolidated group. For example, if a parent holds debt issued by its subsidiary, the debt is extinguished in the parent’s consolidated financial statements.

If another member of a consolidated group to which the entity belongs acquires the entity’s debt from a third party, the debt is accounted for as being extinguished in any consolidated financial statements that include both entities. For example, if a parent acquires debt issued by its subsidiary from a third party, the debt is accounted for as if it had been extinguished in the parent’s consolidated financial statements. Note, however, that the debt would still be included in separate financial statements of the debtor if those financial statements do not include the consolidation of the entity that acquired the debt.

Example 9-9

Parent Acquisition of Subsidiary Debt

Parent P owns an 85 percent interest in the common stock of Subsidiary S. Subsidiary S is included in P’s consolidated financial statements and has debt outstanding that trades in an active, public market. Subsidiary S’s debt is currently trading at a discount to its par amount. Parent P has purchased some but not all of S’s debt in the public market. Parent P intends to temporarily hold the debt and either (1) sell it to S or (2) resell it back into the public market.

In P’s consolidated financial statements, the acquisition of S’s debt should be accounted for as an extinguishment of debt. Although from S’s perspective the debt remains outstanding, the debt has been reacquired by the consolidated entity and, therefore, has been extinguished in the consolidated financial statements of P. Any difference between the carrying amount and the reacquisition price should be accounted for as an extinguishment gain or loss in the consolidated financial statements.

No portion of the extinguishment gain or loss recognized in P’s consolidated financial statements would be allocated to the noncontrolling interest in S upon P’s purchase of the debt. The holders of the noncontrolling interest in S will not realize any extinguishment gain or loss until S reacquires the debt.

In S’s separate financial statements, a debt extinguishment has not occurred and no accounting entry would be recorded. Further, S has not been released from the debt and, accordingly, should continue to reflect the entire balance as outstanding.

If S subsequently reacquires the debt from P in a transaction based on the current fair value of the debt in the public market, S should recognize an extinguishment gain or loss in its separate financial statements on the basis of the difference between the carrying amount of the debt and the reacquisition price paid by S. If S’s reacquisition of its debt from P does not occur on the basis of the current fair value of the debt, the difference between the current fair value of the debt and the reacquisition price paid by S should be treated as a capital transaction or as an expense. For example, the difference would be treated as a capital contribution if P were to settle for less than the current fair value of the debt (thereby forgiving a portion of the debt).

9.3.7.4 Debt Extinguished by Related Party

Nonauthoritative AICPA Guidance

Technical Q&As Section 4160, “Contributed Capital”

.01 Payment of Corporate Debt by Stockholders

Inquiry — Three shareholders own stock in Corporations A and B. They agree to personally pay a debt of Corporation A by giving the creditor stock in Corporation B. How should this transaction be recorded on the books of Corporation A?

Reply — The payments by the three stockholders of Corporation A’s debt would represent an additional contribution by the stockholders to Corporation A. This can be recorded as a credit to “additional capital.”

If a related party (e.g., a significant shareholder) repays an entity’s debt and thereby relieves the entity of its obligation to pay it, the entity should record the transaction as a capital contribution from the related party.

Example 9-10

Debt Repaid by a Related Party

Entity T has outstanding debt with a net carrying amount of $100. Investor U, a significant shareholder, repays the debt, which relieves T of its obligation to pay it. Entity T does not pay U for the extinguishment. Accordingly, T should record a capital contribution for the benefit received from U:

9.3.8 Rate-Regulated Entities

ASC 980-470

40-1 Subtopic 470-50 requires recognition in income of a gain or loss on an early extinguishment of debt in the period in which the debt is extinguished. For rate-making purposes, the difference between the entity’s net carrying amount of the extinguished debt and the reacquisition price may be amortized as an adjustment of interest expense over some future period.

40-2 If the debt is reacquired for an amount in excess of the entity’s net carrying amount, the regulator’s decision to increase future rates by amortizing the difference for rate-making purposes provides reasonable assurance of the existence of an asset (see paragraph 980-340-25-1). Accordingly, the regulated entity shall capitalize the excess cost and amortize it over the period during which it will be allowed for rate-making purposes.

40-3 If the debt is reacquired for an amount that is less than the entity’s net carrying amount, the regulator’s decision to reduce future rates by amortizing the difference for rate-making purposes imposes a liability on the regulated entity (see paragraph 980-405-25-1(c)). Accordingly, the entity would record the difference as a liability and amortize it over the period during which permitted rates will be reduced.

ASC 980-470 exempts rate-regulated entities from the requirement to recognize debt extinguishment gains and losses in earnings; such entities may instead amortize gains and losses as an adjustment to interest expense. If the regulator decides to increase future rates for an extinguishment loss, the debtor records an asset and amortizes it over the period in which it is permitted to do so for rate-making purposes. If the regulator decides to reduce future rates for an extinguishment gain, the debtor records a liability and amortizes it over the period in which permitted rates are reduced.

Footnotes

Allocating to the separately recognized equity component an amount equal to the amount initially recognized for that component is different from accounting for a redemption of a convertible debt instrument that contains an embedded conversion option that has been reclassified from a derivative liability to a separate component of equity. This difference is justified because in these situations, only a portion of the entire fair value of the embedded conversion option, as opposed to its entire fair value, is recognized as a separate component of equity.

9.4 Derecognition of Liabilities for Prepaid Stored-Value Products

9.4.1 Background

Prepaid stored-value products are products with a preloaded monetary value (e.g., a gift card, phone card, or traveler’s check) that are commonly accepted as a means of payment for goods or services. For example, a prepaid stored-value product might be issued by a financial services company and used as a means of payment at network-accepting merchant locations. Sometimes, the holder also has an option to redeem all or part of the stored monetary value for cash. Unlike a credit card, which is backed by a line of credit, or a debit card, which is linked to a bank account, a prepaid stored-value product typically is prefunded by the initial holder of the product (e.g., through a cash payment).

When an entity sells a prepaid stored-value product, it incurs a liability for the obligation associated with the stored monetary value. If the holder uses all or a portion of the product’s stored monetary value to buy goods or services from a third party, the issuer must reimburse the third party. When the issuer settles all or part of its obligation to the third-party provider, a corresponding portion of the issuer’s liability is extinguished. However, the issuer often expects “breakage,” which refers to the portion of the stored monetary value that will never be used by holders. For instance, some holders might misplace the product and others might decide not to use the full amount if the remaining balance is small.

ASC 606-10 includes breakage guidance for liabilities associated with revenue contracts with customers (e.g., a retailer’s obligation for a gift certificate that a customer can redeem for goods or services at that retailer). However, ASC 606-10 does not apply to liabilities that meet the definition of a financial liability (such as contractual obligations to pay cash; see Section 2.3.4). Although the holder of a prepaid stored-value product can redeem it for goods or services with a merchant, the issuer has an obligation to pay cash to the merchant. Since a derecognition approach on the basis of a settlement or legal release of an obligation may not reflect the economics of prepaid stored-value products, such liabilities are exempt from the general extinguishment accounting guidance in ASC 405-20-40-1.

9.4.2 Scope

ASC 405-20

40-3 Prepaid stored-value products are products in physical and digital forms with stored monetary values that are issued for the purpose of being commonly accepted as payment for goods or services. While the holder of a prepaid stored-value product also may be permitted to redeem the product for cash, prepaid stored-value products do not include products that only can be redeemed by the product holder for cash (for example, nonrecourse debt, bearer bonds, or trade payables). Examples of prepaid stored-value products include prepaid gift cards issued on a specific payment network and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler’s checks. The derecognition guidance in paragraph 405-20-40-4 does not apply to liabilities related to either of the following:

Prepaid stored-value products (or portions of those products) for which any breakage (that is, the portion of the dollar value of prepaid stored-value products that ultimately is not redeemed by product holders for cash or not used to purchase goods and/or services) must be remitted in accordance with unclaimed property laws
Prepaid stored-value products that are attached to a segregated bank account like a customer depository account.

The guidance also does not apply to customer loyalty programs or transactions within the scope of other Topics (for example, Topic 606 on revenue from contracts with customers).

The guidance in ASC 405-20 on prepaid stored-value products does not apply to:

Financial liabilities that can be redeemed for cash only (e.g., nonrecourse debt, bearer bonds, and trade payables). The extinguishment conditions in ASC 405-20-40-1 (see Section 9.3) apply to such liabilities.
Financial liabilities “for which any breakage . . . must be remitted in accordance with unclaimed property laws.” Since unclaimed property laws vary among jurisdictions, an issuer may have breakage liabilities that are subject to different legal requirements. The determination of whether unclaimed property laws apply to a specific breakage liability is a legal question that may need to be evaluated with the assistance of legal specialists.
Financial liabilities related to “[p]repaid stored-value products that are attached to a segregated bank account like a customer depository account.” For example, the guidance does not apply to a debit card that is attached to a bank account.
Obligations under customer loyalty programs, such as frequent flier miles and credit card reward programs (see Deloitte’s Roadmap Revenue Recognition).
Transactions within the scope of other GAAP, such as closed-system prepaid gift cards that are issued by a merchant to permit the holder to purchase goods or services from that merchant in the future; see Deloitte’s Roadmap Revenue Recognition.

9.4.3 Accounting

ASC 405-20

40-4 If an entity expects to be entitled to a breakage amount for a liability resulting from the sale of a prepaid stored-value product in the scope of paragraph 405-20-40-3, the entity shall derecognize the amount related to the expected breakage in proportion to the pattern of rights expected to be exercised by the product holder only to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. If an entity does not expect to be entitled to a breakage amount for prepaid stored-value products in the scope of paragraph 405-20-40-3, the entity shall derecognize the amount related to breakage when the likelihood of the product holder exercising its remaining rights becomes remote. At the end of each period, an entity shall update the estimated breakage amount to represent faithfully the circumstances present at the end of the period and the changes in circumstances during the period. Changes to an entity’s estimated breakage amount shall be accounted for as a change in accounting estimate in accordance with paragraphs 250-10-45-17 through 45-20.

50-2 An entity that recognizes a breakage amount in accordance with paragraph 405-20-40-4 shall disclose the methodology used to recognize breakage and significant judgments made in applying the breakage methodology.

ASC 405-20 requires an issuer to recognize breakage associated with prepaid stored-value products (see Section 9.4.2) in a manner similar to breakage associated with revenue transactions within the scope of ASC 606-10 (see Deloitte’s Roadmap Revenue Recognition). Under the breakage guidance in ASC 405-20, an issuer of a prepaid stored-value product must first determine whether it expects to be entitled to a breakage amount. Expected breakage amounts can only be recognized to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently be required. In evaluating whether it is entitled to a breakage amount, the issuer may, by analogy to ASC 606-10-55-48, consider factors similar to those in ASC 606-10-32-12. That guidance provides examples of “[f]actors that could increase the likelihood or the magnitude of a . . . reversal,” including the following:

“The uncertainty about the amount . . . is not expected to be resolved for a long period of time.”
“The entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.”

If the issuer expects to be entitled to a breakage amount, it derecognizes a portion of its liability for the prepaid stored-value product over time to reflect expected breakage amounts. Breakage is not recognized immediately upon issuance of the prepaid stored-value product. Instead, expected breakage amounts are recognized over time in proportion to the pattern of rights expected to be exercised by the holder (i.e., in proportion to amounts redeemed). At the end of each reporting period, the issuer updates its breakage estimates to reflect current circumstances and accounts for the changes as a change in accounting estimate under ASC 250-10-45-17 through 45-20.

Example 9-11

Derecognition of Prepaid Gift Cards — Breakage Anticipated

On the basis of a portfolio assessment, an issuer of prepaid gift cards within the scope of ASC 405-20 expects breakage of 20 percent of the initial dollar balance on each card. Upon issuance of a gift card, the issuer recognizes the full stated balance as the initial carrying amount of its liability for the gift card. Each time holders redeem gift cards and the issuer pays its associated obligation, the issuer derecognizes a portion of its liability for prepaid gift cards equal to the amount extinguished, plus an additional amount equal to 25 percent of amounts redeemed, to reflect expected breakage (20% ÷ 80%). When a gift card holder redeems $80 of the card balance to purchase goods or services from a third-party merchant, the issuer reimburses the merchant in $80 of cash. Accordingly, the issuer derecognizes $80 of its liability to reflect the amount extinguished and derecognizes another $20 to reflect expected breakage (25% × $80). When a gift card holder redeems another $160, another $40 of breakage is recognized (25% × $160). If the pattern of rights expected to be exercised by holders slows so that expected breakage declines to 70 percent of initial dollar balances, the issuer accounts for the change as a change in estimate under ASC 250-10.

If the issuer does not expect to be entitled to a breakage amount, it derecognizes a portion of its liability to reflect such an amount only when the likelihood that the holder will exercise its remaining rights becomes remote.

Example 9-12

Derecognition of Prepaid Gift Cards — Breakage Not Anticipated

An issuer of prepaid gift cards within the scope of ASC 405-20 does not expect to be entitled to any breakage. Upon the cards’ issuance, the issuer recognizes the full stated balance as a liability. Over time, the issuer derecognizes any amount that it settles. Any remaining unused balance is derecognized only when the likelihood is remote that such amounts will ultimately be redeemed.