BATANGAS STATE UNIVERSITY
The National Engineering University
Rizal Avenue Extension, Batangas City
College of Accountancy, Business Economics and International
Hospitality Management
INTERMEDIATE ACCOUNTING II
BS Management Accounting
1st Semester, AY 2024 - 2025
Reference: Conrado Valix, et.al
DEBT RESTRUCTURE
Debt restructuring is a situation where the creditor, for economic or legal reasons related to the debtor's financial
difficulties, grants to the debtor concession that would not otherwise be granted in a normal business relationship.
The concession either stems from an agreement between the creditor and debtor, or is imposed by law or a court.
The objective of the creditor in a debt restructuring is to make the best of a bad situation or maximize recovery of
investment.
The three types of debt restructuring are asset swap, equity swap and modification of terms of the old liability.
Asset swap
An asset swap is the transfer by the debtor to the creditor of any asset, such as real estate, inventory, accounts
receivable and investment in full payment of an obligation. Under PFRS 9, paragraph 3.3.1, asset swap is treated as
derecognition of a financial liability or extinguishment of an obligation.
Paragraph 3.3.3 provides that the difference between the carrying amount of the financial liability and the
consideration given shall be recognized in profit or loss.
Illustration
Note payable 2,000,000
Accrued interest payable 400,000
At year-end, the entity transferred to the creditor land with carrying amount of P 1,500,000 and fair value of
P2,200,000.
What is the journal entry to record the gain on extinguishment of debt?
Equity swap
An equity swap is a transaction whereby a debtor and creditor may renegotiate the terms of financial liability with
the result that the liability is fully or partially extinguished by the debtor issuing equity instruments to the
creditor.
Simply stated, an equity swap is the issuance of share capital by the debtor to the creditor in full or partial
payment of an obligation.
Under IFRIC 19, the equity instruments issued to extinguish a financial liability shall be measured at the
following amounts in the order of priority:
a. Fair value of equity instruments issued
b. Fair value of liability extinguished
c. Carrying amount of liability extinguished
The difference between the carrying amount of the financial liability and the initial measurement of the equity
instruments issued shall be recognized as gain or loss on extinguishment.
The gain or loss on extinguishment of a financial liability by issuing equity shares shall be reported as a separate
line item in the income statement.
Illustration
An entity showed the following data at year-end:
Bonds payable 5,000,000
Accrued interest payable 500,000
ACC 309 Module 9 – Debt Restructure
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BATANGAS STATE UNIVERSITY
The National Engineering University
Rizal Avenue Extension, Batangas City
College of Accountancy, Business Economics and International
Hospitality Management
The entity issued share capital with a total par value of P2,000,000 and fair value of 4,500,000 in full settlement of
the bonds payable and accrued interest payable.
On the other hand, the fair value of the bonds payable is 4,700,000
Modification of terms
Modification may involve either the interest, maturity or both. Interest concession may involve a reduction of
interest rate, forgiveness of unpaid interest or a moratorium on interest.
Maturity value concession may involve an extension maturity date or a reduction of the principal amount.
PFRS 9, paragraph 3.3.2, provides that a substantial modification of terms of an existing financial liability
shall be accounted for as an extinguishment of the old financial liability and the recognition of a new financial
liability.
Under Application Guidance B3.3.6 of P FRS 9, there is substantial modification of terms if the gain or loss on
modification is at least 10% of the old financial liability.
The gain or loss on modification is the difference between carrying amount of the old liability and the present
value of the new liability, including any fees paid, discounted at the original effective interest rate.
The new liability is discounted using the original effective rate only for purposes of determining whether the gain
or loss on modification satisfies the 10% test.
If the old liability is determined to be substantially modified, the new liability shall be measured at fair value or
present value using the prevailing market rate of interest.
The difference between the carrying amount of the old liability and the fair value or present value of the new
liability market rate of interest shall be accounted for as gain or loss on extinguishment.
Any costs or fees incurred because of the substantial modification of terms shall be recognized as part o/ the gain
or loss on extinguishment.
In other words, any costs or fees incurred because of the substantial modification of terms shall be deducted from
any gain on extinguishment or added to the loss on extinguishment of the old financial liability.
Substantial modification
On January 1, 2022, an entity showed the following:
Note payable due January 1, 2022 — 14%
Accrued interest payable 700,000
The entity is granted by the creditor the following concessions on January 1, 2022:
The accrued interest of P700,000 is forgiven.
The principal obligation is reduced to 4,000,000
The new interest rate is 10% payable every December 31.
The new date of maturity is December 31, 2025.
The market rate of interest is 12% for similar liability.
The entity paid P 150,000 to the creditors as arrangement fee for the restructuring.
ACC 309 Module 9 – Debt Restructure
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BATANGAS STATE UNIVERSITY
The National Engineering University
Rizal Avenue Extension, Batangas City
College of Accountancy, Business Economics and International
Hospitality Management
EXERCISES
1. Problem 9-14 (AICPA Adapted) The following information pertains to the transfer of real estate pursuant
to a debt restructuring by Knob Company to Mene Company in full liquidation of Knob Company’s liability
to Mene Company:
Carrying amount of liability liquidated 1,500,000
Carrying amount of real estate transferred 1,000,000
Fair value of real estate transferred 900,000
Under IFRS, what amount of gain on extinguishment of debt?
Under US GAAP, what is the gain on restructuring?
Under US GAAP, what amount should be reported as gain or loss on transfer of land?
2. Sunset Company had bonds payable with face amount of 5,000,000 and a carrying amount of 4,800,000.
In addition, unpaid interest on the bonds was accrued in the amount of 250,000.
The creditor agreed to the settlement of the bonds payable in exchange for 50,000 shares of 50 par value.
The shares had current market value of 4,500,000. The fair value of bonds was 4,600,000.
Determine the amount of share premium and the gain/loss on extinguishment:
a. If the fair value of the equity instrument is used.
b. If the fair value of bonds is used.
c. If the carrying amount of financial liability is used.
3. During 2022, Mann Company experienced financial difficulties and is likely to default on a P5,000,000,
15% three-year note dated January 1, 2020 payable to Summit Bank. On December 31, 2022, the bank
agreed to settle the note and unpaid interest of P750, 000 for P4, 100,000 cash payable on January 31,
2023.
What amount should be reported as gain from extinguishment of debt in the 2022 income statement?
4. On January l, 2022, Kingdom Company 10% note payable of and accrued interest payable of P500,000.
The entity is granted by the creditor in a debt restructuring agreement the following concessions:
a. Accrued interest of P500,000 is forgiven.
b. The new interest rate is 14% payable annually every December 31.
c. The new maturity date of the note is December 31, 2025.
d. The entity paid P290,000 to the creditor as arrangement fee or modification cost.
Considering the effect of the modification cost or arrangement fee, the new effective interest rate is 12%.
The market rate of interest for similar note is 9%. 10% 12%
PV of 1 for 4 periods 0.71 0.68 0.64
PV of an ordinary annuity of 1 for 4 periods 3.24 3.17 3.04
What amount of loss on modification should be recognized for 2022?
What amount should be reported as interest expense for 2022?
What is the carrying amount of the modified note payable on December 31, 2022?
ACC 309 Module 9 – Debt Restructure
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BATANGAS STATE UNIVERSITY
The National Engineering University
Rizal Avenue Extension, Batangas City
College of Accountancy, Business Economics and International
Hospitality Management
MULTIPLE CHOICES
1. In a debt restructuring that is considered an asset swap, the gain on extinguishment is equal to
a. Excess of the fair value of the asset over the carrying amount
b. Excess of the carrying amount of the debt over the fair value of the asset
c. Excess of the fair value of the asset over its carrying amount of debt
d. Excess of the carrying amount of the debt over the carrying amount of the asset.
2. For a debt restructuring involving substantial modification of terms, it is appropriate for a debtor to
recognize a gain when the carrying amount of the debt.
a. Exceeds the total future cash payments specified by the new terms
b. Is less than the total future cash payments specified by the new terms
c. Exceeds the present value of the future cash payments specified by the new terms
d. Is less than the present value of the future cash payments specified by the new terms
3. For a debt restructuring involving a substantial modification of terms, which of the following the specified
by the new terms would be compared to the carrying amount of the debt to determine if the debtor
should report a gain on extinguishment?
a. The total future cash payments
b. The present value of the debt at the original interest rate
c. The present value of the debt at the modified interest rate
d. The amount of future cash payments
4. Under a debt restructuring involving substantial modification of terms, the future cash flows under the
new terms shall be discounted using
a. Original effective interest rate
b. Interest rate under the new terms
c. Market rate of interest
d. Prime interest rate
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