CHAPTER

BLUE NOTES
Debt restructuring
31 S
L
 The creditor grants the debtor concession that would not otherwise be granted in a normal business
relationship
 Concession - stems from an agreement between creditor and debtor or imposed by law or a court
Note: The creditor usually sustains an accounting loss on debt restructuring and the debtor realizes an accounting gain

The common forms of debt restructuring

Asset swap
 The transfer by the debtor to the creditor of any asset, in full payment of an obligation.
 Treated as a derecognition of financial liability or extinguishment of obligation through transfer of any
asset such as real estate, inventory or investment by the debtor
Note: The difference between the carrying amount of the financial liability and the consideration given shall be recognized in profit or loss

Illustration
An entity provided the following balances on December 31, 2013:
Note payable 2,000,000
Accrued interest payable 400,000
On December 31, 2013, the entity transferred to the creditor land recorded at cost of P1,500,000 with fair value of
P2,200,000.
PAS 39 USA GAAP
Note payable 2,000,000 FV of Land 2,200,000
Accrued interest payable 400,000 Less: Cost of Land 1,500,000
Total liability 2,400,000 Gain on exchange 700,000
Less: Cost of land 1,500,000
Gain on extinguishment 900,000 Note payable 2,000,000
Accrued interest payable 400,000
Total liability 2,400,000
Less: FV of Land 2,200,000
Gain on debt restructuring 200,000

Note payable 2,000,000 Note payable 2,000,000

Accrued interest payable 400,000 Accrued interest payable 400,000
Land 1,500,000 Land 1,500,000
Gain on extinguishment 900,000 Gain on exchange 700,000
Gain on debt restructuring 200,000
Note: the gain on extinguishment under PAS 39 includes BOTH the gain on exchange and gain on debt restructuring under USA GAAP. PAS 39 shall

Theory of Accounts Practical Accounting 1

112 USL Blue Notes Chapter 31 – Debt Restructuring

be followed as this is in conformity with international accounting standard.

Dacion en pago accounting

This arises when a mortgaged property is offered by the debtor in full settlement of the debt.
Equity swap
 Issuance of share capital by the debtor to the creditor in full or partial payment of an obligation
 Measurement of equity instrument under IFRIC 19 in order of priority
a. Fair value of equity instrument
b. Fair value of liability extinguished
c. Carrying amount of liability extinguished
Note: The difference between the carrying amount of the financial liability extinguished and the “initial measurement” of the equity instrument
issued shall be recognized in profit or loss and shall be disclosed as a separate line item in the income statement

Illustration
An entity provided the following balances on December 31, 2013:
Bonds payable 5,000,000
Accrued interest payable 500,000
On December 31, 2013, the entity issued share capital with a total par value of 2,000,000 and fair value of 4,500,000 in
full settlement of the bonds payable and accrued interest. The fair value of the bonds payable is 4,700,000.

Fair value of the share capital is used Computation

Bonds payable 5,000,000 FV of share capital 4,500,000
Accrued interest payable 500,000 Par value of share capital 2,000,000
Share capital 2,000,000 Share premium 2,500,000
Share premium 2,500,000
Gain on extinguishment 1,000,000 Carrying amount of bonds 5,500,000
FV of share capital 4,500,000
Gain on extinguishment 1,000,000

Fair value of the bonds payable is used Computation

Bonds payable 5,000,000 FV of bonds payable 4,700,000
Accrued interest payable 500,000 Par value of share capital 2,000,000
Share capital 2,000,000 Share premium 2,700,000
Share premium 2,700,000
Gain on extinguishment 800,000 Carrying amount of bonds 5,500,000
FV of bonds payable 4,700,000
Gain on extinguishment 800,000

Practical Accounting 1 Theory of Accounts

Chapter 31 – Debt Restructuring USL Blue Notes 113

Carrying amount of the bonds payable is used Computation

Bonds payable 5,000,000 FV of bonds payable 5,500,000
Accrued interest payable 500,000 Par value of share capital 2,000,000
Share capital 2,000,000 Share premium 3,500,000
Share premium 3,500,000

Modification of terms
 May involve either the interest or maturity value or both
 Interest concession-may involve a reduction of the interest rate, forgiveness of unpaid interest or a
moratorium on interest payment
 Maturity value concession-may involve an extension of the maturity date reduction of the amount to
be paid on maturity
 Substantial modification of terms
 Accounted as an extinguishment of old financial liability and the recognition of new liability
 Under Application Guidance B3.3.6 PFRS 9, there should be gain or loss on extinguishment for at least
10% or 10% or more of the carrying amount old financial liability
Illustration
On January 1, 2013, an entity showed the following:
Note payable- due Jan. 01,2013- 14% 5,000,000
Accrued interest payable 1,000,000
The entity is granted by the creditor the following concessions on January 1, 2013:
a. The accrued interest of 1,000,000 is forgiven.
b. The principal obligation is reduced to 4,000,000.
c. The new interest rate is 10% payable every December 31.
d. The new date of maturity is December 31, 2016.
The present value of 1 at 14% for 4 periods is 0.5921 and the present value of an ordinary annuity of 1 at 14% for 4
periods is 2.9137.
PV of principal (4,000,000 x .5921) 2,368,400 Note payable- old 5,000,000
PV of interest payments (400,000 x 2.9137) 1,165,480 Accrued interest 1,000,000
PV of restructured liability 3,533,880 Total liability 6,000,000
Face value of new note payable 4,000,000 PV of restructured liability 3,533,880
Discount on note payable 466,120 Gain on extinguishment 2.466.120
Note: Present value of new liability minus carrying amount of old liability is equal to gain or loss on extinguishment
Present value is computed using the original effective interest rate
Any cost or fees incurred shall be recognized as part of gain or loss on extinguishment
don’t forget that in computing for the present value, always use the OLD effective rate.
1. To record the extinguishment of the old note payable:

Note payable- old 5,000,000

Accrued interest payable 1,000,000
Discount on note payable 466,120
Note payable- new 4,000,000

Theory of Accounts Practical Accounting 1

114 USL Blue Notes Chapter 31 – Debt Restructuring

Gain on extinguishment 2.466.120

2. To record the interest payment on the new note payable for 2010:

Interest expense (10% x 4,000,000) 400,000

Cash 400,000
3. To amortize the discount on note payable for 2010:
Interest expense 94,743
Discount on note payable 94,743

 No substantial modification of terms

 Any gain or loss on extinguishment of the old liability is less than 10%
 Any costs incurred in modifying the terms are adjusted to the carrying amount of the old
liability and amortized over the remaining term of the modified liability
 The old liability is simply continued but with modified interest change
On January 1, 2013, an entity showed the following:
Note payable- due Jan. 01,2013- 10% 5,000,000
Accrued interest payable 1,000,000
The entity is granted by the creditor the following concessions on January 1, 2013:
a. The accrued interest of 1,000,000 is forgiven.
b. The new interest rate is 14% payable every December 31.
c. The new date of maturity is December 31, 2015.

Note payable 5,000,000

Accrued interest payable 1,000,000
Total liability 6,000,000
Again, this requires computation of the present value of the new note payable using the old rate of 10%.
The present value of 1 at 10% for 3 periods is 0.7513 and the present value of an ordinary annuity of 1 at 10% for 3
periods is 2.4869.
PV of principal (5,000,000 x .7513) 3,756,500
PV of interest payments (500,000 x 2.4869) 1,740,830
PV of new liability 5,497,330

Total old liability 6,000,000

PV of new liability 5,497,330
Gain on extinguishment of debt 502,670
The gain is less than 10% of the old liability of 6,000,000. In this case, under PAS 39, there is no substantial
modification of terms. The gain is not recognized because the modification is not an extinguishment of the old
liability. Moreover, any cost incurred in modifying the terms are adjusted to the carrying amount of the old liability
and amortized over the remaining term of the modified liability
The old liability is continued but with modified interest charges. Accordingly a new effective rate must be computed
to equate the carrying value of the old liability with the present value of the cash outflows of the modified liability.

1. To record the modified liability on January 1, 2013:

Practical Accounting 1 Theory of Accounts

Chapter 31 – Debt Restructuring USL Blue Notes 115

Note payable- old 5,000,000

Accrued interest payable 1,000,000
Note payable- new 5,000,000
Premium on note payable 1,000,000
Notice that the gain on extinguishment is not recognized.
2. To record the annual interest payment for 2013:
Interest expense (5,000,000 x 14%) 700,000
Cash 700,000
3. To amortize premium on note payable using the new effective rate:
Premium on the note payable 313,000
Interest expense 313,000
The new effective rate of 6.45% is determined through the use of a financial calculator.
A new effective interest rate must be computed to equate the carrying amount of the old liability with the present
value of the cash outflows of the modified liability

Theory of Accounts Practical Accounting 1