B.C.

Villaluz
Debt Restructuring

DEBT RESTRUCTURING
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 bet granted in a normal business relationship.

The objective of the creditor in a debt restructuring is to make the best of a bad situation or maximize recovery of
investment.

TYPES OF DEBT RESTRUCTURING

1. Debt forgiveness
2. Asset swap
3. Equity swap
4. Modification of terms of debt

Asset Swap
➢ The transfer by the debtor to the creditor of any asset in full payment of an obligation.
➢ Treated as an extinguishment of an obligation.

Equity Swap (IFRIC 19)

➢ The issuance by the debtor of equity instruments to the creditor in full or partial payment of an obligation.

Problem 1: (Debt forgiveness)

Nairobi Company is indebted to Sierra Company under a P5,000,000, 12%, three-year note dated December 31, 2017.
Because of Nairobi’s financial difficulties developing in 2019, Nairobi Company owed accrued interest of P600,000 on the
note on December 31, 2019.

On December 31, 2019, the creditor forgave the accrued interest and half of the principal amount of the loan.

What amount should be reported as gain on extinguishment of liability?

Problem 2: (Asset swap)

Tummy Company is indebted to Taal Company under a P5,000,000, 12%, three-year note dated December 31, 2017.
Because of Tummy’s financial difficulties developing in 2019, Tummy Company owed accrued interest of P600,000 on the
note on December 31, 2019.

Under a debt restructuring on December 31, 2019, Taal Company agreed to settle the note and accrued interest for a
tract of land having a fair value of P4,500,000. The carrying amount of the land is P3,600,000.

Under IFRS, what amount should be reported as gain on extinguishment of liability?

Problem 3: (Equity swap)

At year-end, Mikasa Company showed the following data with respect to a matured obligation:

Note payable 5,000,000

Accrued interest payable 500,000

The company is threatened with a court suit if it could not pay a maturing debt. Accordingly, the company entered into
an agreement with the creditor for the issuance of share capital in full settlement of the note payable.

The agreement provided for the issue of 35,000 shares with par value of P100. The share is currently quoted at P130. The
fair value of the note payable on the date of restructuring is P4,700,000.
 B.C.Villaluz
1. What amount should be recognized as gain from extinguishment of debt?
2. If the shares do not have fair value, what amount should be recognized as gain from extinguishment
of debt?
3. If both the shares and the note payable do not have fair value, what amount should be recognized
as gain from extinguishment of debt?

Problem 4: (Substantial modification of terms)

Due to extreme financial difficulties, Amanda Company had negotiated a restructuring of a 10% P5,000,000 note payable
due on December 31, 2018. The unpaid interest on the note on such date is P500,000.

The creditor had agreed to reduce the face value to P4,000,000, forgive the unpaid interest, reduce the interest rate to
8% and extend the due date three years from December 31, 2018.

The PV of 1 at 10% for three periods is 0.75 and the PV of an ordinary annuity of 1 at 10% for three periods is 2.49.

What is the gain on extinguishment of debt in 2018?

Problem 5: (Non-substantial modification of terms)

Due to adverse economic circumstances and poor management, Aero Company had negotiated a restructuring of its 9%
P6,000,000 note payable to Second Bank due on January 1, 2018. There is no accrued interest on the note.

The bank has reduced the principal obligation from P6,000,000 to P5,000,000 and extend the maturity to 3 years or on
December 31, 2020. However, the new interest rate is 13% payable annually every December 31.

The present value of 1 at 9% for three periods is .77 and the present value of an ordinary annuity of 1 at 9% for three
periods is 2.53.

What is the gain on extinguishment of debt to be recognized for 2018?

END OF HANDOUT