DEBT RESTRUCTURE

Substantial Modification

A. Determine the present value of the new liability using the original effective rate.
B. Get the difference between the old liability and the sum of the present value of the new liability
based on the original effective rate and any arrangement fee or modification cost.
C. There is substantial modification if the difference is at least 10% of the old liability. There is non-
substantial modification if the difference is less than 10% of the old liability.
D. If the old liability is substantially modified, the new liability shall be measured at fair value or
present value of the new liability using the prevailing market rate of interest.
E. The difference between the old liability and the sum of the present value of the new liability based
on market rate of interest and any arrangement fee or modification cost shall be recognized as gain
or loss on extinguishment.
F. The arrangement fee or modification cost is included in the measurement of gain or loss on
extinguishment.

Non-substantial Modification

A. Ignore the prevailing market rate of interest.

B. Determine the present value of the new liability using the original effective rate.
C. The difference between the old liability and the present value of the new liability using the original
effective rate shall be recognized as gain or loss on modification.
D. Any arrangement fee or modification cost shall be included in the measurement of the new liability.
In other words, the arrangement fee or modification cost is deducted from the present value of new
liability using the original effective rate.
E. A new effective rate must be determined to reflect the arrangement fee or modification cost.
LECTURE DRILLS
Problem 1
Hull Company is indebted to Apex under a ₱5,000,000, 12%, 3-year note dated December 31, 2020.
Because of Hull’s financial difficulties developing in 2022, Hull Company owed accrued interest of
₱600,000 on the note on December 31, 2022. Under a debt restructuring on December 31, 2022, Apex
Company agreed to settle the note and accrued interest for a tract of land having a fair value of
₱4,000,000. The carrying amount of the land is ₱3,600,000.

1. Under IFRS, what amount should be recorded as gain on extinguishment of debt?

a. 1,400,000
b. 2,000,000
c. 1,000,000
d. 1,600,000
2. Under US GAAP, what amount should be recorded as gain on restructuring?
a. 1,600,000
b. 1,000,000
c. 1,400,000
d. 0
3. Under US GAAP, what amount should be recorded as gain on transfer of land?
a. 1,000,000
b. 1,600,000
c. 400,000
d. 600,000

Problem 2
Due to extreme financial difficulties, an entity negotiated a restructuring of a 10%, 5,000,000 note
payable due on December 31, 2022. The unpaid interest on the note on such date is ₱500,000. The
creditor agreed to reduce the face amount to ₱4,500,000, forgive the unpaid interest, reduce the
interest rate to 8% and extend the due date three years from December 31, 2022. The entity paid
₱200,000 as arrangement fee to the creditor. The market rate of interest is 12%. The present value of 1
at 10% for three periods is 0.75 and the present value of an ordinary annuity of 1 at 10% for three
periods is 2.49. The PV of 1 at 12% for three periods is 0.71 and the PV of an ordinary annuity of 1 for
three periods is 2.40.

1. Under IFRS, what is the gain on extinguishment for 2022?

a. 1,228,600
b. 1,028,600
c. 1,441,000
d. 1,241,000
2. What is the discount or premium on the new note payable on December 31, 2022?
a. 228,600 premium
b. 228,600 discount
c. 441,000 premium
d. 441,000 discount
3. What amount should be reported as interest expense for 2023?
a. 360,000
b. 487,080
c. 427,140
 d. 540,000
4. What is the carrying amount of note payable on December 31, 2023?
a. 4,500,000
b. 3,931,920
c. 4,186,080
d. 4,338,540

Problem 3
An entity is threatened with bankruptcy due to its inability to meet interest payments and fund
requirements to retire ₱6,000,000 note payable with accrued interest payable of ₱600,000. The entity
has entered into an agreement with the creditor to exchange equity instruments for the liability. The
terms of the exchange are 300,000 ordinary shares with ₱5 par value and ₱10 market value, and 25,000
preference shares with ₱10 par value and ₱60 market value. The fair value of the note payable is
₱5,000,000.

1. What is the gain on the extinguishment of the note payable?

a. 2,100,000
b. 1,500,000
c. 2,750,000
d. 1,600,000
2. What is the total share premium from the issuance of the preference and ordinary shares?
a. 2,750,000
b. 4,850,000
c. 1,500,000
d. 3,250,000

Problem 4
An entity 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 had agreed
to the settlement of the bonds payable in exchange for 50,000 shares of ₱50 par value. The shares have
no reliable measure of fair value. However, the bonds are quoted at ₱3,500,000. What is the gain on the
extinguishment of the bonds payable under equity swap?
a. 1,500,000
b. 1,300,000
c. 1,550,000
d. 0

Problem 5
Due to adverse economic circumstances and poor management, an entity had negotiated a restructuring
of its 8% ₱6,000,000 note payable to Second Bank due on December 31, 2022. There is no accrued
interest on the note. The bank has reduced the principal obligation from ₱6,000,000 to ₱5,000,000 and
extend the maturity to 3 years on December 31, 2025. However, the new interest rate is 12% payable
annually every December 31. The entity paid ₱120,000 to the creditor as an arrangement fee. The
arrangement fee is included in the measurement of the modified liability. The new effective rate is 9%
after considering the arrangement fee. The present value of 1 at 8% for three periods is 0.79 and the
present value of an ordinary annuity of 1 at 8% for three periods is 2.58.

1. What amount should be reported as gain on modification for 2022?

 a. 502,000
b. 632,000
c. 372,000
d. 0
2. What is the discount or premium on the new note payable on December 31, 2022?
a. 498,000 premium
b. 498,000 discount
c. 378,000 premium
d. 378,000 discount
3. What amount should be reported as interest expense for 2023?
a. 430,240
b. 484,020
c. 494,820
d. 439,840
4. What is the carrying amount of the note payable on December 31, 2023?
a. 5,262,020
b. 5,337,840
c. 5,000,000
d. 5,392,820