I would like to record about the key points of the US CPA exam content.
<Create and note the points based on mainly Becker’s workbook>
Troubled debt restructuring with fixed assets
- When assets are transferred in a troubled debt restructuring, the asset (for example real estate) is adjusted to fair value and an ordinary gain or loss recorded. Then, the gain or loss on restructuring is recorded as the difference between the debt and fair value of asset transferred.
The gain or loss on extinguishment of the bond
- Reacquisition price: 1600
- Carrying value: Face amount: 1500 less unamortized discount (200), less unamortized bond issuance cost (100) = Net carrying value 1200.
- loss of extinguishment : 1600 -1200 = 400.
the option of calling the bond
- Because the issuer can call the bond, a bondholder will typically require a higher rate of return for callable bonds as compensation for the risk that the bond is called early and then having to reinvest the cash proceeds at lower market interest rates; therefore, the call price is often set at a premium to par.
- When interest rates move lower, it becomes more attractive for the borrower to “refinance” the debt at lower rates. Because a callable bond provides an early redemption option to the issuer, it is more likely to “call” a bond as rates moves lower (in the hopes of reissuing debt at now lower rates). The call price is often set at a premium to par.
Concept of In-Substance Defeasance
- Defeasance: Defeasance refers to the process where a debtor places sufficient funds in a trust or escrow account to cover future payments of principal and interest. This makes the debt essentially “risk-free” for the creditor. Typically, government securities are purchased to generate such cash flows and guarantee the debt payments.
- In-Substance Defeasance: In-substance defeasance is the act where the debtor transfers cash or government securities to an irrevocable trust dedicated to paying off the debt. while this action effectively guarantees that the debt will be paid, it does not legally extinguish the debtor’s obligation.
- Freezing Payments: This means that the payments of principal and interest are effectively guaranteed by the assets placed in the trust. This provides assurance to the creditors.
- Liability Remains on the Books: Even if separate assets are set aside, the debt is not considered extinguished for accounting purposes. Therefore, the debt remains on the debtor’s balance sheet.
- Debtor is the Primary Obligor: The debtor remains legally responsible for the debt. If the trust’s assets are insufficient to cover the debt, the debtor is responsible for making up the shortfall.
