Good afternoon, Class! So, before anything else, let’s pray first.

Lord, we offer to you our class today. May we value each other’s contributions as
a building block towards harmony and peace. All this we ask in your powerful name.
Amen.
So, as usual, everyone’s present in this class. Last meeting, we’ve discussed the
different types of current and non-current liabilities. And today, we’re going to
discuss about “debt restructure.”
We have 3 learning objectives, first is to understand the nature and purpose of debt
restructuring. Second, to identify the types of debt restructuring. Lastly, to know
the accounting for an asset swap, equity swap, and modification of terms of the old
liability.
Let’s begin with 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 be granted in a normal
business relationship.
So, from the word itself “restructuring,” meaning it is an act of altering an already
existing contract. This usually occurs where borrowers are deemed financially
unstable and are unable to meet debt obligations.
So, what’s the purpose of debt restructuring? On the part of the creditor, this is to
make the best of a bad situation or maximize recovery of investment. While on the
part of the debtor, this is to pay his/her obligation following the agreement made
or what is imposed by law or a court.
So, what is the effect of debt restructuring to both parties? The creditor usually
sustains an accounting loss on debt restructuring, while the debtor usually realizes
an accounting gain.
In this case, the borrowing party must negotiate with the creditor to create a
situation where both parties are better off. Of course, lenders don’t want
borrowers to default on their loans because this may fall to bankruptcy. So, most
of the time, lenders will agree to negotiate with underwater borrowers to
restructure the loan. This leads to the 3 types of debt restructuring, which are
considered to be the options of debtor in paying his/her debt. So, first is the asset
swap, second is the equity swap, and lastly, the modification of terms.
So, the question is what is asset swap?
Asset swap is the transfer by the debtor to the creditor of any asset, such as real
estate, inventory, receivables, and investment, in full payment of an obligation.
Under PFRS 9, paragraph 3.3.1, asset swap is treated as a 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.
Let’s proceed in our example.
An entity provided the following balances at year-end:
Note payable 2,000,000
Accrued interest payable 400,000
At year end, the entity transferred to the creditor land with carrying amount of
1,500,000 and fair value of 2,200,000.
So, for the computation, we have note payable of 2,000,000 pesos plus accrued
interest payable of 400,000 pesos totaling to the total liability of 2,400,000 pesos.
Next, we’ll deduct the carrying amount of the land from the total liability, which
gives us a gain on extinguishment of debt amounting to 900,000 pesos.
And then for the journal entry, we have:
Debit note payable 2,000,000
Debit accrued interest payable 400,000
Credit land 1,500,000
Credit gain on extinguishment of debt 900,000

On the right-side, we have another computation, right? But as you notice, it’s
almost the same with the left side computation. This is because on the right side,
the computation for the gain is divided into two: the gain on exchange and the gain
on debt restructuring. It must be noted, however, that the gain on extinguishment
under PFRS 9 includes both the gain on exchange and gain on debt restructuring
under US GAAP. In this case, the PFRS 9 shall be followed as this is in conformity
with international accounting standard.
So, naiintindihan naman ba class?
Class: Yes po.
Okay, let’s proceed on dacion en pago accounting. What is dacion en pago? I know
you’re already familiar with this since we tackled this on our Obligation and
Contracts class. But, just to refresh it from your mind, dacion en pago arises when
a mortgaged property is offered by the debtor in full settlement of the debt. The
transaction shall be accounted for as an “asset swap” form of debt restructuring.
So, if the balance of the obligation including accrued interest and other charges is
more than the carrying amount of the property mortgaged, there is a gain on
extinguishment of debt. Otherwise, if the balance of the obligation is less than the
carrying amount of the property mortgaged, there is a loss on extinguishment.
For the illustration, Land costing 500,000 pesos and building costing 4,000,000
pesos with accumulated depreciation of 800,000 pesos were mortgaged to secure
a bank loan of 3,000,000.
The problem also stated the face amount of the loan amounting to 3,000,000,
accrued interest payable of 200,000 pesos, and legal fee and bank service charges
of 50,000. Subsequently, the land and building were given to the bank in full
payment of the liability.
So, for the journal entry, we’ll have a:
Debit mortgage payable 3,000,000
Debit accrued interest payable 200,000
Debit bank service charges 50,000
Debit loss on extinguishment of debt 450,000
Debit accumulated depreciation 800,000
Credit land 500,000
 Credit building 4,000,000

Question, ma’am how did you get that loss on extinguishment of debt amounting
to 450,000? So, the computation for that is the total liability (which is sum of
mortgage payable, accrued interest payable, and bank service charges) less the
carrying amount of land and building (500,000 + 3,200,000), totaling to the loss on
extinguishment of debt of 450,000.
Nage-gets ba, class?
Class: Yes po.
Okay, let’s move on to the other type of debt restructuring which is the equity
swap. 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 particularly share capital to
the creditor. So, kung kanina sa asset swap, in full payment of obligation, here in
equity swap, the obligation may be fully or partially extinguished by the debtor
upon issuing equity instruments.
• The accounting issue regarding equity swap is now well-settled under IFRIC
19. IFRIC 19 provides that when equity instruments issued to extinguish all
or part of a financial liability are recognized initially, an entity shall measure
the equity instruments at the fair value of the equity instruments issued,
unless that fair value cannot be measured reliably. So, if the fair value of the
equity instruments cannot be measured reliably, the equity instruments shall
be measured to reflect the fair value of the financial liability extinguished.
Simply stated, the equity instruments issued to extinguish a financial liability
shall be measured at the following amounts in the order of priority:
First is the fair value of equity instruments issued. Second is the fair value of
liability extinguished, and last is the carrying amount of liability extinguished.
We have here an example. An entity showed the following data at year-end:
Bonds payable 5,000,000
Accrued interest payable 500,000
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. On the other hand, the fair value of the bonds payable is 4,700,000.
Since in the given problem, we cannot reliably measure the equity
instruments issued, we have to follow the other basis for measurement in
order of priority.
If the fair value of shares issued is used, we’ll have:
Debit bonds payable 5,000,000
Debit accrued interest payable 500,000
Credit share capital 2,000,000
Credit share premium 2,500,000
Credit gain on extinguishment of debt 1,000,000

For the computation of share premium, we have:

• Fair value of shares issued 4,500,000 less par value of shares issued
2,000,000 equals share premium 2,500,000.
• We also have bonds payable 5,000,000 plus accrued interest payable
500,000 equals 5,500,000 less fair value of shares issued equals
1,000,000 gain on extinguishment of debt.

If the fair value of bonds payable is used, we’ll have:

Debit bonds payable 5,000,000
Debit accrued interest payable 500,000
Credit share capital 2,000,000
Credit share premium 2,700,000
Credit gain on extinguishment of debt 800,000
For the computation of share premium, we have:
• Fair value of bonds payable 4,700,000 less par value of shares issued
2,000,000 equals share premium 2,700,000.
• We also have carrying amount of bonds payable 5,500,000 (which is
composed of the bonds payable and accrued interest payable) less fair
value of bonds payable equals 800,000 gain on extinguishment of debt.

If the carrying amount of bonds payable is used, we’ll have:

Debit bonds payable 5,000,000
Debit accrued interest payable 500,000
Credit share capital 2,000,000
Credit share premium 3,500,000

For the computation of share premium, we’ll have:

• Carrying amount of bonds payable 5,500,000 less par value of shares
issued 2,000,000 for a total of 3,500,000 share premium.

It must be noted, class, that if the carrying amount of the liability is

used, there is no gain or loss on extinguishment.

Let’s now proceed to the third type of debt restructuring which is the
modification of terms. Modification may involve either the interest, maturity
value or both.
• Interest concession may involve a reduction of interest rate, forgiveness
of unpaid interest or moratorium of interest, while the maturity value
concession may involve an extension of the maturity date or a reduction
of the principal amount.
• Under PFRS 9, modification of terms may be classified as either
substantial or no substantial. PFRS 9, par. 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 new financial liability.

• There is substantial modification of terms if the gain or loss on

extinguishment is at least 10% of the old financial liability. On the other
hand, there is no substantial modification of terms if the gain or loss on
extinguishment is less than 10% of the carrying amount of old financial
liability.
• The difference between the carrying amount of the old liability and the
present value of new or restructured liability shall be accounted for as gain
or loss on extinguishment of debt.
• The old effective rate is used in computing the present value of the new
liability.
This is an example of substantial modification of terms:
On January 1, 2020, an entity showed the following:
Note payable – due January 1, 2020 – 14% 5,000,000
Accrued interest payable 1,000,000
The entity is granted by the creditor the following concessions on January 1,
2020:
a. The accrued interest of P1,000,000 is forgiven.
b. The principal obligation is reduced to P4,000,000.
c. The new interest rate is 10% payable every December 31.
d. The new date of maturity is December 31, 2023.
• This requires computation of the present value of the new note payable
using the old rate of 14%.
• The present value of the new note payable is equal to the present value of
the new principal plus the present value of the interest payments on the new
principal liability.
 • The PV of 1 at 14% for 4 periods is 0.5921 and the PV of an ordinary annuity of 1 at 14%
for 4 periods is 2.9137.

So, for the computation, we have here the:

• Present value of principal (which is 4,000,000 multiply by .5921 equals
2,368,400) plus present value of interest payments (which is 400,000 multiply
by 2.9137 equals 1,165,480) totaling to a present value of new note payable
of 3,533,880. The present value of new note payable will then be deducted to
the face value of new note payable that result to a discount on note payable
amounting to 466,120.

• The other computation would be the note payable – old of 5,000,000 plus the
accrued interest payable of 1,000,000 equals to carrying amount of old
liability of 6,000,000. After that, the carrying amount of old liability will be
deducted to the present value of new note payable amounting to 3,533,880 to
arrive at the gain on extinguishment of debt totaling 2,466,120.

• So, as you can see in the example, there is a gain on extinguishment of debt
totaling to 2,466,120, meaning, it is more than the 10% of 6,000,000 old
liability or simply 600,000. Therefore, this is considered to a substantial
modification of terms.

To better understand the difference between the 2 classifications of modification

of terms, I also provided an example of no substantial modification of terms.
On January 1, 2020, an entity showed the following:
Note payable – due January 1, 2020 – 10% 5,000,000
Accrued interest payable 1,000,000
The entity is granted by the creditor the following concessions on January 1,
2020:
a. The accrued interest of P1,000,000 is forgiven.
b. The interest rate is 14% payable every December 31.
c. The date of maturity is December 31, 2022.
• This requires computation of the present value of the new note payable
using the old rate of 10%.
• The PV of 1 at 10% for 3 periods is 0.7513 and the PV of an ordinary annuity
of 1 at 10% for 3 periods is 2.4869.

So, for the computation, we have here the:

• Present value of principal (which is 5,000,000 multiply by .7513 equals
3,756,500) plus present value of interest payments (which is 5,000,000
multiply by 14% then multiply again by 2.4869 equals 1,740,830) totaling to
a present value of new liability amounting to 5,497,330.
• To compute for the gain on modification, we have to add carrying amount of
old liability amounting to 6,000,000 and the face amount of new note
payable of 5,497,330 that will result to a gain of modification totaling to
502,670.
• Lastly, the present value of new note payable must be deducted to the face
amount of new note payable to determine whether there is a discount or
premium on the new note payable. In this case, there is a premium on the
new note payable amounting to 497, 330 because the present value of new
note payable amounting to 5,497,330 is greater than the 5,000,000, face
amount of new note payable.
• Unlike the previous example, the gain on modification amounting to 502,670
here is less than the 10% of the 6,000,000 old liability. Therefore, this is
considered as no substantial modification of terms.

As you notice class, if there is substantial modification of terms, the debtor

receives a discount on note payable. On the other hand, if there is no
substantial modification of terms, the debtor receives a premium on note
payable.
Since we’re running out of time, I’ll ask you just simple questions to assess
your learnings regarding our topic for today’s session.
Can anyone from the class tell me what are the 3 types of debt restructuring?
Lhorena: The asset swap, equity swap, and modification of terms, ma’am.
Very good, Ms. Delos santos! How about the two classifications of
modification of terms, anyone?
Ate: The substantial and no substantial modification of terms, ma’am.
You’re right, Ms. Morales! Can anyone tell me what is the difference
between the two?
Anna: In substantial modification of terms, the gain or loss on
extinguishment is at least 10% of the old financial liability, while in no
substantial modification of terms, the gain or loss on extinguishment is less
than 10% of the carrying amount of old financial liability.
Very well said, Ms. Palisoc!
Just a reminder class that on Monday we’ll have a quiz and this topic we’ve
discussed today will be included. If you have any concern, just see me during
our consultation hour. Thank you for listening and participating, Class! Bye!