12-1 copyright 2007 mcgraw-hill australia pty ltd ppts t/a australian financial accounting 5e by...

12-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig DeeganSlides prepared by Craig Deegan

Chapter 12

Set-off and extinguishment of debt


Learning objectives

• Understand that there are a number of ways in which debt can be removed from the balance sheet

• Understand what it means to ‘extinguish’ debt• Understand that the practice of using insubstance debt

defeasance is no longer allowed in Australia as a result of the adoption of IFRSs

• Understand what a debt ‘set-off’ is and when it can be undertaken

• Be able to explain the benefits of undertaking a debt set-off


Relevant standard

AASB 132 ‘Financial Instruments: Presentation’


Introduction

• The chapter discusses procedures for removing debt from the balance sheet

• The issues of debt being ‘forgiven’ and offsetting assets and liabilities for balance sheet presentation are covered

• There is a brief discussion of insubstance debt defeasance– now explicitly prohibited by AASB 132


Set-off of assets and liabilities

• Set-off– reduction of an asset by a liability or of a liability by an

asset in the presentation of the balance sheet

– the net amount only is presented

• AASB 132 requires a financial asset and a financial liability to be offset and the net amount presented on the balance sheet when– a legally enforceable right of set-off exists; and

– the entity intends either to settle on a net basis or realise the asset and settle the liability simultaneously


Set-off of assets and liabilities (cont.)• A financial asset (AASB 132) is

– cash; or – a contractual right to receive cash or another financial

asset from another entity

• A financial liability (AASB 132) is– a contractual obligation or a contract to deliver cash or

another financial asset to another entity

• A right of set-off is– a right allowing an entity to offset the amount owed to

one entity against the amount owed by that of another entity

– recognised by law or in equity

• Refer to Worked Example 12.1 (p. 443)


Defining extinguishment and defeasance of debt

• Debt is ‘extinguished’ when– there is no further future obligation to an external party

to transfer economic benefits

– as a result, debt can be removed from the balance sheet

• Defeasance was previously defined as (AASB 1014, now withdrawn)– the release of a debtor from the primary obligation for a

debt

• Defeasance is not defined or addressed in ‘new’ AASB 132


Defining extinguishment and defeasance of debt (cont.)

• Legal defeasance was previously defined as (AASB 1014)– when the release of a debtor from the primary obligation

is acknowledged formally by the creditor or trustee of the creditor or by legal judgment

• Legal defeasance might arise from legal judgments, forgiveness of a debt or assumption of a debt by a third party

• The term is not used explicitly in the ‘new’ AASB 132, but it remains acceptable


Defining extinguishment and defeasance of debt (cont.)

• Forgiveness of a debt– where a debt is cancelled so the debtor no longer has to

pay the amount that was due

– the journal entry in the books of the debtor

Debit Liability

Credit Gain on release of debt

• Refer to Worked Example 12.2


Insubstance debt defeasance (ISDD)

• Previously defined as (AASB 1014)– where the debtor achieves release from the primary

obligation for a debt by- placing in trust assets that are adequate to service the

debt; or

- having a suitable entity assume responsibility for servicing the debt

• AASB 132 prohibits the removal of debt from the balance sheet as a result of an ISDD– the standard takes more of a form-over-substance

approach than did AASB 1014, which allowed ISDD


Insubstance debt defeasance (cont.)• Deegan (1985) indicated numerous advantages

of ISDDs– debt can be retired without reference to individual debt

holders

– provides management with the ability to ‘manage’ company earnings

– can allow strategic rethinking of business policies

– can avoid the effect of forcing up the market price of securities by buying back debt

– restrictive limitations imposed by trustee for debenture holders might be relaxed

– if defeasance is applied to all debt under a trust deed, all deed restrictions may be removed


Summary

• The chapter addresses various issues regarding debt set-offs and debt extinguishment

• If debt is no longer required to be paid, entity is better off and the gain is recognised as income

• Previously, ISDD meant that, in substance, the debt had been repaid and a gain or loss was recorded

• ISDD is now specifically prohibited by AASB 132

• Debt set-off can be a cost-effective approach to reducing the entity’s reported leverage

12-1 copyright 2007 mcgraw-hill australia pty ltd ppts t/a australian financial accounting 5e by...

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