What is Debt modification or extinguishment?
In short
When a borrower and the same lender modify or exchange debt, it is treated as an extinguishment if the present value of the new cash flows differs by at least 10% from that of the remaining old cash flows. Otherwise it is a modification.
Key takeaways
- In an extinguishment, the old debt is derecognized and a gain or loss recognized; the new debt is recorded at fair value.
- In a modification, no gain or loss is recognized, and a new effective interest rate is applied going forward.
- Fees paid to the lender are part of the gain or loss in an extinguishment and amortized in a modification.
Where it's tested
FAR: Long-Term Debt (Bonds & Notes) — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
Bonds with a face amount of $500,000 and an 8% annual coupon are issued for $470,000 when the market rate is 9%. Using the effective interest method, what is interest expense for the first year?