Discussion Board Forum 5 Case 11-5
Early Extinguishment of Debt
Remzi Ababora
Liberty University
October 4, 2022
Chapter 11 - Long-Term Liabilities
Case 11-5 - Early Extinguishment of Debt
Gains or losses from the early extinguishment of debt that is refunded can theoretically be
accounted for in three ways:
1.Amortized over the life of old debt
2.Amortized over the life of the new debt issue
3.Recognized in the period of extinguishment
A.Discuss the supporting arguments for each of the three theoretical methods of
accounting for gain and loss from early extinguishment of debt.
The early extinguishment of debt occurs when the issuer of debt recalls the securities
prior to their scheduled maturity date. The early extinguishment of debt may take two forms:
a.Debt retirement – the borrowed funds may no longer be needed, and the debt is
therefore cancelled.
b.Debt refunding – the existing debt may be replaced with another debt issue.
According to Schroeder, Clark & Cathey (2017, p. 247), any gain or loss resulting from
the difference between the carrying value and the call price is treated as a gain or loss in the year
the extinguishment takes place. The theory behind this treatment is that the recall is of the debt
was a current decision, and its effect should therefore be reflected in current income.
1.Amortized Over the life of old debt
The method of amortizing over life of old debt issue is used to consider the gain or loss as
an adjustment to the cost of borrowing that results from obtaining an alternative arrangement
for the unexpired term of the old arrangement. According to Savage (1973), the
extinguishment of the old debt results in modifying the existing contract and the difference at
the time of the refund should be spread over the unexpired term of the original issue to obtain
the proper periodic cost of borrowing money. Amortized Over the life of old debt is view as
the period of benefit – that is, a higher interest cost would have been incurred during this
period if the old issue had not been refunded (Schroeder, Clark & Cathey, 2017).
2.Amortized over the life of the new debt issue
Amortizing the early extinguishment of debt over the life of the new debt issue is usually
provoked by estimated future interest rates; when interest rates are expected to increase, it is
advantageous to amortize over the life of the new debt issue because of the expected benefits
obtained over the life of the new arrangement. Therefore, under this view, the primary
motivation is to create a more favorable interest rate over the term of the new issue debt.
3.Recognized in the period extinguishment
Recognition in the period of extinguishment is stating that the value of the debt has
changed over time and paying either the call price or the current market value is the most
favorable way to extinguish the debt. Accountants favoring immediate write-off argue that this
method is the most logical because the value of the debt has changed over time and paying the
call price is the most favorable method of eliminating the debt (Schroeder, Clark & Cathey,
2017).
B.Which of the three methods would provide a balance sheet measure that reflects the
present value of the future cash flows discounted at the interest rate that is
commensurate with the risk associated with the new debt issue? Why?
Recognition in the period of extinguishment method provides a balance sheet measure
that reflects the present value of the future cash flows discounted at the interest rate that is
commensurate with the risk associated with the new debt issue. The main reason behind this
method is that recognizing in the period of extinguishment has to do with both the market and
References
book value. If the market value of the debt is greater than its book value the transaction results
in an accounting loss, but if the market value of the debt is less than its book value the
transaction results in an accounting gain (Carpenter, 1997).
C.Which of the three methods is generally accepted, and how should the appropriate
amount of gain or loss be shown in a company’s financial statement?
Once again, I would say the method that is generally accepted is the recognition of the
period of extinguishment method. Both gains and losses from the extinguishment of debt which
are included in the determination of net income are intended to be aggregated and, if material,
classified as an extraordinary item that is net of the related income tax effect (FASB, 1975).
Biblical Integration
In proverbs 22:7, It stated that “The rich rules over the poor, and the borrower is the slave
of the lender” (NIV). God does not want us to be slave to our debtor and when we borrow we
must pay back what we owed the first chance we get. The other verses in the bible that speak
about debt, says “the wicked borrows but does not pay back but the righteous is generous and
gives back” (Psalm 37:21, ESV). We must not be like the wicked and not pay back what we
borrow. We must be righteous and gives back what we owe.
Carpenter, B. W. (1997). An Examination of the Reporting and Disclosure of Early Debt
Extinguishments. Journal of Applied Business Research, 13(3), 55-66. Retrieved from
http://search.proquest.com/docview/227552951?pq-origsite=gscholar
FASB. (1975). Statement of Financial Accounting Standards No. 4. Retrieved from
http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220126431&acce
ptedDisclaimer=true
Savage, C. L. (1973). Review of APB Opinion No. 28--"Early extinguishment of debt". The
CPA Journal, 43(000004). Retrieved from
http://search.proquest.com/docview/214920945/citation/4CD43175D16A4060PQ/1?acco
untid=11488
Schroeder, G., Clark, W., & Cathey, M., (2017). Financial accounting theory and analysis. Text
and cases (11th ed.). Hoboken, NJ: Wiley.
The Holy Bible (2011). New International Version (NIV). Retrieved from
https://www.biblegateway.com/passage/?search=Proverbs+22%3A7&version=NIV
https://www.biblegateway.com/passage/?search=Psalm+37%3A21&version=NIV
