1. 12-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Chapter 12 Set-off and extinguishment of debt

2. 12-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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

3. 12-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Relevant standard AASB 132 ‘Financial Instruments: Presentation’

4. 12-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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

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

6. 12-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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)

7. 12-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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

8. 12-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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

9. 12-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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 DebitLiability CreditGain on release of debt Refer to Worked Example 12.2

10. 12-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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

11. 12-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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

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