GASB Releases Guidance on Debt Extinguishment Issues

By:
Chris Gaetano
Published Date:
May 16, 2017
ChangesAheadSquare

The Governmental Accounting Standards Board has released new guidance for transactions in which cash and other monetary assets acquired with only existing resources—resources other than the proceeds of refunding debt—are placed in an irrevocable trust for the sole purpose of extinguishing debt.

Current rules regarding debt extinguishment are governed by GASB Statements 7 and 23, which establish accounting and financial reporting requirements for current and advance fundings. The volume of such transactions, already common among governments, has been increasing significantly since 2008, which prompted a look at the effectiveness of the literature as it currently stands. While the research indicated that the current standards are "conceptually sound, generally operational, and meeting user needs," there were certain application inconsistencies when governments place cash or other monetary assets in an irrevocable trust for the purposes of debt extinguishment. Application was found to be inconsistent between when those assets are placed in the trust using only existing resources, and when they are placed in the trust using a combination of existing resources and refunding debt proceeds. 

"The main issue identified was that when cash and other monetary assets acquired with only existing resources were placed in an irrevocable trust for the sole purpose of extinguishing debt, some governments would derecognize the debt and assets while other governments would continue to report the debt and assets," said the GASB in the guidance. 

The new guidance essentially harmonizes the requirements of the two situations. Currently Statement No. 7, Advance Refundings Resulting in Defeasance of Debt, requires debt be considered defeased in substance when the debtor irrevocably places cash or other monetary assets acquired with refunding debt proceeds in a trust to be used solely for satisfying scheduled payments of both principal and interest of the defeased debt. The trust also is required to meet certain conditions for the transaction to qualify as an in-substance defeasance. The new guidance establishes essentially the same requirements for when a government places cash and other monetary assets acquired with only existing resources in an irrevocable trust to extinguish the debt. 

However, if the financial statement uses the economic resources measurement focus, governments should recognize any difference between the reacquisition price (the amount required to be placed in the trust) and the net carrying amount of the debt
defeased in substance using only existing resources as a separately identified
gain or loss in the period of the defeasance. Further, if the government that defeases the debt uses only existing resources, it should provide a general description of the transaction in the financial statement notes during that period. In all periods following an in-substance defeasance of debt using only existing resources, the amount of that debt that remains outstanding at period-end should be disclosed.

In addition to these issues, the GASB also determined that there needed to be authoritative guidance for prepaid insurance when the related debt is defeased, as Statement 65 removed the references to issuance costs from the calculation of net carrying amount of the old debt, which had been the previous authoritative guidance on how to treat prepaid insurance related to refunded debt. 

The new guidance says that governments that extinguish debt, whether through a legal extinguishment or through an in-substance defeasance, any remaining prepaid insurance related to the extinguished debt be included in the net carrying amount of that debt for the purpose of calculating the difference between the reacquisition price and the net carrying amount of the debt.

The new guidance is effective for reporting periods beginning after June 15, 2017. Earlier application is encouraged. 

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