Early Extinguishment of Debt

Rational Debt Management or Earnings Management?

Abhijit Barua, PhD

Throughout the years, there has been much discussion about the financial reporting related to gains or losses from early extinguishment of debt. The debate usually surrounds the classification of this item on the income statement—specifically, whether gains or losses from early extinguishment of debt should be reported as an extraordinary item or as a part of continuing operations. Until 2002, they were classified as an extraordinary item in the income statement; however, since the introduction of Statement of Financial Accounting Standards (SFAS) 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, gains or losses from early extinguishment of debt have been treated as an ordinary income statement item, unless they satisfy the criteria of an extraordinary item, as prescribed by Accounting Principles Board (APB) 30 (Accounting Standards Codification [ASC] 470-50-45). The change in reporting rules for gains and losses from early extinguishment of debt gives companies an opportunity to use decisions about when to retire debt in order to manage earnings before extraordinary items.