Post on 20-Dec-2014
description
Intermediate AccountingCasePresentation
Troubled Debt Restructuring
Zheng Yuchuan
Lu Huiping
SalmanKamani
Qu Xin
Presentation FlowPresentation FlowPart IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Q&A
Part I
BackgroundIntroduction
$50 Millionof 8% bonds, issued years ago
Behindin interest payments and contributions to its bonds retirement fund
60%of par: $30 million
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Bondsto
Preference Shares
$30 million$30 million
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Here’s the Problem…
Bonds liability 50m Preference share capital 50m
Bonds liability 50mPreference share capital 30mExtraordinary gain on debt restructuring 20m
We really have
NO choice!You had use of the
money, and you won’t have to pay it back.
“
”
Auditor:Here we are, almost bankrupt, and you tell us we must report $20 m as a gain.
Are you
kiddingme?
“
”
Company:
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
What should we do?
??
?
?
?
?
? ?
Part II
DebtRestructuring
Debt Restructuring
“
”
• Outstanding debt
• Alter debt agreements
• Achieve advantages.
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
ModificationSettlementDebt
Impairments
• Creditor’s perspective
•Unable to collect all amounts due• Loss contingency
• Extraordinary loss
• Creditors: Grant a concession
•Asset/Equity Swap
• Less than CV
• Creditors: Grant a concession
•More favorable terms
• Extinguishment & Establishment
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Then…
When shall we recognize gains?
Debt Impairment
No Gain!!!
CV
Only Loss!!!
PV of expected future CF
using historical rates
Loss on Impairment
Bad Debt XXAllowance for Doubtful A/C XX
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Modification
Restructured gain = CV of debt – PV of expected CFs using
historical rates
Interest Payable XXBonds Payable XX Restructured Debt XX Gain on Restructuring of Debt XX
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Settlement - Equity/Asset Swap
Debt Equity/Asset
CV of Debt FMV of Asset/Equity
Not a troubled debt Restructuring
Restructured gain = CV of debt – Asset/Equity FMV
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Note Payable XXProperty Investment XXOrdinary Gain on Asset Disposition XXExtraordinary Gain on Debt Restructuring XX
Creditor
Asset Swap
Note Payable XXShare Capital XXShare Premium XXExtraordinary Gain on Debt Restructuring XX
Equity Swap
Allowance for doubtful A/C XXShare/Property Investment XXBonds Receivable XX
Debtor
Asset/Equity Swap
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Part III
RationalesBehind
Company’s Way (No Gain)
•Ridiculous financial statements situation •Bankrupt <-> $20 M gain?
•Misinterpretation of the company’s financial condition •Accounting gain <-> Economic loss
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Auditor’s Way (With Gain)•Accounting standard requirement•Equity swap -> fair market value of the debt or equity
•Creditor’s consideration•Exchange of one asset (Bond receivable) to another (Capital investment)
•Boost stock price•Higher reported net income
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Part IV
Influence onFinancial Statements
Company’s WayBonds liability 50m Preference share capital 50m
Bonds liability 50mPreference share capital 30mExtraordinary gain on debt restructuring 20m
Auditor’s Way
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Income Statement
Company’s Way
Auditor’s Way
No gainNo interestexpense
$20MExtraordinary Gain
No interest expense
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Balance Sheet
Company’s Way
ReducedBond Liability
IncreasedPreference Share Capital
$50M$50M
Auditor’s Way
$50MReducedBond Liability
$30M
$20MIncreased
Preference Share Capital
IncreasedRetainedProfits
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Cash Flow Statement
Company’s Way
Reduced cash outflow of annual interest expense
$4M
Auditor’s Way
Reduced cash outflow of annual interest expense
$4M
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Statement of Shareholders’ Equity
Company’s Way
IncreasedPreference Share Capital
$50M
Auditor’s Way
$30MIncreasedPreference Share Capital
$20MIncreasedRetained Profits
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Part V
Influence onStakeholders
Stakeholders
Shareholders
Creditors
InvestorsExternalAuditors
Government
CustomersEmployeesCommunities
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Needs:
• More dividends
• Accurate financial statements
Impact:
Company’s way• Increased
preference share capital ($50m)
• No retained profits allocated
Auditor’s Way• Potential raising
stock price•More accurate
financial information
Needs:
• Principal & interest repayment (high liquidity)
• Accurate financial statement for business decisions - lending
Auditor’s Way• Increased
preference share capital ($30m)
Company’s way•More attractive •Higher shareholder’s equity on book
Principal Bondholders
Auditor’s Way• Favorable debt-to-
equity ratio•More attractive to
creditors•More accurate
financial information
Company’s way• Favorable debt-to-
equity ratio
Potential Bondholders Needs:• Accurate financial statements
e.g.Government – tax obligationExternal auditor – follow accounting standardsEmployee – salary payment
Auditor’s Way•More accurate
financial information
Company’s way•Misinterpret
reported income
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Part VI
Economics of Transaction
Bonds liability 50m Preference share capital 50m
Company’s Way
$20m GainNot Realized
Overstatementof
Preference Share Capital
Favorabledebt-to-equity
ratio
Failto capture
adverse effect
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Bonds liability 50mPreference share capital 30mExtraordinary gain on debt restructuring 20m
Auditor’s Way
$20m GainRealized
Favorabledebt-to-equity
ratio
ReflectsEssence of transaction
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Aftermath Credibility Difficult Financing
•Damaged reputation and lower credibility.
•Investors: reluctant to invest
•Investors demand higher premium.
•Higher cost of debt/equity financing
Part IBackgroundIntroduction
Part IIDebtRestructuring
Part IIIRationalesBehind
Part IVInfluence onFinancialStatements
Part VInfluence onStakeholders
Part VIEconomics ofTransactions
Part VIIConclusion
Company’s Way Auditor’s WayNo Recognition of Gain Recognition of GainNo adverse effect on Financial Statements
No adverse effect on Financial Statements
Overstatement of Preference Share Capital
Preference Share Capital at Fair Value
• Both fail to faithfully represent the economics of the transaction.
• Auditor’s is fair and gives better information to stakeholders.