Accounting of the restructuring of problematic debts SFAS No.

54

CONTENTS

Paragraph

PREFACE 01 - 09

Objective 01 - 09
Scope 01 - 04
Definitions 05

ACCOUNTING OF THE DEBTOR 10 - 27

Settlement of debt through the transfer of asset 11 - 13

Settlement of debt through the delivery of shares 14
Modifications of the terms and conditions of the debt 15 -19
Combination of several methods of restructuring problematic debt 20 - 21
Related Matters 22 - 25
Disclosures by the Debtor 26 - 27

ACCOUNTING OF THE CREDITOR 28 - 39

Full settlement of the Receivable through the receipt of asset 28 - 29

Modifications of the terms and conditions of the debt 30 - 32
Combination of several method of restructuring problematic debt 33
Related Matters 34 - 36
Replacement or Addition of Debtor 37 - 38
Disclosures by the creditor 39

TRANSITION PERIOD 40

EFFECTIVE DATE 41

Paragraphs printed in bold letters are standard paragraphs which must be read in
the context of the explanatory paragraphs and implementation guidance printed in

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Accounting of the restructuring of problematic debts SFAS No. 54

normal letters. There is no requirement to apply this standard on items considered

to be immaterial.

INTRODUCTION

Objective

01. This statement regulates the financial accounting standard and the reporting of the
restructuring of problematic debts, either for the debtor or for the creditor. This
statement does not cover the accounting for the provision for uncollectible
receivables and does not regulate the method of estimating uncollectible
receivables.

02. For the purpose of this statement, a restructuring of a problematic debt occurs if,
based on economic or legal consideration, the creditor grants a special concession
to the debtor, namely a concession which would not be given if the debtor were
not in a financial difficulty. The concession may originate from an agreement
between the creditor and the debtor or from a court verdict or from legal statutes.
As an example, the creditor may restructure the terms of the debt to alleviate the
burden of the short term need for cash of the debtor. Many loan restructuring
efforts cover the changes in the borrowing terms to minimize and to defer the cash
payment required by the debtor in a short period to help the debtor improve tis
financial position so it can pay back its debts to the creditor. As an Example, the
creditor can receive cash, other asset, or shares from the debtor as payment of the
debtor’s liabilities, although the value received by he creditor is lower than the
total debts payable by the debtor, since the creditor considers that this step will
maximize the recovery of investment conducted by the creditor.

03. Whatever the form of concession given by the creditor to the debtor in the
restructuring of problematic debt is, the objective of the creditor is to obtain the
best under a difficult situation. The creditor expects to obtain more cash or other
value from the debtor, or to increase the probability of receiving cash by granting a
concession as compared to not granting any concession at all.

04. In this statement, a receivable or a debt (collectively referred to as debt) constitute

a contractual right to receive cash or a contractual obligation to pay cash based on
demand or on a specified date, which is shown as an asset or liability on the
balance sheet of the debtor or creditor at the time the restructuring takes place.
Receivables or payables included in the restructuring of problematic debt generally
occurs as a result of loans or the lending out of cash, investment in debt securities
previously issued, or the purchase or sale of goods and services on a credit basis.
Examples are receivables or payables, promissory notes, debentures and bonds
(secured or unsecured or convertible or non-convertible), and if any, interest due
related to the debts. Generally, the restructuring of each receivable or payable is
negotiated separately, however, quite often two or more receivables or payables
are negotiated simultaneously. For example, a debtor may negotiate a
restructuring with a group of creditors, although the debtor has initially sign a debt

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instrument on an individual basis with each creditor. For the purpose of this
statement, the restructuring of each receivable or payable, including those
negotiated and restructured at the same time, must be accounted for on an
individual basis. The reference is the substance, not the formal form. As an
example, for a debtor, a bond constitutes a liability, although there are many
holders of the bonds.

Scope

05. This statement is applicable to the accounting on restructuring of problematic debt.

This statement does not address:

a. The costs of pension benefit already regulated in SFAS No. 24

b. Leasing already regulated in SFAS No. 30
c. Accounting of investment in a specific debt security already regulated in SFAS
No. 50
d. Quasi-reorganization already regulated in SFAS No. 51.

Definitions

06. Following are definitions of terms used in this statement :

Fair value is the amount that can be used as a basis for the exchange of assets or
the settlement of debt between knowledgeable parties who intend to conduct an
arm’s length transaction.

Market price is the amount that can be obtained from the sale of an investment in
an active market.

Carrying amount is the book value, i.e. the acquisition cost of an asset after
deducting accumulated depreciation.

07. The restructuring of a debt covers, but is not limited to, one or more of the
following combinations :

a. The transfer of the following assets : real estate, receivable from a third party
or other assets from the debtor to the creditor to settle a part or the
entire debt (including transfer resulting from reacquisition or collateral
confiscation (seizure)).
b. The issuance of new shares or the delivery of the debtor’s shares to settle a
part of or the entire debt, except if the shares are delivered to fulfill a pre-
determined condition to convert debt into shares (for example the
exchange of a convertible bond).

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c. Modifications in the terms and conditions of the debt, such as one or more of
the following combinations :

1. A reduction of the interest rate for the remaining debt period.

2. An extension of the settlement period or a postponement of the maturity
date with a lower interest rate than the interest rate prevailing in the
market for new debts with the similar risks.
3. A reduction (absolute or contingent) of the debt principal or the amount
payable on the maturity of the debt as indicated in the debt
instrument or agreement document.
4. A reduction (absolute or contingent) of the interest payable.

08. The restructuring of problematic debt can take place before, on or after the
maturity date of debt indicated in the agreement and there will be a time gap
between the time of the agreement, court decision etc. and the transfer of asset or
delivery of shares, the effective date of the new terms and conditions or the
occurrence of other event which represents the implementation of the
restructuring. In this statement, the effective date of the implementation is the
time of the restructuring.

09. For the purpose of this statement the restructuring of debt is not always a
restructuring of a problematic debt due to the condition of the debtor who is
having financial difficulties. As an example, a restructuring of debt, which does not
represent a restructuring of problematic debt takes place if :

a. the net value of cash, other assets or shares to be received by the creditor from
the debtor in settlement of the debt is at least the same as the investment
in the receivable recorded by the creditor.
b. the fair value of other asset or shares transferred by the debtor to the creditor
in full settlement of the debt is at least the same as the carrying value of
the debtor’s debt.
c. the creditor reduces the effective interest rate of the debt to reflect a general
reduction in the market interest rate, or
d. the debtor issues a marketable debt security to replace the old debt. The new
debt bears an effective interest rate based on the market interest rate, with the
same maturity date and interest rate of a debt security issued by a debtor
without a problem.

EXPLANATION

Accounting of the debtor

10. The accounting treatment by the debtor of the restructuring of a problematic debt
is as follows :

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SETTLEMENT OF DEBT THROUGH THE TRANSFER OF ASSET

11. With respect to the settlement of debt through the transfer of assets in the
form of land and buildings, other assets and receivables to the creditor in full
settlement of his debt; the debtor can recognize the profit arising as a result
of the restructuring of the debt. The profit shall be calculated as the excess
difference between :

a. the carrying value of the debt settled (the nominal amount less or plus
interest payable and premium, discount, financial expenses or
unamortized issuance expenses) with
b. the fair value of the asset transferred to the creditor.

12. The fair value of the asset transferred is the amount expected to be received by the
debtor from the most recent sale to an interested buyer (not from a compulsory
sale transaction or liquidation). The fair value of the asset must be measured using
the market price, if a market price is available for the asset. If a market price is not
available for the asset, but there is a market price for the same type of asset, the
market price for the similar asset can be used as a reference to estimate the market
price of the asset transferred. If a market price for the same type of asset is not
available, the determination of the fair value of the asset transferred shall be made
using a reliable method of valuation, such as by calculating the present value of the
expected cash flows at a discount rate commensurate with the risks related to the
future cash flows.

13. The difference between the fair value of the asset and the carrying value of
the debt shall be recognized as a profit arising as a result of the restructuring
of the debt in accordance with paragraphs 22. The difference between the
fair value and the carrying value of the asset transferred to the creditor for
the settlement of the debt represents a profit or loss from the transfer of asset.
The debtor shall recognize such profit or loss in determining the net profit for
the period during which the transfer of asset takes place.

Settlement of debt through the assignment of shares

14. A settlement of debt through the issuance of new shares or the assignment of
the debtor’s shares shall be recorded at the fair value of the shares. The
difference between the fair value of shares issued and the carrying value of
the debt shall be recognized as a profit arising as a result of the debt
restructuring in accordance with paragraph 22.

Modification of the terms and conditions of the debt

15. In a debt restructuring through the modifications of the terms and condition
without the transfer of asset or delivery of shares, the debtor must record the
effect of the restructuring on a prospective basis since the time the
restructuring is implemented, and is not allowed to change the carrying value

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of the debt at the time of restructuring, except if the carrying value exceeds
the total future cash payments stipulated under the new terms. The total
future cash payments must cover the total interests and the total principal of
the debt during the future period, without contemplating their present
values.

16. Interest expenses must be calculated using a constant effective interest rate times
the carrying value of the debt at the beginning of each period between the time of
the restructuring until the maturity date. The new effective interest rate is the
discount rate which equalizes the present value of the total future cash payments as
stipulated under the new terms (excluding contingent liabilities) with the carrying
value.

17. If the total future cash payments as stipulated in the new terms of the debt,
including payments of interest as well as the debt principal, is lower than the
carrying value, the debtor must reduce the carrying value to the amount
equals to the total future cash payments as stipulated under the new terms
and must recognize the profit arising from the debt restructuring in the
amount of the debt reduction in accordance with paragraph 22. Thereafter,
all the payments are considered as a reduction of the carrying value of the
debt and there are no interest expenses recognized from the time of
restructuring until maturity date.

18. A debtor is not allowed to recognize a profit from debt restructuring

involving undetermined future cash payments, as long as the future cash
payments at the maximum do not exceed the carrying value of the debt.

19. The amount of interest or principal payable under the new terms may be a
contingent liability, dependent upon a certain event or condition. As an example,
the debtor may be required to make a certain amount of payment if his financial
condition improves up to a certain level during a certain period. To determine
whether the debtor must recognize the profit, the contingent amount must be
included in the future cash payments based on the new terms, to the extent this is
required to avoid recognition of profit at the time of restructuring which is
subsequently credited with future interest expenses. The debtor must apply SFAS
no. 08 contingency and subsequent events after Balance Sheet date which indicates
that the probability of a contingent profit is not a factor justifying that future cash
payments need not to be made. The same principle apply to future cash payments
which quite often must be estimated.

Combination of several methods of restructuring problematic debt

20. The restructuring of problematic debt could be in the form of partial

settlement of the debt by the transfer of the debtor’s asset or delivery of
shares (or both) to the creditor and the modification of the terms of the
remaining debt.

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21. The debtor must be accountable for the restructuring of a problematic debt
involving partial settlement and modifications of the terms of the debt as
described in paragraphs 15 - 20; by means of :

firstly, deducting the recorded value of debts with the total fair value of assets
or the assignment of shares;
secondly, recognizing the difference between the fair value and the carrying
value of asset transferred to the creditor as a profit or loss from the transfer
of asset and not as a profit from debt restructuring.
thirdly, only thereafter calculating the future cash payments. If the
remaining carrying value of the debt is greater than the total future cash
payments (including the amount of contingent liabilities) stipulated in the
terms of the debt, without considering their present values, the difference
between the two values shall be recognized as profit from debt restructuring
in accordance with paragraph 22.

Related matters

22. The net profit from debt restructuring after related income tax, shall be
recognized in the calculation of net profit for the period of restructuring and
shall be classified as an extra ordinary item.

23. If the debt restructuring involves a contingent liability, the contingent

amount shall be recognized as future debt principal and interest expenses.
Therefore, in general interest expenses on the contingent payments shall be
recognized in accordance with SFAS No. 08 during the period (a) the debt
has been recognized and (b) the amount of debt can be estimated. Before the
recognition of a contingent liability and contingent interest expenses, the
amount of debt or the contingent payments must be deducted from the
carrying value of the restructured debt only to the extent where the
calculation of the payments of the contingent liability in the total future cash
payments based on the new terms does not result in a recognition of profit at
the time of restructuring.

24. A reduction of a contingent liability from the balance of a restructured debt which
results in a recognition of profit, is not permitted if the amount of the contingent
liability is not recorded as part of the debt resulting from the restructuring at the
time of restructuring, otherwise there is a possibility that the recognized amount of
profit from restructuring will be higher. This does not conform to the principles of
conservatism thereby the recognition of a contingent profit is not permitted.
Consequently, the contingent amount cannot be deducted from the carrying value
of the debt.

25. Other expenses incurred by the debtor related to the delivery of shares to the
creditor in the restructuring of problematic debt shall be deducted from the
profit. All other direct expenses incurred by the debtor in the restructuring
of a problematic debt shall be deducted in the calculation of profit from debt

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restructuring and must be recorded as expenses for the period of

restructuring, if there is no profit obtained at the time of restructuring.

DISCLOSURES BY THE DEBTOR

26. The debtor must disclose, in the financial statements, or in the notes to the
financial statements, information on the restructuring of problematic debt
that takes place during the period covered by the financial statements :

a. For each restructuring, explanation regarding the basic changes in the

terms and settlement of the debt.
b. The amount of profits from the debt restructuring and the related income
tax effect.
c. The amount of net profit or loss from the transfer of assets recognized
during that period.

27. The debtor must disclose the total amount of contingent liability included in
the restructured carrying value in the financial statements for the period
after the restructuring of problematic debt.

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ACCOUNTING OF THE CREDITOR

Full settlement of the receivables through the receipt of assets.

28. The accounting by the creditor of the restructuring of problematic debt is as

follows :

The creditor who receives full settlement from the debtor in the form of (a) a
receivable of the debtor, land and buildings, or other assets or (b) shares or other
evidence of the delivery of shares from the debtor, or both, shall record the assets
(including the delivery of shares) at the fair values on the date of restructuring.

29. The excess of the balance of the receivable over the fair values of the assets
received less expenses to sell the assets represents a recognized loss.

Modifications of the terms and conditions of the debt.

30. In a restructuring of problematic debt with a modification of the terms of the

debt without resulting in a receipt of assets (including receipt of shares from
the debtor), the creditor must record the effect of the restructuring on a
prospective basis and shall not change the carrying value of the debt on the
date of restructuring, except if the amount exceeds the present value of future
cash receipts stipulated under the new terms. The effect of a change in the
amounts or maturity dates (or both) of cash receipts either as interest or
principal of the debt shall be recognized prospectively in future periods.

31. However, if the total of the present value of future cash receipts as stipulated
in the new terms of the debt, including the receipt of interest, and debt
principal, is lower than the balance of the receivable before restructuring, the
creditor shall reduce the balance of the receivable to an amount equals to the
present value of future cash receipts as stipulated in the new terms. The
amount of the reduction shall be recognized as a loss. Thereafter, all cash
receipts based on the terms of the restructured debt, either the interest or the
debt principal, shall be recorded as repayment of the debt principal and
interest income in accordance with their proportion.

32. In determining the loss from restructuring the amounts of contingent

payments shall be included in the present value of future cash payments
stipulated in the new terms, only if at the time of restructuring the contingent
amounts satisfy the requirements for recognition (probable). This means that
the creditor recognizes the loss from the future contingent cash receipts at the
time the restructuring is performed.

Combination of several method of restructuring a problematic debt.

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33. The restructuring of problematic debt can be performed through the receipt
of asset (including the acquisition of shares from the debtor) as partial
settlement of the debt and modification of the terms of the remaining debt.
The creditor shall record the restructuring by recognizing the assets received
at the fair values less the estimated expenses to sell the assets and by reducing
the carrying value of the receivable by the fair value of the assets after
deducting the estimated expenses to sell the assets. The excess of the carrying
amount of the receivable balance over the present value of future cash
receipts in accordance with the new terms of the restructured debt shall be
recognized as a loss from restructuring.

RELATED MATTERS

34. The loss from the reduction of the carrying amount of the receivable can be
recognized before restructuring by reducing the estimated provision for receivables
on the balance sheet and subsequently increasing the estimated non-collectible
receivables in the calculation of net profit.

35. If the restructuring of problematic debt covers the amount of contingent

receivables, the interest income on the contingent receivables must not be
recognized as interest income in future periods, before the contingent
receivable meets the requirements for recognition as real receivables and
interest income is received.

36. Other expenses incurred by the creditor in the restructuring of problematic

debt shall be recorded as expenses at the time incurred.

Replacement or Addition of Debtors

37. The restructuring of problematic debt may include the replacement of debt
by other companies, individuals or government agencies handling
problematic debts or additions of other debtors. Such restructuring shall be
recorded in accordance with the substance, although payments to the
creditor are made by the substitute debtor or the additional debtor.

38. This treatment is also applicable in case of the involvement of agents,

curators or other parties.

DISCLOSURES BY THE CREDITOR

39. The creditor must disclose in his financial statements or in the notes to the
financial statements, information related to the restructuring of problematic
debt on the balance sheet as follows :

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a. The balances of receivables, the terms of which have been modified in

the restructuring of problematic debts, by the following major groups :

(i). the balances of the receivables and the balances of the allowance
for non-collectible receivables related to the balances of the
receivables to the balances of the receivables set up based on this
statement; and
(ii). the balances of the receivables without the allowance for non-
collectible receivables set up based on this statement.

b. The accounting policy for the recognition of interest income on

problematic debt, including the method of recording cash receipts.

c. for each period of comparative financial statements presentation : (i)

the average of the balance of problematic debts, (ii) interest income
recognized at the occurance of the problematic debts, (iii) unless
impractical, the amount of interest income recognized on a cash basis
during the problematic debt period.

d. The total commitments, if any, to lend additional funds to the debtors,

whose terms of debt have been modified in the restructuring of
problematic debt.

TRANSITION PERIOD

40. The application of this standard shall be made on a prospective basis.

Financial statements for periods before the application of this standard do
not have to be restated.

EFFECTIVE DATE

41. This statement becomes effective for restructuring transactions that take
place after approval of this statement. Early implementation is encouraged
by observing paragraph 40.

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