Debt Extinguishments—Reexamination of Statements 7, 23, and 62
Research Description: The initial objectives of this pre-agenda research activity are (1) to evaluate the effectiveness of Statements No. 7, Advance Refundings Resulting in Defeasance of Debt, and No. 23, Accounting and Financial Reporting for Refundings of Debt Reported by Proprietary Activities, and relevant sections of Statement No. 62, Codification of Accounting and Financial Reporting Guidance Contained in Pre-November 30, 1989 FASB and AICPA Pronouncements, and (2) to consider the need for revisions to existing standards.
Status: Added to Research Agenda: May 2014
Debt Extinguishments—Reexamination of Statements 7, 23, and 62—PROJECT PLAN
Background: General guidance on extinguishment of debt has historically been based on APB Opinion No. 26, Early Extinguishment of Debt, and FASB Statement No. 76, Extinguishment of Debt. GASB Statements 7 and 23 were issued specifically to address certain refunding situations. The guidance incorporated into the GASB literature by Statement 62 addresses all extinguishments of debt, early or not (whereas Statements 7 and 23 deal with only one type of extinguishment of debt—early retirement through refunding).
Refundings involve the issuance of new debt and using the proceeds to repay outstanding debt that carries a higher interest rate. Current refundings actually retire the old debt, whereas advance refundings place the proceeds of the new debt with an escrow agent that invests the proceeds and makes principal and interest payments as they come due. The old debt is considered defeased (either legally or in-substance) and the government is allowed to derecognize it. In Statements 7 and 23, the Board concluded that viewing refundings as substitutions of debt better reflected the economic substance of refundings in the government environment than the approach in APB Opinion 26. The Board required the recognition of the difference between the new and old debt over future periods rather than immediately.1
Statements 7 and 23 have been in effect since periods beginning after December 15, 1986, and June 15, 1994, respectively. All other extinguishments of debt were codified in Statement 62 but derive from APB Opinion 26, which has been in effect since 1973.
Neither Statement 7 nor 23 has been reexamined previously. Moreover, the guidance incorporated by Statement 62 was brought in “as is” without consideration of its effectiveness. Refunding transactions in the municipal bond markets have grown significantly in volume and complexity over the past two to three decades since those standards became effective. Extinguishments of debt and refundings continue to be prevalent transactions among state and local governments. The GASB issued Statement 7 in response to a large volume of advance refundings by governmental entities during favorable municipal bond conditions in the mid-1980s. The period since the beginning of the recession in 2008 also has witnessed a significant volume of refunding activity.
Debt refundings are among the more common technical inquiry topics that the GASB responds to (for pronouncements beyond their implementation date), averaging about 25 to 30 inquires per year.
The topic has been ranked in the top half of all research activities and potential topics over the past four GASAC annual prioritization discussions. The GASAC members ranked the priority of this topic sixth in 2014.
1GASB Statement No. 65, Items Previously Reported as Assets and Liabilities, amended the standards to require reporting of the difference as a deferred outflow of resources or a deferred inflow of resources and as a component of interest expense in a systematic and rational manner over the life of the new or old debt, whichever is shorter. Because these provisions have been effective only since periods beginning after December 15, 2012, they will not be reexamined as a part of the research.
Major Research Issues: The major issue to be studied is whether Statements 7 and 23 provide sufficient guidance in reporting refundings and advance refundings resulting in defeasance of debt. As part of this issue, the following elements that have been raised through the technical inquiry process would be considered:
- How decision-useful has information about refundings been subsequent to the implementation of these pronouncements?
- What are the distinguishing indicators of a refunding versus a change in a bond’s mode—the basis on which a bond’s variable payment is calculated, such as an auction or a short-term index? Does restructured debt qualify as an advanced refunding?
- If the new debt issued is more than the amount needed to refund the old debt, how should the disclosure requirements of paragraph 11 of Statement 7 apply, and how should the cash flow difference in economic gain or loss be calculated?
- For purposes of the recognition period, how do call options affect what is considered the remaining life of the refunded bonds?
- What constitutes an extinguishment of debt?
- What information should be reported or disclosed when debt is extinguished?
- Should the standards for specific types of debt extinguishments, such as refundings, be consistent with the general standards for debt extinguishment?
- Does the governmental environment operate in a manner such that the Board’s perspective of substitution of debt still prevails?
- Pre-agenda research approved: April 2014
Research Work Plan: The research will consist of a literature review, archival research, and surveys and interviews with of financial statement preparers, auditors, and users.
Conclude analysis of results of research and draft research memorandum.
Review results of research.