ALTERNATIVES
AND IMPLICATIONS
•
Debt settled through the use of an asset
– Debtor must have an asset available for payment of the
loan
– Debtor may need to adjust the carrying amount of the
asset to its fair value prior to recording its exchange for a
debt
• How does bank determine fair value?
– Difference between carrying amount and fair value of the
asset is recorded as an ordinary gain or loss on disposition
of assets.
– Difference between the carrying amount of the debt and
the fair value of the asset given up is also recorded as an
ordinary gain on debt restructuring.
An asset swap will reduce total assets and total
liabilities.
• Total financial resources available for business
operations will decline
•
– Liquidity and long term solvency will suffer because
decrease in total assets will affect ability of business to
meet future commitments
– Limited financial assets may hamper the company’s access
to credit thereby hampering business operations
– Financial leverage should improve
•
Important that bank consider above before pursuing
asset swap.

Asset swap should have a positive effect on
the income statement if …
 Recognition of accounting gain due to debt
restructuring and a follow-on increase to reported
stockholders’ equity.
 Increase in income may have tax affect

Business owners: mixed feelings
 Favorable and unfavorable?
▪ Favorable: positive effect on the income performance
brought about by the recognition of the accounting gain
on debt restructuring
▪ Higher return on investment
▪ Higher EPS

Business owners: mixed feelings
▪ Unfavorable: equity holders may find an asset swap
uncomfortable because asset decreases may have
negative financial and operating impact.
▪ Creditors wary of the paying ability even after debt
restructuring agreement because asset payment has
impact on liquidity/solvency position
•
•
•
•
Payment to settle debt in the form of shares of the debtor’s stock
Debtor must have available unissued shares available for issuance.
Stochastic valuation should be completed
Balance sheet effect
▫ Equity swap has no effect on total assets because no asset was used to
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settle debt
Liabilities decline as a result of debt payment
Stockholders’ equity increases as a result of the issuance of the shares
of stock
Debt to equity ratio will improve because of the decrease in total
liabilities.
No Income statement effect - no accounting gain is recognized
No cash flow statement effect


Equity dilution
Voting powers and policy making powers
may be curtailed by the new stockholders.



Local creditors of Maynilad Water Services
agreed to convert three billion pesos of debt
to coupon, convertible and redeemable
preferred shares
After restructuring, Maynilad would be 39%
owned by shareholders, 19% by an
investment group, 2% by the bank, 4% by
employees and 36% by a holding corporation.
.

Key Stockholders’ Concern
 Stockholders will find modification of debt terms
favorable
▪ overall effect on the financial position and income
performance limited effect
▪ The debt paid but at a later date
▪ Hence, on date of the debt restructure no effect on balance sheet
▪ If a gain is to be recognized, the effect on the income statement
is positive but this represents non operating credit


Key Stockholders’ Concern
Payment of debt is usually postponed to a
later date.
 Hence, corresponding effect on the financial
statements is likewise spread over the new
repayment period

Key Stockholders’ Concern
 Payment of debt is usually postponed to a later
date.
▪ Hence, corresponding effect on the financial statements
is likewise spread over the new repayment period