Deferred Financing Costs: When debt is extinguished or modified, the entity should

Deferred Financing Costs: When debt is extinguished or modified, the entity should

• A. perform an analysis to determine the treatment of both existing and/or new financing costs
• B. record a default immediately
• C. classify costs as equity
• D. ignore the changes unless significant

Answer: (A)

When debt is extinguished or modified, you must determine how theDeferred financing costs should be treated in the new situation. The reason is that the accounting hinges on whether the change is a modification or an extinguishment, and on whether the modification is substantial. If the change is considered extinguishment (a substantial modification), the old liability is removed and a new one is recognized. The unamortized financing costs tied to the old debt are included in the measurement of the gain or loss on extinguishment, and any new financing costs for the new debt are added to the carrying amount of the new debt and amortized over its term. If the change is not substantial and is treated as a modification, the debt is remeasured but the existing unamortized financing costs generally continue to be amortized over the life of the modified debt, while any incremental costs related to the modification are capitalized as part of the new debt and amortized over its term. So, you perform this analysis to decide how to treat both the existing and any new financing costs. Recording an automatic default, classifying costs as equity, or ignoring the changes would not reflect the correct accounting treatment under these situations.

When debt is extinguished or modified, you must determine how theDeferred financing costs should be treated in the new situation. The reason is that the accounting hinges on whether the change is a modification or an extinguishment, and on whether the modification is substantial.

If the change is considered extinguishment (a substantial modification), the old liability is removed and a new one is recognized. The unamortized financing costs tied to the old debt are included in the measurement of the gain or loss on extinguishment, and any new financing costs for the new debt are added to the carrying amount of the new debt and amortized over its term. If the change is not substantial and is treated as a modification, the debt is remeasured but the existing unamortized financing costs generally continue to be amortized over the life of the modified debt, while any incremental costs related to the modification are capitalized as part of the new debt and amortized over its term.

So, you perform this analysis to decide how to treat both the existing and any new financing costs. Recording an automatic default, classifying costs as equity, or ignoring the changes would not reflect the correct accounting treatment under these situations.