Distressed Debt Buyback Journal Entry
I've hit a bit of a pickle and can't seem to find the answer anywhere on WSO or the internet at large.
Let's say you're looking at a firm with 100 in LTD on the balance sheet. They've been financially distressed and so the firm decides to buy it at 50 through a tender offer and it is accepted. How in the world would you account for this on the balance sheet?
I understand that Cash is credited 50, but your debt should go down by 100. Would the remaining balance go to goodwill?
Income statement Gain on extinguishment of debt: 50 (calculated as par value of 100 - purchase price of 50) NI: 50
CFS NI: 50 Gain on extinguishment of debt: -50 CFO: 0 Buyback of debt: -50 Total change in cash: -50
BS Cash:-50 LTD:-100 NI:50 BS balances
I believe your example is incorrect. You forgot taxes at 20%. Here is the corrected example but even then it may seem confusing:
IS: +50 gain on exting. of debt, -10 taxes, +40 NI CF: +40 NI, -50 non-cash gain, -50 debt repayment, -60 cash BS: -60 cash, -100 exting. + gain on debt, +40 NI, balanced.
I prefer to have it done via 2-steps in which company first writes down owed debt and then records repayment of debt. This is so that you understand precisely how the cash is flowing for each transaction rather than agglomerating them and potentially forgetting debt repayment vs. gain on debt extinguishment in the CF statement.
IS: +50 owed debt write-down, -10 taxes, +40 NI CF: +40 NI, -50 non-cash gain on owed debt write-down, -10 cash BS: -10 cash, -50 debt (write-down), +40 NI
And then the repayment scheme: IS: no change CF: -50 debt payback BS: -50 cash used to repay debt, -50 debt from being repaid, no change to SE
A final note: Don't believe GW changes here. GW either is written-down due to impairment or is increased as the excess purchase price/premium via purchase price allocation (equity purchase less Net Identifiable Assets). of course, you may have GW being negative due to gain on bargain sale, but I believe GW only pops up in equity purchases (not single debt transactions). Someone correct me if I'm wrong as I am also not very knowledgeable on GW.
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