Acquisition through debt assignment

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Aady001
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Acquisition through debt assignment

Post by Aady001 »

Dear All,
I have below query, where I need your inputs

There are two companies X and Y
X has significant loans from banks and facing liquidity issues
Y agreed to acquire X and the deal is structured as under:
All the loans of X will be taken over by Y
X will issue fresh equity shares to X, for the loan value, so that the control of X will be passed on to Y.
As at the yearend, while the loan assignment has happened to Y, the issuance of equity and passing of control through the board is pending, due to various legal and procedural formalities.
My question is how X will disclose the loan assignment to Y in its financial statements as at the year-end, considering the passing of control and issuance of equity is not expected to take place till the release of financial statements.

Thank you
pub_acco
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Re: Acquisition through debt assignment

Post by pub_acco »

Can I assume that X is contractually obligated to issue and assign new shares to Y as of the reporting date? If so, I think X should account for the obligation as equity and apply the "debt for equity swap" accounting in accordance with IFRIC 19. Otherwise, I'm not sure if we can account for the arrangement as a economically reasonable transaction :o (What if X refuses to issue shares even though the loans are already taken over!)
Aady001
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Re: Acquisition through debt assignment

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Yes there is a contractual obligation on X.
Further, what nomenclature to be used to present this amount even under equity.
Can this also be treated as share application money pending allotment?
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Marek Muc
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Re: Acquisition through debt assignment

Post by Marek Muc »

Does Y control X at year-end and how this control is effected if the shares were not issued yet?
Aady001
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Re: Acquisition through debt assignment

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The control is not formally passed as at the yearend
Aady001
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Re: Acquisition through debt assignment

Post by Aady001 »

I also checked Debt equity swap but due to below condition I think it will be out of scope.

'the creditor and the entity are controlled by the same party or parties
before and after the transaction and the substance of the transaction
includes an equity distribution by, or contribution to, the entity.'
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Marek Muc
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Re: Acquisition through debt assignment

Post by Marek Muc »

are you sure the debt is effectively taken over by Y if the control is not yet passed?

If so, I would recognise the debt, and the debit (edited) entry will be some kind of prepayment (other asset) - representing an advance paid (by assumption of debt) for the transfer of control in the future

and of course you're not yet consolidating X, right?
JRSB
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Re: Acquisition through debt assignment

Post by JRSB »

If the debt is all-encompassing, eg the debt holder needs to approve key transactions, perhaps holding the debt gives de facto control.
Aady001
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Re: Acquisition through debt assignment

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Marek Muc wrote: 31 Dec 2020, 15:22 I would recognise the debt, and the credit entry will be a some kind of prepayment (other asset) - representing an advance paid (by assumption of debt) for the transfer of control in the future
Can you tell me what is the logic you are applying for this or is there any specific guidance?

Yes not consolidating X
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Marek Muc
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Re: Acquisition through debt assignment

Post by Marek Muc »

oops, I meant the *debit* entry:

I would recognise the debt, and the debit entry will be some kind of prepayment (other asset) - representing an advance paid (by assumption of debt) for the transfer of control in the future

so:
credit: debt
debit: prepayment
Aady001
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Re: Acquisition through debt assignment

Post by Aady001 »

I think you are referring to the accounting treatment for Y.
Pls let me know your view about X.

Also since we are discussing Y also now, if Y renegotiated the loan with the bank and the bank gave the option to waive a certain amount of loan due to early payment, will Y initially recognise original amount of loan or net of expected discount.

For ex - Orignal loan taken over is 100, and there is an option to prepay only 90.
JRSB
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Re: Acquisition through debt assignment

Post by JRSB »

What has changed for X prior to the issue of new shares?
Aady001
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Re: Acquisition through debt assignment

Post by Aady001 »

Debts from banks have gone
JRSB
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Re: Acquisition through debt assignment

Post by JRSB »

But if just assigned then all the same terms and obligations apply, just a different holder?
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Marek Muc
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Re: Acquisition through debt assignment

Post by Marek Muc »

oh right, I was talking about Y, now I see that you asked about X

So why again you don't see IFRIC 19 apply to X?

re. Y: yes you should take expected prepayment into account
Aady001
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Re: Acquisition through debt assignment

Post by Aady001 »

Due to the below exclusion in IFRIC 19
'the creditor and the entity are controlled by the same party or parties
before and after the transaction and the substance of the transaction
includes an equity distribution by, or contribution to, the entity.

Y and X will be controlled by shareholders of Y and the substance of the transaction is equity distribution by X.
JRSB wrote: 01 Jan 2021, 18:26 But if just assigned then all the same terms and obligations apply, just a different holder?
I have not said that the terms are the same.
Now there is no term as its not a loan [No right to interest, no collateral nothing, Y has totally put itself at risk :D ]
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Marek Muc
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Re: Acquisition through debt assignment

Post by Marek Muc »

note that this exclusion states that the common control criterion must be satisfied also before the transaction, so this does not apply to your case
you're in the scope of IFRIC 19
Aady001
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Re: Acquisition through debt assignment

Post by Aady001 »

The Board control will pass on to Y before conversion of equity, so it won't apply
Conversion of equity is the last step to complete the transaction.

The order of activity is like
Debt assignment to Y>>>>>>>>Passing of Board control [Once all the approvals are in place]>>>>>>>Equity issuance to settle the assignment [On satisfaction of all other customary conditions]
pub_acco
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Re: Acquisition through debt assignment

Post by pub_acco »

IFRIC 19 applies to your case because the "debt equity swap" takes place on the date of the debt assignment in the accounting sense. You need an account to credit when the bank loans go away, and it is the only economically reasonable interpretation to assume that a certain form of equity is issued as soon as the debt ceases to exist. But as you see, it is not a usual form of equity, so you need a thorough analysis whether the contractual situation as of the reporting date does meet the definition of equity. (I'm a little bit doubtful if a contract really exists in a unambiguous manner....)
Aady001
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Re: Acquisition through debt assignment

Post by Aady001 »

pub_acco wrote: 02 Jan 2021, 10:23 the contractual situation as of the reporting date does meet the definition of equity
This is what is the missing link, and that is why the query
The substance of the transaction is of equity only, however since the approvals are not in place and there is no arrangement between the parties to deal with any such situation, the probability of cancellation of transition and refund of money cant be negated at the time of closing the financial statements.

Further, the background of IFRIC 19, reads as under:
A debtor and creditor might renegotiate the terms of a financial liability with
the result that the debtor extinguishes the liability fully or partially by issuing
equity instruments to the creditor. These transactions are sometimes referred
to as ‘debt for equity swaps’.

Based on the facts of the query, Y is the creditor at the period end which will subsequently get settled through equity, and hence I believe the scope exclusion should apply.
pub_acco
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Re: Acquisition through debt assignment

Post by pub_acco »

If Y can potentially request repayment, then X should record the obligation as a liability to Y. If so, IFRIC 19 may or may not apply depending on the contractual terms, but at the end of the day, I think there is no clear answer because no clear contract seems to exist.
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