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Chapter 12

Set-off and extinguishment of debt

12.1 A set-off is the reduction of an asset by a liability or a liability by an asset in the presentation

of a balance sheet so that only the net amount is presented.

12.2 AASB 132 allows assets and liabilities to be set-off for balance sheet purposes when a legallyrecognised right of set-off exists, and the entities expect to settle the debts on a net basis.Specifically, paragraph 2 of AASB 132 states!

A financial asset and a financial liability shall be offset and the net amount presented inthe balance sheet when, and only when, an entity!"a# currently has a legally enforceable right to set off the recognised amounts$ and"b# intends either to settle on a net basis, or to realise the asset and settle the

liability simultaneously.

12.3 By performing a set-off of assets and liabilities a company%s reported gearing ratios wouldshow impro&ement. 'his may be particularly beneficial for companies that are sub(ect to debtconstraints, or where debt le&els loo) unfa&ourable relati&e to competitors*industry norms.

12. A legal defeasance is not defined in AASB 132. +t was formerly defined in AASB 11. Adefeasance% occurs when there is a release of a debtor from the primary obligation of a debt.A legal defeasance% is considered to occur when the release of the debtor from the primaryobligation for a debt is either ac)nowledged formally by the creditor or by a duly appointedtrustee of the creditor, or established by legal (udgement. An example would be where a debtis formally forgi&en.

12. 'he Accounting Standards do not explicitly re/uire disclosures relating to the set-off. 'o theextent that the right of set-off exists and is exercised, then there would be no further obligation in relation to the debt and therefore such debt, and the related recei&able, wouldnot re/uire disclosure.

12.0 'here could be a perception that by showing lower amounts of debt on the balance sheet, and by pro&iding information which would lead to the calculation of lower le&erage indicators,the readers of the financial statements will assess that the reporting entity is of lower ris) thatmight otherwise be the case. 'his in turn might enable the organisation to attract funds at alower cost. +mplicit in this answer is an assumption that the capital mar)et may not be fullyefficient, and as result, the act of offsetting an asset against a liability "a reasonablyinexpensi&e exercise# will lead to material benefits.

Solutions anual t*a Australian Financial Accounting  *e by raig eegan 1241

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12.5 6irstly, we need to determine the original issue price so that we may determine the balance of the unamortised discount at the date the debt was forgi&en.

7resent &alue of debenture principal8discounted for 9 years at 10:

; x .3 ;1 2 7resent &alue of debenture interest8annuity for 9 years discounted at 10:;0 x .330 ;2 00 10

;3 2

'he (ournal entries to record the forgi&eness of the debt would therefore be!

r ebentures r iscount on debentures 3 2r ?ain on forgi&eness of debt 0 @5

12.9 An entity may wish to perform a set-off to reduce gearing ratios such as debt to assets, or debt to shareholders% funds. +f Arthur was to perform a set-off, the post set-off balance sheetwould be!

Balance sheet7ost set-off 

oans payable 5 oans recei&able @ Shareholders% e/uity 1 6ixed assets 9

;1 5 ;1 5

As we can see, as a result of the set-off, the debt-to-asset ratio has mo&ed from : to1.2:, whilst the debt to shareholders% funds has mo&ed from 1: to 5:.

12.@ es, the two amounts can be set-off. +f one entity in an economic entity "for example, 7arenttd# owes an outside entity "for example,

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12.1 An insubstance debt defeasance was defined in AASB 11 "now replaced by AASB 132# asa defeasance, other than a legal defeasance, in which the debtor effecti&ely achie&ed releasefrom the primary obligation for a debt, either by placing in trust assets which are ade/uate tomeet the ser&icing re/uirements "both interest and principal# of the debt, or by ha&ing a

suitable entity assume responsibility for those ser&icing re/uirements. +t was referred to as aninsubstance% defeasance as the creditor had not actually been repaid, but the substance of thetransaction was that no further amount was li)ely to be paid, so in substance%, the debt waseffecti&ely paid. Since the firm would ha&e to pay nothing further in relation to the debt, theyhad, in substance, paid off the debt.

6rom 2, AASB 132 prohibits the remo&al of debt from the balance sheet as a result of aninsubstance debt defeasance. Specifically, paragraph @ of AASB 132 notes that theconditions set out in paragraph 2 "pertaining to the remo&al of debt from the balance sheet#are generally not satisfied and offsetting is inappropriate when financial assets are set aside intrust by a debtor for the purpose of discharging an obligation without those assets ha&ing

 been accepted by the creditor in settlement of the debt. 'hat is, the in&ol&ement of thecreditor in the action is now re/uired.

'he abo&e prohibition now contained in AASB 132 is interesting. AASB 132 seems to ta)e amuch more form o&er substance% approach than the pre&ious Australian position under AASB 11. +f the probability that further payments will be necessary is remote because theassets irre&ocably transferred to the trust are sufficient to meet the debt ser&icingre/uirements then it ma)es sense that debt should be remo&ed from the balance sheet. 'hat is,the former treatment pro&ided by AASB 11 appears logical. +t is not clear that the AASB132 is as logical.

12.11 ay 211

Boo)s of Snapper td

r oan payable8Cirra td r ?ain on release from debt "a re&enue item#

Boo)s of Cirra td

r oss on release of debtor8Snapper td "an expenseitem#

r oan recei&able8Snapper td

Solutions anual t*a Australian Financial Accounting  *e by raig eegan 1243