ASC 405-20
Extinguishments of Liabilities
405 Liabilities
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ASC 405-20 governs when a debtor may derecognize a liability because it has been extinguished. Under 405-20-40-1, extinguishment occurs if and only if the debtor pays the creditor (cash, other financial assets, goods or services, or reacquisition of its own debt securities) and is relieved of the obligation, or the debtor is legally released as primary obligor judicially or by the creditor. The Subtopic also contains special derecognition (breakage) rules for liabilities from prepaid stored-value products and excludes debt conversions and troubled debt restructurings (see 470-20 and 470-60).
Key points (7)
- A debtor shall derecognize a liability if and only if it has been extinguished, meaning either payment with relief of the obligation or legal release as primary obligor (405-20-40-1); a sale plus assumption of nonrecourse debt by a third party in conjunction with sale of the sole collateral asset effectively accomplishes a legal release.
- The Subtopic applies to all entities and to extinguishments of all financial and nonfinancial liabilities (including derivative nonfinancial liabilities such as a written commodity option) unless derecognition is addressed elsewhere, such as 924-405 gaming chips or Topic 606 breakage (405-20-15-1 through 15-2).
- If a creditor releases the debtor conditioned on a third party assuming the obligation with the original debtor secondarily liable, the original liability is extinguished but the debtor recognizes a guarantee obligation at fair value, which reduces the gain or increases the loss on extinguishment (405-20-40-2; see Topic 460).
- In-substance defeasance does not extinguish the liability because the debtor is not released, the lender is not limited to the trust assets, and the debtor retains control of the trust assets' benefits (405-20-55-3 through 55-4); a legal defeasance can extinguish the liability if 405-20-40-1(b) is met, which is a matter of law (405-20-55-9).
- For prepaid stored-value products in scope, expected breakage is derecognized in proportion to the pattern of rights expected to be exercised, only to the extent a significant reversal is probable of not occurring; if no breakage is expected, derecognize when the likelihood of exercise becomes remote (405-20-40-4), with estimate updates treated as changes in accounting estimate under 250-10-45-17 through 45-20.
- The breakage guidance does not apply to products whose breakage must be remitted under unclaimed property laws, products attached to a segregated bank account, customer loyalty programs, or transactions within other Topics such as 606 (405-20-40-3).
- Entities recognizing breakage must disclose the methodology used and significant judgments made in applying it (405-20-50-2); see also 470-50-50-1 for in-substance defeasance disclosure and 860-30-50-1A for assets set aside to satisfy a specific obligation.
For students. The classic trap is thinking that setting aside dedicated assets (in-substance defeasance) removes the debt from the balance sheet — it does not; only payment with relief or a legal release works. Also remember that a released debtor who becomes secondarily liable must book a fair value guarantee liability that reduces the extinguishment gain.
extinguishment of liabilitiesderecognitionlegal release from primary obligorin-substance defeasancelegal defeasanceprepaid stored-value productsbreakageguarantee obligation
Machine-generated study aid for ASC 405-20. Check the source paragraphs below.
405-20-00Status
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405-20-00-1
The following table identifies the changes made to this Subtopic.
405-20-05Overview and Background
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405-20-05-2
An entity may settle a liability by transferring assets to the creditor or otherwise obtaining an unconditional release. Alternatively, an entity may enter into other arrangements designed to set aside assets dedicated to eventually settling a liability. Accounting for those arrangements has raised issues about when a liability should be considered extinguished. This Subtopic establishes standards for resolving those issues.
405-20-10Objectives
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405-20-15Scope and Scope Exceptions
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Entities
405-20-15-1
The guidance in this Subtopic applies to all entities.
Transactions
405-20-15-2
The guidance in this Subtopic applies to extinguishments of all liabilities, including both financial and nonfinancial liabilities, unless derecognition of a financial or nonfinancial liability is addressed in another Topic (for example, the derecognition guidance for gaming chips in Subtopic 924-405 on casinos or the breakage guidance in Topic 606 on revenue from contracts with customers). Derivative instruments that are nonfinancial liabilities (for example, a written commodity option) are included in the scope of this Subtopic.
405-20-40Derecognition
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405-20-40-1
Unless addressed by other guidance (for example, paragraphs or paragraphs ), a debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met:
- aThe debtor pays the creditor and is relieved of its obligation for the liability. Paying the creditor includes the following:
- 1Delivery of cash
- 2Delivery of other financial assets
- 3Delivery of goods or services
- 4Reacquisition by the debtor of its outstanding debt securities whether the securities are cancelled or held as so-called treasury bonds.
- 1
- bThe debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor. For purposes of applying this Subtopic, a sale and related assumption effectively accomplish a legal release if nonrecourse debt (such as certain mortgage loans) is assumed by a third party in conjunction with the sale of an asset that serves as sole collateral for that debt.
Transition date:(P) December 16, 2027; (N) December 16, 2028Transition guidance:
818-10-65-1Unless addressed by other guidance (for example, paragraphs or paragraphs ), a debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met: - aThe debtor pays the creditor and is relieved of its obligation for the liability. Paying the creditor includes the following:
- 1Delivery of cash
- 2Delivery of other financial assets
- 3Delivery of goods or services
- 4Reacquisition by the debtor of its outstanding debt securities whether the securities are cancelled or held as so-called treasury bonds
- 5Delivery of environmental credits.
- 1
- bThe debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor. For purposes of applying this Subtopic, a sale and related assumption effectively accomplish a legal release if nonrecourse debt (such as certain mortgage loans) is assumed by a third party in conjunction with the sale of an asset that serves as sole collateral for that debt.
405-20-40-2
If a creditor releases a debtor from primary obligation on the condition that a third party assumes the obligation and that the original debtor becomes secondarily liable, that release extinguishes the original debtor's liability. However, in those circumstances, whether or not explicit consideration was paid for that guarantee, the original debtor becomes a guarantor. As a guarantor, it shall recognize a guarantee obligation in the same manner as would a guarantor that had never been primarily liable to that creditor, with due regard for the likelihood that the third party will carry out its obligations. The guarantee obligation shall be initially measured at fair value, and that amount reduces the gain or increases the loss recognized on extinguishment. See Topic 460 for accounting guidance related to guarantees.
Prepaid Stored-Value Products
405-20-40-3
Prepaid stored-value products are products in physical and digital forms with stored monetary values that are issued for the purpose of being commonly accepted as payment for goods or services. While the holder of a prepaid stored-value product also may be permitted to redeem the product for cash, prepaid stored-value products do not include products that only can be redeemed by the product holder for cash (for example, nonrecourse debt, bearer bonds, or trade payables). Examples of prepaid stored-value products include prepaid gift cards issued on a specific payment network and redeemable at network-accepting merchant locations, prepaid telecommunication cards, and traveler's checks. The derecognition guidance in paragraph 405-20-40-4 does not apply to liabilities related to either of the following:
- aPrepaid stored-value products (or portions of those products) for which any breakage (that is, the portion of the dollar value of prepaid stored-value products that ultimately is not redeemed by product holders for cash or not used to purchase goods and/or services) must be remitted in accordance with unclaimed property laws
- bPrepaid stored-value products that are attached to a segregated bank account like a customer depository account.
405-20-40-4
If an entity expects to be entitled to a breakage amount for a liability resulting from the sale of a prepaid stored-value product in the scope of paragraph 405-20-40-3, the entity shall derecognize the amount related to the expected breakage in proportion to the pattern of rights expected to be exercised by the product holder only to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. If an entity does not expect to be entitled to a breakage amount for prepaid stored-value products in the scope of paragraph 405-20-40-3, the entity shall derecognize the amount related to breakage when the likelihood of the product holder exercising its remaining rights becomes remote. At the end of each period, an entity shall update the estimated breakage amount to represent faithfully the circumstances present at the end of the period and the changes in circumstances during the period. Changes to an entity's estimated breakage amount shall be accounted for as a change in accounting estimate in accordance with paragraphs .
405-20-50Disclosure
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405-20-50-1
See paragraph 470-50-50-1 for a disclosure requirement for debt considered to be extinguished by in-substance defeasance. In addition, see paragraph 860-30-50-1A for disclosure requirements for assets that are set aside solely for the purpose of satisfying scheduled payments of a specific obligation.
Prepaid Stored-Value Products
405-20-50-2
An entity that recognizes a breakage amount in accordance with paragraph 405-20-40-4 shall disclose the methodology used to recognize breakage and significant judgments made in applying the breakage methodology.
405-20-55Implementation Guidance and Illustrations
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Implementation Guidance
405-20-55-1
This Section provides implementation guidance related to the extinguishment of liabilities.
405-20-55-2
The following provides guidance on the application of the liability extinguishment criteria, specifically related to the following:
- aIn-substance defeasance transactions
- bTransfers of noncash financial assets in settlement of a creditor's receivable
- c
- dExtinguishment via legal defeasance.
405-20-55-3
In an in-substance defeasance transaction, a debtor transfers essentially risk-free assets to an irrevocable defeasance trust and the cash flows from those assets approximate the scheduled interest and principal payments of the debt being extinguished.
405-20-55-4
An in-substance defeasance transaction does not meet the derecognition criteria in either Section 405-20-40 for the liability or in Section 860-10-40 for the asset. The transaction does not meet the criteria because of the following:
- aThe debtor is not released from the debt by putting assets in the trust; if the assets in the trust prove insufficient, for example, because a default by the debtor accelerates its debt, the debtor must make up the difference.
- bThe lender is not limited to the cash flows from the assets in trust.
- cThe lender does not have the ability to dispose of the assets at will or to terminate the trust.
- dIf the assets in the trust exceed what is necessary to meet scheduled principal and interest payments, the transferor can remove the assets.
- e
- fThe debtor does not surrender control of the benefits of the assets because those assets are still being used for the debtor's benefit, to extinguish its debt, and because no asset can be an asset of more than one entity, those benefits must still be the debtor's assets.
405-20-55-5
A cash payment or conveyance of noncash financial assets from a debtor to a creditor results in full or partial settlement of the creditor's receivable from the debtor. Whether or not that settlement is an extinguishment is governed by paragraph 405-20-40-1. However, if a noncash financial asset was conveyed to the creditor in full or partial settlement of a creditor's receivable, it would be rare to conclude that debt has been extinguished if the criteria of paragraph 860-10-40-5 were not also met.
405-20-55-9
In a legal defeasance, generally the creditor legally releases the debtor from being the primary obligor under the liability. Liabilities are extinguished by legal defeasances if the condition in paragraph 405-20-40-1(b) is satisfied. Whether the debtor has in fact been released and the condition in that paragraph has been met is a matter of law. Conversely, in an in-substance defeasance, the debtor is not released from the debt by putting assets in the trust. For the reasons identified in paragraph 405-20-55-4, an in-substance defeasance is different from a legal defeasance and the liability is not extinguished.
405-20-65Transition and Open Effective Date Information
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405-20-65-1
Paragraph superseded on 08/12/2020 after the end of the transition period stated in Accounting Standards Update No. 2016-04, Liabilities—Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products.