In: Accounting
Headquartered in Montreal, Canada, Valeant Pharmaceuticals International is a multinational company that develops and markets prescription and non-prescription products in dermatology and neurology. The company is listed both on the NYSE and Toronto Stock Exchange. Its 2015 Income Statement reported the following line item.
$Millions 2015 2014 2013
Loss of Extinguishment debt------------------ $20.0 $129.6 $65.0
a) What is a ‘Loss of extinguishment of debt’? When does such a loss occur?
b) How is this loss calculated?
c) How does this loss impact the financial statements?
d) Why might management want to retire this debt early, even if it was at a loss?
1. First of all, extinguishment of debt refers to writing off debt from the financial statements. Debt needs to be written off in case of early payment of debt or prepayment of debt.
Therefore loss on extinguishment on debt arise when there is prepayment of debt.
2. Calculation of loss on extinguishment of debt,
It is calculated as follows:
Fair value of payments made - Carrying Amount of debt
Fair value refers to the discounted value of the payments to be made at the time of extinguishment
Carrying value refers to the amount at which the debt appears in the books of accounts on the date of extinguishment.
3. Impact on financial statements:
It is an expense of a financial nature and is recorded in the financial statements as borrowing cost. Hence, it reduces the profit for the period in which it is recorded.
4. Why management may want to retire the debt early even if it was at a loss:
There may be several reason of why management may want to retire this debt early even if it was at a loss:
a) The main reason can be if the management had excess cash surplus then what was required. It can use the excess for prepayment of debt to reduce the interest cost.
b) Another reason can be that if funds are available at a cheaper rate than what the management is using. For eg Management's current cost of debt is 6% and the funds are now available at a rate of 5%. Now management may want to retire the debt bearing interest rate of 6% and borrow at 5%.
c) If management had some capital receipts in the year. It may instead of investing in fixed assets decide to repay the debt early to reduce the interest cost.