Another form of early extinguishment of debt is referred to as in-substance defeasance, or economic defeasance. In-substance defeasance is a process of transferring assets, generally cash and securities, to an irrevocable trust, and using the assets and earnings therefrom to satisfy the long-term obligations as they come due. In some instances, the debt holders are not aware of these transactions and continue to rely on the issuer of the debt for settlement of the obligation. In other words, there has been no “legal defeasance” or release of the debtor from the legal liability.
Before FASB Statement No. 125 was issued in 1996, an in-substance defeasance was treated as an extinguishment of debt even though the debt is not actually repaid. The provisions of Statement No. 125 (and its successor, Statement No. 140) no longer allow debt to be removed from the balance sheet through in-substance defeasance.
Under Statement No. 140, what conditions must be satisfied for debt to be removed from the balance sheet? In what way do these conditions stop the use of in-substance defeasance as a way to remove debt from the balance sheet?