Audit of Construction and Real Estate Industry Practice Test 2026 - Free Practice Questions and Study Guide

When debt is extinguished or modified, you must determine how theDeferred financing costs should be treated in the new situation. The reason is that the accounting hinges on whether the change is a modification or an extinguishment, and on whether the modification is substantial.

If the change is considered extinguishment (a substantial modification), the old liability is removed and a new one is recognized. The unamortized financing costs tied to the old debt are included in the measurement of the gain or loss on extinguishment, and any new financing costs for the new debt are added to the carrying amount of the new debt and amortized over its term. If the change is not substantial and is treated as a modification, the debt is remeasured but the existing unamortized financing costs generally continue to be amortized over the life of the modified debt, while any incremental costs related to the modification are capitalized as part of the new debt and amortized over its term.

So, you perform this analysis to decide how to treat both the existing and any new financing costs. Recording an automatic default, classifying costs as equity, or ignoring the changes would not reflect the correct accounting treatment under these situations.