What is accounting defeasance?

Accounting defeasance refers to a financial process where a borrower effectively removes a debt obligation from their balance sheet by setting aside sufficient funds, typically in the form of high-quality securities, to cover future interest and principal payments on that debt. This process allows the debt to be considered extinguished for accounting purposes, as the cash flow obligations are fully covered by the dedicated investments.

By investing in these high-quality securities, the borrower assures that payments will be made when they are due, creating a legal structure that allows them to treat the obligation as fulfilled, even though the borrower retains ownership of the property or asset associated with the debt. This method is advantageous for improving the borrower's financial ratios and can potentially enhance their credit rating, as it demonstrates that the obligation is fully funded and mitigates the risk of default.

The other options do not accurately define accounting defeasance. For instance, simply paying off a debt obligation with cash does not entail the complex financial structuring and asset designation involved in defeasance. Exchanging a debt obligation for equity changes the nature of the obligation rather than extinguishing it through earmarked securities, and restructuring a debt into a longer-term loan alters the terms rather than removing the obligation entirely from the balance sheet.