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Chapter 14: Q13P (page 763)

Question: (Restructure of Note under Different Circumstances) Halvor Corporation is having financial difficulty and therefore has asked Frontenac National Bank to restructure its \(5 million note outstanding. The present note has 3 years remaining and pays a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The note was issued at its face value.

Instructions

The following are four independent situations. Prepare the journal entry that Halvor and Frontenac National Bank would make for each of these restructurings.

(a) Frontenac National Bank agrees to take an equity interest in Halvor by accepting common stock valued at \)3,700,000 in exchange for relinquishing its claim on this note. The common stock has a par value of \(1,700,000.

(b) Frontenac National Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of \)3,250,000 and a fair value of \(4,000,000.

(c) Frontenac National Bank agrees to modify the terms of the note, indicating that Halvor does not have to pay any interest on the note over the 3-year period.

(d) Frontenac National Bank agrees to reduce the principal balance due to \)4,166,667 and require interest only in the second and third year at a rate of 10%.

Short Answer

Expert verified

Answer

  1. Halvor corporation generates a gain of$1,300,000 on restructuring.
  2. Halvor corporation generates a gain of disposal of$750,000 and gains on the restructuring of$1,000,000.
  3. Modification in terms of the loan does not require any entry to be made in the books of Halvor, because there is no difference between the aggregate cash flow and the carrying amount.
  4. Frontenac national bank will report$1,212,083 as bad debt expenses.

Step by step solution

01

Definition of Restructuring Loan

The process adopted by the corporates and the government to avoid default over loans by generating new terms of loans is known as restructuring of loans. Under this process, they negotiate upon the interest charged on the loan.

02

Journal entries when Frontenac national bank takes an equity interest in Halvor

Date

Accounts and Explanation

Debit ($)

Credit ($)

In the books of Halvor corporation

Note payable

5,000,000

Common stock

1,700,000

Gain on restructuring

1,300,000

Paid-in-capital in excess of par – common stock

2,000,000

In the books of Frontenac national bank

Equity investment – Halvor corporation

3,700,000

Allowance for bad debts

1,300,000

Note receivable

5,000,000

Working note:

Calculation of gain on restructuring:

Particular

Amount $

Carrying amount of debt

$5,000,000

Less: Fair value of the equity exchanged

(3,700,000)

Gain on restructuring

$1,300,000

03

Journal entries when the Frontenac national bank agrees to accept land

Date

Accounts and Explanation

Debit ($)

Credit ($)

In the books of Halvor corporation

Note payable

5,000,000

Land

3,250,000

Gain on disposal of land

750,000

Gain on restructuring

1,000,000

In the books of Frontenac national bank

Land

4,000,000

Allowance for bad debts

1,000,000

Note receivable

5,000,000

Working note:

Calculation of gain on disposal of land:

Particular

Amount $

Fair value of land

$4,000,000

Less: book value of land

(3,250,000)

Gain on disposal of land

$750,000

Calculation of gain on restructuring:

Particular

Amount $

Note payable

$5,000,000

Less: fair value of land

(4,000,000)

Gain on restructuring debt

$1,000,000

04

Journal entries when the Frontenac national bank agrees to modify the term of note

Date

Accounts and Explanation

Debit ($)

Credit ($0

On the book of Halvor

No journal entry is required for Halvor Corporation because the aggregate cash flow is same as the carrying amount of the note payable.

In the books of Frontenac national bank

Bad debt expenses

1,245,000

Allowance for doubtful accounts

1,245,000

Working note:

Calculation of bad debt expenses:

Particular

Amount $

Carrying amount of loan before restricting

$5,000,000

Less: Present value of the restructured cash flow $5,000,000 (n=3, r=10%) (0.751)

(3,755,000)

Loss on restructuring debt

$1,245,000

05

Journal entries when the Frontenac national bank agrees to reduce the principal balance

Date

Accounts and Explanation

Debit ($)

Credit ($)

In the books of Halvor

No journal entry is required because the aggregate cash flow is same as the carrying amount of the note payable

In the books of Frontenac national bank

Bad debt expenses

1,212,083

Allowance for doubtful accounts

1,212,083

Working note:

Calculation of aggregate cash flow and carrying amount:

Particular

Amount $

Principal

$4,166,667

Add: Interest

833,333

Aggregate cash flow

$5,000,000

Calculation of creditor loss on restructuring:

Particular

Amount $

Carrying amount before restructuring

$5,000,000

Less: Present value of restructured loan

Present value of $4,166,667 (n=3, r=10%) (0.751)

(3,129,167)

Present value of interest payable annually $416,667 (n=3, r=10%) (PVOAF: 2.49)

(1,037,500)

Present value of interest due in first year (n=3, r=10%) (0.909)

378,750

Loss due to restructuring

$1,212,083

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Most popular questions from this chapter

Question: The following information is taken from the 2017 annual report of Bugant, Inc. Bugant’s fiscal year ends December 31 of each year. Bugant’s December 31, 2017, balance sheet is as follows.

Bugant, Inc.

Balance Sheet

December 31, 2017

Assets

Cash \( 450

Inventory 1,800

Total current assets 2,250

Plant and equipment 2,000

Accumulated depreciation (160)

Total assets \)4,090

Liabilities

Bonds payable (net of discount) \(1,426

Stockholders’ equity

Common stock 1,500

Retained earnings 1,164

Total liabilities and stockholders’ equity \)4,090

Note X: Long Term Debt:

On January 1, 2016, Bugant issued bonds with face value of \(1,500 and a coupon rate equal to 10%. The bonds were issued to yield 12% and mature on January 1, 2021.

Additional information concerning 2018 is as follows.

  1. Sales were \)3,500, all for cash.
  2. Purchases were \(2,000, all paid in cash.
  3. Salaries were \)700, all paid in cash.
  4. Property, plant, and equipment was originally purchased for \(2,000 and is depreciated straight-line over a 25-year life with no salvage value.
  5. Ending inventory was \)1,900.
  6. Cash dividends of \(100 were declared and paid by Bugant.
  7. Ignore taxes.
  8. The market rate of interest on bonds of similar risk was 12% during all of 2018.
  9. Interest on the bonds is paid semiannually each June 30 and December 31.

Accounting

Prepare a balance sheet for Bugant, Inc. at December 31, 2018, and an income statement for the year ending December 31, 2018. Assume semiannual compounding of the bond interest.

Analysis

Use common ratios for analysis of long-term debt to assess Bugant’s long-run solvency. Has Bugant’s solvency changed much from 2017 to 2018? Bugant’s net income in 2017 was \)550 and interest expense was $169.

Principles

The FASB and the IASB allow companies the option of recognizing in their financial statements the fair values of their long-term debt. That is, companies have the option to change the balance sheet value of their long-term debt to the debt’s fair value and report the change in balance sheet value as a gain or loss in income. In terms of the qualitative characteristics of accounting information (Chapter 2), briefly describe the potential trade-off(s) involved in reporting long-term debt at its fair value.

Question: Potlatch Corporation has issued various types of bonds such as term bonds, income bonds, and debentures. Differentiate between term bonds, mortgage bonds, debentures bonds, income bonds, callable bonds, registered bonds, bearer or coupon bonds, convertible bonds, commodity-backed bonds, and deep discount bonds.

Question: What are the general rules for measuring and recognizing gain or loss by a debt extinguishment with modification?

On March 1, 2017, Sealy Company sold its 5-year, $1,000 face value, 9% bonds dated March 1, 2017, at an effective annual interest rate (yield) of 11%. Interest is payable semiannually, and the first interest payment date is September 1, 2017. Sealy uses the effective-interest method of amortization. The bonds can be called by Sealy at 101 at any time on or after March 1, 2018.

Instructions

a. (1) How would the selling price of the bond be determined?

(2) Specify how all items related to the bonds would be presented in a balance sheet prepared immediately after the bond issue was sold.

b. What items related to the bond issue would be included in Sealy’s 2017 income statement, and how would each be determined?

c. Would the amount of bond discount amortization using the effective-interest method of amortization be lower in the second or third year of the life of the bond issue? Why?

d. Assuming that the bonds were called in and redeemed on March 1, 2018, how should Sealy report the redemption of the bonds on the 2018 income statement?

Good-Deal Inc. developed a new sales gimmick to help sell its inventory of new automobiles. Because many new car buyers need financing, Good-Deal offered a low down payment and low car payments for the first year after purchase. It believes that this promotion will bring in some new buyers.

On January 1, 2017, a customer purchased a new \(33,000 automobile, making a down payment of \)1,000. The customer signed a note indicating that the annual rate of interest would be 8% and that quarterly payments would be made over 3 years. For the first year, Good-Deal required a $400 quarterly payment to be made on April 1, July 1, October 1, and January 1, 2018. After this one-year period, the customer was required to make regular quarterly payments that would pay off the loan as of January 1, 2020.

Instructions

(a) Prepare a note amortization schedule for the first year.

(b) Indicate the amount the customer owes on the contract at the end of the first year.

(c) Compute the amount of the new quarterly payments.

(d) Prepare a note amortization schedule for these new payments for the next 2 years.

(e) What do you think of the new sales promotion used by Good-Deal?
See all solutions

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