(Term Modification with Gain—Debtor’s Entries) Use the same information as in E14-22 above except that American Bank reduced the principal to \(1,900,000 rather than \)2,400,000. On January 1, 2021, Barkley pays $1,900,000 in cash to American Bank for the principal. Instructions

(a) Can Barkley Company record a gain under this term modification? If yes, compute the gain for Barkley Company.

(b) Prepare the journal entries to record the gain on Barkley’s books.

(c) What interest rate should Barkley use to compute its interest expense in future periods? Will your answer be the same as in E14-22 above? Why or why not?

(d) Prepare the interest payment schedule of the note for Barkley Company after the debt restructuring.

(e) Prepare the interest payment entries for Barkley Company on December 31, of 2018, 2019, and 2020.

(f) What entry should Barkley make on January 1, 2021?

Step by step solution

01

Definition of Bonds Payable

Bonds payable can be defined as the security issued by the business entity for generating cash for the business entity. These securities are debt securities.

02

(a) Recording gain under term modification

The business entity can record gains generated under term modification. The gain will be calculated as follow:

Particular	Amount $
Principal	$1,900,000
Less: Interest$\left(\$1,900,000\times 10\%\times 3years\right)$	570,000
Total future value of cash flow after restructuring	$2,470,000
Less: carrying amount before restructuring	(3,000,000)
Gain on restructuring	$530,000

03

(b) Journal entry to record the gain

Date	Accounts and Explanation	Debit ($)	Credit ($)
	Note payable	530,000
	Gain on restructuring		530,000

04

(c) Future interest rate

Since the new carrying value of the note is the same as the sum of future cash flows without discounting, therefore imputed interest rate will be 0%. Therefore, all the future cash flows will reduce the principal balance, and interest expenses will not be recognized.

05

(d) Interest payment schedule after debt restructuring

Date	Cash paid $\left(\$1,900,000\times 10\%\right)$	Interest expenses	Reduction of carrying amount	Carrying amount of note
31 Dec 2017				$2,470,000
31 Dec 2018	$190,000	$0	$190,000	2,280,000
31 Dec 2019	$190,000	0	190,000	2,090,000
31 Dec 2020	$190,000	0	190,000	1,900,000
Total	$570,000	$0	$570,000

06

(e) Journal entries for interest payments

Date	Accounts and Explanation	Debit ($)	Credit ($)
31 Dec 2018	Note payable	190,000
	Cash		190,000
31 Dec 2019	Note payable	190,000
	Cash		190,000
31 Dec 2020	Note payable	190,000
	Cash		190,000

07

(f) Journal entry on 1 January 2021

Date	Accounts and Explanation	Debit ($)	Credit ($)
1 Jan 2021	Note payable	1,900,000
	Cash		1,900,000

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