Vargo Corp. owes \(270,000 to First Trust. The debt is a 10-year, 12% note due December 31, 2017. Because Vargo Corp. is in financial trouble, First Trust agrees to extend the maturity date to December 31, 2019, reduce the principal to \)220,000, and reduce the interest rate to 5%, payable annually on December 31.

Instructions

1. Prepare the journal entries on Vargo’s books on December 31, 2017, 2018, 2019.
2. Prepare the journal entries on First Trust’s books on December 31, 2017, 2018, 2019.

Date

Particulars

Debit ($)

Credit ($)

2017

Notes payable

28,000

Gain on the restructuring of debt

28,000

2018

Notes payable

11,000

Cash$\left(5\%\times \$220,000\right)$

11,000

2019

Notes payable

231,000

Cash

$\left[\$220,000+\left(5\%\times \$220,000\right)\right]$

231,000

$270,000

$270,000

Date

Particulars

Debit ($)

Credit ($)

Dec. 31, 2017

Bad debt expense

76,027

Allowances for doubtful accounts

76,027

Dec. 31, 2018

Cash

11,000

Allowance for doubtful accounts

12,277

Interest revenue

23,277

Dec. 31, 2019

Cash

11,000

Allowances for doubtful accounts

13,750

Interest revenue

24,750

Dec. 31, 2019

Cash

220,000

Allowance for doubtful accounts

50,000

Notes receivable

270,000

$394,054

$394,054

Pre-restructure carrying amount

$270,000

Present value of restructured cash flows:

Present value of $220,000 due in 2 years

At 12%, interest payable annually

(Table 6-2); $\left(\$220,000\times 0.79719\right)$$175,382

Present value of $11,000 interest payable

Annually for 2 years at 12 % (Table 6-4);

$\left(\$11,000\times 1.69005\right)$18,591

193,973

Creditor’s loss on restructuring of debt

$(76,027)

Date

Cash interest

Effective interest

Increase in

Carrying

Amount

Carrying

Amount of Note

12/31/17

$193,973

12/31/18

$11,000

$\left(\$220,000\times 0.05\right)$

$23,277

$\left(\$193,973\times 12\%\right)$

$12,277

$\left(\$23,277-\$11,000\right)$

206,250

12/31/19

11,000

24,750

13,750

220,000