Restructuring (Debtor) Oakwood Corporation is delinquent on a $2,400,000, 10% note to Second National Bank that was due January 1, 2019. At that time, Oakwood owed the principal amount plus $34,031.82 of accrued interest. Oakwood enters into a debt restructuring agreement with the bank on January 2, 2019.
Required:
Prepare the
- 1. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 8%.
- 2. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%.
- 3. The bank accepts 160,000 shares of Oakwood’s 55 par value common stock, which is currently selling for $14.50 per share, in full settlement of the debt.
- 4. The bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Oakwood’s books at a cost of $2,200,000.
1.
Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date as on 31st December 2022, forgives the accrued interest owed, reduces the principal by $200,000 and reduces the interest to 8%.
Explanation of Solution
Troubled Debt Restructuring: A troubled debt restructuring happens if a creditor, for legal or economic reasons associated to a debtor’s financial complications, grants a concession to a debtor that would not be otherwise considered.
Calculate carrying value of note:
Calculate total amount to be repaid of notes payable.
Therefore, no gain recognized by the debtor, because the repaid amount of notes is exceeds the current carrying value of the note and interest.
Calculate amount of restructuring agreement using effective interest rate method.
Particulars | Amount (A) | Present value factor (B) | Value of the Bonds (A × B) |
Present value of principal | $2,200,000 | 0.822702 | $1,809,944.44 |
Add: Present value of interest | $176,000 | 3.545951 | $624,087.38 |
Restructuring agreement | $2,434,031.82 |
Table (1)
Note: The Present value of an ordinary annuity of $1 for 4 periods at 5% is 3.545951 (refer Table 4 in TVM Module). And the present value of $1 for 4 periods at 5% is 0.822702 (refer Table 3 in TVM Module).
Working note:
(1)Calculate present value interest amount.
Calculate interest expense and principal reduction using amortization schedule.
AMORTIZATION SCHEDULE - NOTES PAYABLE | ||||
Date | Cash (A) | Interest expense ( B = Prior period D × 5%) | Notes payable (C = A –B) | Carrying Value of Note (D = Prior period D –C) |
1/2/2019 | $2,434,031.82 | |||
12/31/2019 | $176,000 | $121,701.59 | $54,298.41 | $2,379,733.41 |
12/31/2020 | $176,000 | $118,986.67 | $57,013.33 | $2,322,720.08 |
12/31/2021 | $176,000 | $116,136.00 | $59,864.00 | $2,262,857.08 |
12/31/2022 | $2,376,000 | $113,142.92 | $2,262,857.08 | $0.00 |
Table (2)
Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date as on 31st December 2022, forgives the accrued interest owed, reduces the principal by $200,000 and reduces the interest to 8%.
Date | Account titles and Explanation | Debit | Credit |
January 2, 2019 | Interest payable | $34,031.82 | |
Notes payable | $34,031.82 | ||
(To record transfer of accrued interest payable to notes payable) | |||
December 31, 2019 | Interest expense | $121,71.59 | |
Notes payable | $54,298.41 | ||
Cash | $176,000.00 | ||
(To record payment of interest expense and interest payable) | |||
December 31, 2020 | Interest expense | $118,986.67 | |
Notes payable | $57,013.33 | ||
Cash | $176,000.00 | ||
(To record payment of interest expense and interest payable) | |||
December 31, 2021 | Interest expense | $116,136.00 | |
Notes payable | $59,864.00 | ||
Cash | $176,000.00 | ||
(To record payment of interest expense and interest payable) | |||
December 31, 2022 | Interest expense | $113,142.92 | |
Notes payable | $2,262,857.08 | ||
Cash | $2,376,000.00 | ||
(To record payment of interest expense and interest payable) |
Table (3)
2.
Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date to December 31, 2022, forgives the interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%.
Explanation of Solution
Calculate carrying value of note:
Calculate total amount to be repaid of notes payable.
Calculate gain recognized by the debtor.
Therefore, gain recognized by the debtor is $146,031.82. Because the repaid amount of notes is lesser than the current carrying value of the note and interest.
Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date to December 31, 2022, forgives the interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%.
Date | Account titles and Explanation | Debit | Credit |
January 2, 2019 | Interest payable | $34,031.82 | |
Notes payable | $34,031.82 | ||
(To record transfer of accrued interest payable to notes payable) | |||
January 2, 2019 | Notes payable | $146,031.82 | |
Gain on debt restructure | $146,031.82 | ||
(To record gain on debt restructuring) | |||
December 31, 2019 | Notes payable | $22,000 | |
Cash | $22,000 | ||
(To record payment of notes payable) | |||
December 31, 2020 | Notes payable | $22,000 | |
Cash | $22,000 | ||
(To record payment of notes payable) | |||
December 31, 2021 | Notes payable | $22,000 | |
Cash | $22,000 | ||
(To record payment of notes payable) | |||
December 31, 2022 | Notes payable | $22,000 | |
Cash | $22,000 | ||
(To record payment of notes payable) |
Table (4)
3.
Prepare journal entries to record the debt restructuring agreement assuming the bank accepts 160,000 shares of Corporation O, par value of common stock, which is currently selling for $14.50 per share, in full settlement of the debt.
Explanation of Solution
Calculate gain recognized by the debtor.
Prepare journal entries to record the debt restructuring agreement assuming the bank accepts 160,000 shares of Corporation O, par value of common stock, which is currently selling for $14.50 per share, in full settlement of the debt.
Date | Account titles and Explanation | Debit | Credit |
January 2, 2019 | Notes payable | $2,400,000 | |
Interest payable | $34,031.82 | ||
Gain on Debt restructure | $114,031.82 | ||
Common stock | $800,000 | ||
Additional paid in capital on common stock (balancing figure) | $1,520,000.00 | ||
(To record payment of debt restructuring) |
Table (5)
Working note:
(2)Calculate common stock.
4.
Prepare journal entries to record the debt restructuring agreement assuming the bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Corporation O’s books at a cost of $2,200,000.
Explanation of Solution
Prepare journal entries to record the debt restructuring agreement assuming the bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Corporation O’s books at a cost of $2,200,000.
Date | Account titles and Explanation | Debit | Credit |
January 2, 2019 | Notes payable | $2,400,000 | |
Interest payable | $34,031.82 | ||
Gain on debt restructure | $134,031.82 | ||
Gain on disposal of land | $100,000 | ||
Land | $2,200,000.00 | ||
(To record payment of debt restructuring) |
Table (6)
Working notes:
(3)Calculate gain on debt restructure.
(4)Calculate gain recognized by the debtor.
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