1 APPENDIX G ACCOUNTING FOR TROUBLED DEBT Illustration G-1 Usual Progression in Troubled Debt Situations Practically every day the Wall Street Journal runs a story about some company in financial difficulty. For example, recently Huffy Corp., a name that adorned the first bicycle of many American children, declared bankruptcy. Its creditors, Chinese suppliers, ended up taking a 30 percent equity stake in Huffy. Other examples are Delphi, Northwest Airlines, and United Airlines. The purpose of this appendix is to explain how creditors and debtors report information in financial statements related to these troubled debt situations. Two different types of situations result with troubled debt. 1 Impairments. 2 Restructurings: a. Settlements. b. Modification of terms. In a troubled-debt situation, the creditor usually first recognizes a loss on impairment. Subsequently, the creditor either modifies the terms of the loan or the debtor settles the loan on terms unfavorable to the creditor. In unusual cases, the creditor forces the debtor into bankruptcy in order to ensure the highest possible collection on the loan. Illustration G-1 shows this continuum. Loan Origination Loan Impairment Modification of Terms Bankruptcy OBJECTIVE 1 Describe the accounting for a loan impairment. IMPAIRMENTS A creditor considers a loan 1 impaired when it is probable, 2 based on current information and events, that it will not collect all amounts due (both principal and interest). Creditors should apply their normal review procedures in making the judgment as to the probability of collection FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan, (Norwalk, Conn.: FASB, May 1993), defines a loan as a contractual right to receive money on demand or on fixed and determinable dates that is recognized as an asset in the creditor s statement of financial position. For example, accounts receivable with terms exceeding one year are considered loans. 2 Recall the definitions of probable, reasonably possible, and remote with respect to contingencies, as defined in FASB Statement No Normal review procedures include examination of watch lists, review of regulatory reports of examination, and examination of management reports of total loan amounts by borrower.
2 Impairments 1109 If considering a loan impaired, the creditor should measure the loss due to the impairment as the difference between the investment in the loan (generally the principal plus accrued interest) and the expected future cash flows discounted at the loan s historical effective interest rate. 4 When using the historical effective loan rate, the value of the investment will change only if some of the legally contracted cash flows are reduced. A company recognizes a loss in this case because the expected future cash flows have changed. The company ignores interest rate changes caused by current economic events that affect the fair value of the loan. In estimating future cash flows, the creditor should use reasonable and supportable assumptions and projections. 5 Example of Loss on Impairment On December 31, 2008, Prospect Inc. issued a $500,000, five-year, zero-interest-bearing note to Community Bank. Prospect issued the note to yield 10% annual interest. As a result, Prospect received, and Community Bank paid, $310,460 ($500, ) on December 31, The time diagram in Illustration G-2 depicts the factors involved. Present Value $310,460 Interest Rate i = 10% Future Value $500,000 Illustration G-2 Time Diagram for Zero- Interest-Bearing Loan 12/31/08 12/31/09 12/31/10 12/31/11 12/31/12 12/31/13 Number of Periods n = 5 Illustration G-3 shows how Community Bank (creditor) and Prospect (debtor) record these transactions. Community Bank (Creditor) December 31, 2008 Prospect Inc. (Debtor) Notes Receivable 500,000 Cash 310,460 Discount on Notes Discount on Notes Receivable 189,540 Payable 189,540 Cash 310,460 Notes Payable 500,000 Illustration G-3 Creditor and Debtor Entries to Record Note Assuming that Community Bank and Prospect use the effective-interest method to amortize discounts, Illustration G-4 (page 1110) shows the amortization of the discount and the increase in the carrying amount of the note over the life of the note. 4 The creditor may also, for the sake of expediency, use the market price of the loan (if such a price is available) or the fair value of collateral if it is a collateralized loan. FASB Statement No. 114, par FASB Statement No. 114, par Present value of $500,000 due in five years at 10%, annual compounding (Table 2 in Appendix A) equals $500,
3 1110 Appendix G Accounting for Troubled Debt Illustration G-4 Schedule of Interest and Discount Amortization (Before Impairment) Community Bank Cash Interest Carrying Received Revenue Discount Amount of Date (0%) (10%) Amortized Note 12/31/08 $310,460 12/31/09 $0 $ 31,046 a $ 31, ,506 b 12/31/ ,151 34, ,657 12/31/ ,566 37, ,223 12/31/ ,322 41, ,545 12/31/ ,455 45, ,000 Total $0 $189,540 $189,540 a $31,046 $310, b $341,506 $310,460 $31,046 Unfortunately, during 2010 Prospect s business deteriorated due to increased competition and a faltering regional economy. After reviewing all available evidence at December 31, 2010, Community Bank determines that Prospect will probably pay back only $300,000 of the principal at maturity. As a result, Community Bank declares the loan impaired. It now needs to record a loss. To determine the loss, Community Bank first computes the present value of the expected cash flows, discounted at the historical effective rate of interest (10%). This amount is $225,396. The time diagram in Illustration G-5 highlights the factors involved in this computation. Illustration G-5 Time Diagram for Impaired Loan Present Value $225,396 Interest Rate i = 10% Future Value $300,000 12/31/10 12/31/11 12/31/12 12/31/13 Number of Periods n = 3 The loss due to impairment is the difference between the present value of the expected future cash flows and the recorded carrying amount of the investment in the loan. Illustration G-6 shows the calculation of the loss. Illustration G-6 Computation of Loss Due to Impairment Carrying amount of investment (12/31/10) Illustration G-4 $375,657 Less: Present value of $300,000 due in 3 years at 10% interest compounded annually (Table 2 in Appendix A); FV(PVF 3,10% ); ($300, ) 225,396 Loss due to impairment $150,261 The loss due to the impairment is $150,261, not $200,000 ($500,000 $300,000). Why? Because Community Bank must measure the loss at a present-value amount, not an undiscounted amount, at the time it records the loss. Community Bank records the loss as follows.
4 Troubled-Debt Restructurings 1111 Community Bank (Creditor) December 31, 2010 Prospect Inc. (Debtor) Bad Debt Expense 150,261 No entry Allowance for Doubtful Accounts 150,261 Illustration G-7 Creditor and Debtor Entries to Record Loss on Note Community Bank (creditor) debits Bad Debt Expense for the expected loss. At the same time, it reduces the overall value of its loan receivable by crediting Allowance for Doubtful Accounts. 7 What entry does Prospect (the debtor) make? It makes no entry because it still legally owes $500, TROUBLED-DEBT RESTRUCTURINGS A troubled-debt restructuring occurs when a creditor for economic or legal reasons related to the debtor s financial difficulties grants a concession to the debtor that it would not otherwise consider. 9 Thus a troubled-debt restructuring does not apply to modifications of a debt obligation that reflect general economic conditions leading to a reduced interest rate. Nor does it apply to the refunding of an old debt with new debt having an effective interest rate approximately equal to that of similar debt issued by nontroubled debtors. A troubled-debt restructuring involves one of two basic types of transactions: OBJECTIVE 2 Describe the accounting for a debt restructuring. 1 Settlement of debt at less than its carrying amount. 2 Continuation of debt with a modification of terms. Settlement of Debt Settling a debt obligation can involve either a transfer of noncash assets (real estate, receivables, or other assets) or the issuance of the debtor s stock. In these situations, the creditor should account for the noncash assets or equity interest received at their fair value. The debtor must determine the excess of the carrying amount of the payable over the fair value of the assets or equity transferred (gain). Likewise, the creditor must determine the excess of the receivable over the fair value of those same assets or equity interests transferred (loss). The debtor recognizes a gain equal to the amount of the excess. The creditor normally charges the excess (loss) against Allowance for Doubtful Accounts. In addition, the debtor recognizes a gain or loss on disposition of assets to the extent that the fair value of those assets differs from their carrying amount (book value). 7 In the event of a loan write-off, the company charges the loss against the allowance. In subsequent periods, if revising estimated expected cash flows based on new information, the company adjusts the allowance account and bad debt account (either increased or decreased depending whether conditions improved or worsened) in the same fashion as the original impairment. We use the terms loss and bad debt expense interchangeably throughout this discussion. Companies should charge losses related to receivables transactions to Bad Debt Expense or the related Allowance for Doubtful Accounts, because they use these accounts to recognize changes in values affecting receivables. 8 Many alternatives are permitted to recognize income by Community Bank in subsequent periods. See FASB Statement No. 118, Accounting by Creditors for Impairment of a Loan Income Recognition and Disclosures (Norwalk, Conn.: FASB, October 1994) for appropriate methods. 9 Accounting by Debtors and Creditors for Troubled Debt Restructurings, FASB Statement No. 15 (Norwalk, Conn.: FASB, June, 1977), par. 1.
5 1112 Appendix G Accounting for Troubled Debt Transfer of Assets Assume, for example, that American City Bank loaned $20,000,000 to Union Mortgage Company. Union Mortgage, in turn, invested these monies in residential apartment buildings. However, because of low occupancy rates, it cannot meet its loan obligations. American City Bank agrees to accept from Union Mortgage real estate with a fair value of $16,000,000 in full settlement of the $20,000,000 loan obligation. The real estate has a carrying value of $21,000,000 on the books of Union Mortgage. American City Bank (creditor) records this transaction as follows. Real Estate 16,000,000 Allowance for Doubtful Accounts 4,000,000 Note Receivable from Union Mortgage 20,000,000 The bank records the real estate at fair value. Further, it makes a charge to the Allowance for Doubtful Accounts to reflect the bad debt write-off. Union Mortgage (debtor) records this transaction as follows. Note Payable to American City Bank 20,000,000 Loss on Disposition of Real Estate 5,000,000 Real Estate 21,000,000 Gain on Restructuring of Debt 4,000,000 Union Mortgage has a loss on the disposition of real estate in the amount of $5,000,000 (the difference between the $21,000,000 book value and the $16,000,000 fair value). It should show this as an ordinary loss on the income statement. In addition, it has a gain on restructuring of debt of $4,000,000 (the difference between the $20,000,000 carrying amount of the note payable and the $16,000,000 fair value of the real estate). Granting of Equity Interest Assume that American City Bank agrees to accept from Union Mortgage 320,000 shares of common stock ($10 par) with a fair value of $16,000,000, in full settlement of the $20,000,000 loan obligation. American City Bank (creditor) records this transaction as follows. Investment 16,000,000 Allowance for Doubtful Accounts 4,000,000 Note Receivable from Union Mortgage 20,000,000 It records the stock as an investment at the fair value at the date of restructure. Union Mortgage (debtor) records this transaction as follows. Note Payable to American City Bank 20,000,000 Common Stock 3,200,000 Additional Paid-in Capital 12,800,000 Gain on Restructuring of Debt 4,000,000 Union Mortgage (debtor) records the stock issued in the normal manner. It records the difference between the par value and the fair value of the stock as additional paid-in capital. Modification of Terms In some cases, a debtor s serious short-run cash flow problems will lead it to request one or a combination of the following modifications: 1 Reduction of the stated interest rate. 2 Extension of the maturity date of the face amount of the debt.
6 Troubled-Debt Restructurings Reduction of the face amount of the debt. 4 Reduction or deferral of any accrued interest. The creditor s loss is based on expected cash flows discounted at the historical effective rate of the loan. 10 The debtor calculates its gain based on undiscounted amounts, as required by the previous standard. As a consequence, the gain recorded by the debtor will not equal the loss recorded by the creditor under many circumstances. 11 Two examples demonstrate the accounting for a troubled-debt restructuring by debtors and creditors: 1 The debtor does not record a gain. 2 The debtor does record a gain. In both instances the creditor has a loss. Example 1 No Gain for Debtor This example demonstrates a restructuring in which the debtor records no gain. 12 On December 31, 2008, Morgan National Bank enters into a debt-restructuring agreement with Resorts Development Company, which is experiencing financial difficulties. The bank restructures a $10,500,000 loan receivable issued at par (interest paid to date) by: 1 Reducing the principal obligation from $10,500,000 to $9,000,000; 2 Extending the maturity date from December 31, 2008, to December 31, 2012; and 3 Reducing the interest rate from 12% to 8%. Debtor Calculations. The total future cash flow, after restructuring of $11,880,000 ($9,000,000 of principal plus $2,880,000 of interest payments 13 ), exceeds the total prerestructuring carrying amount of the debt of $10,500,000. Consequently, the debtor records no gain nor makes any adjustment to the carrying amount of the payable. As a result, Resorts Development (debtor) makes no entry at the date of restructuring. The debtor must compute a new effective-interest rate in order to record interest expense in future periods. The new effective-interest rate equates the present value of the future cash flows specified by the new terms with the pre-restructuring carrying amount of the debt. In this case, Resorts Development computes the new rate by relating the pre-restructure carrying amount ($10,500,000) to the total future cash flow 10 FASB Statement No. 114, par In response to concerns expressed about this nonsymmetric treatment, the FASB stated that Statement No. 114 does not address debtor accounting because the FASB was concerned that expansion of the scope of the statement would delay its issuance. By basing the debtor calculation on undiscounted amounts, the amount of gain (if any) recognized by the debtor is reduced at the time the modification of terms occurs. If fair value were used, the gain recognized would be greater. The result of this approach is to spread the unrecognized gain over the life of the new agreement. We believe that this accounting is inappropriate and hopefully will change as more fair value measurements are introduced into the financial statements. 12 Note that the examples given for restructuring assume the creditor made no previous entries for impairment. In actuality it is likely that, in accordance with Statement No. 114, the creditor would have already made an entry when the loan initially became impaired. Restructuring would, therefore, simply require an adjustment of the initial estimated bad debt by the creditor. Recall, however, that the debtor makes no entry upon impairment. 13 Total interest payments are: $9,000, years $2,880,000.
7 1114 Appendix G Accounting for Troubled Debt ($11,880,000). The rate necessary to discount the total future cash flow ($11,880,000), to a present value equal to the remaining balance ($10,500,000), is %. 14 On the basis of the effective rate of %, the debtor prepares the schedule shown in Illustration G-8. Illustration G-8 Schedule Showing Reduction of Carrying Amount of Note Calculator Solution for Interest Rate N Inputs 4 I/YR? Answer Resorts Development Co. (Debtor) Cash Interest Reduction of Carrying Paid Expense Carrying Amount of Date (8%) ( %) Amount Note 12/31/08 $10,500,000 12/31/09 $ 720,000 a $ 363,944 b $ 356,056 c 10,143,944 12/31/10 720, , ,398 9,775,546 12/31/11 720, , ,167 9,394,379 12/31/12 720, , ,379 9,000,000 $2,880,000 $1,380,000 $1,500,000 a $720,000 $9,000, b $363,944 $10,500, % c $356,056 $720,000 $363,944 PV 10,500,000 PMT 720,000 FV 9,000,000 Thus, on December 31, 2009 (date of first interest payment after restructure), the debtor makes the following entry. December 31, 2009 Notes Payable 356,056 Interest Expense 363,944 Cash 720,000 The debtor makes a similar entry (except for different amounts for debits to Notes Payable and Interest Expense) each year until maturity. At maturity, Resorts Development makes the following entry. December 31, 2012 Notes Payable 9,000,000 Cash 9,000,000 Creditor Calculations. Morgan National Bank (creditor) must calculate its loss based on the expected future cash flows discounted at the historical effective rate of the loan. It calculates this loss as shown in Illustration G An accurate interest rate i can be found by using the formulas given at the tops of Tables 2 and 4 in Appendix A to set up the following equation (1 i) 4 $10,500,000 $9,000,000 (1 i) 4 i $720,000 (from Table 2) (from Table 4) Solving algebraically for i, we find that i %.
8 Troubled-Debt Restructurings 1115 Pre-restructure carrying amount $10,500,000 Present value of restructured cash flows: Present value of $9,000,000 due in 4 years at 12%, interest payable annually (Table 2 in Appendix A); FV(PVF 4,12% ); ($9,000, ) $5,719,680 Present value of $720,000 interest payable annually for 4 years at 12% (Table 4 in Appendix A); R(PVF-OA 4,12% ); ($720, ) 2,186,892 Illustration G-9 Computation of Loss to Creditor on Restructuring Present value of restructured cash flows 7,906,572 Loss on restructuring $ 2,593,428 As a result, Morgan National Bank records bad debt expense as follows (assuming no establishment of an allowance balance from recognition of an impairment). Bad Debt Expense 2,593,428 Allowance for Doubtful Accounts 2,593,428 In subsequent periods, Morgan National Bank reports interest revenue based on the historical effective rate. Illustration G-10 provides the following interest and amortization information. Morgan National Bank (Creditor) Cash Interest Increase of Carrying Received Revenue Carrying Amount of Date (8%) (12%) Amount Note Illustration G-10 Schedule of Interest and Amortization after Debt Restructuring 12/31/08 $7,906,572 12/31/09 $ 720,000 a $ 948,789 b $ 228,789 c 8,135,361 12/31/10 720, , ,243 8,391,604 12/31/11 720,000 1,006, ,992 8,678,596 12/31/12 720,000 1,041,404 d 321,404 d 9,000,000 Total $2,880,000 $3,973,428 $1,093,428 a $720,000 $9,000, b $948,789 $7,906, c $228,789 $948,789 $720,000 d $28 adjustment to compensate for rounding. On December 31, 2009, Morgan National Bank makes the following entry. December 31, 2009 Cash 720,000 Allowance for Doubtful Accounts 228,789 Interest Revenue 948,789 The creditor makes a similar entry (except for different amounts debited to Allowance for Doubtful Accounts and credited to Interest Revenue) each year until maturity. At maturity, the company makes the following entry. December 31, 2012 Cash 9,000,000 Allowance for Doubtful Accounts 1,500,000 Notes Receivable 10,500,000 Example 2 Gain for Debtor If the pre-restructure carrying amount exceeds the total future cash flows as a result of a modification of the terms, the debtor records a gain. To illustrate, assume the facts in the
9 1116 Appendix G Accounting for Troubled Debt previous example except that Morgan National Bank reduces the principal to $7,000,000 (and extends the maturity date to December 31, 2012, and reduces the interest from 12% to 8%). The total future cash flow is now $9,240,000 ($7,000,000 of principal plus $2,240,000 of interest 15 ), which is $1,260,000 ($10,500,000 $9,240,000) less than the pre-restructure carrying amount of $10,500,000. Under these circumstances, Resorts Development (debtor) reduces the carrying amount of its payable $1,260,000 and records a gain of $1,260,000. On the other hand, Morgan National Bank (creditor) debits its Bad Debt Expense for $4,350,444. Illustration G-11 shows this computation. Illustration G-11 Computation of Loss to Creditor on Restructuring Pre-restructure carrying amount $10,500,000 Present value of restructured cash flows: Present value of $7,000,000 due in 4 years at 12%, interest payable annually (Table 2 in Appendix A); FV(PVF 4,12% ); ($7,000, ) $4,448,640 Present value of $560,000 interest payable annually for 4 years at 12% (Table 4 in Appendix A); R(PVF-OA 4,12% ); ($560, ) 1,700,916 6,149,556 Creditor s loss on restructuring $ 4,350,444 Illustration G-12 Debtor and Creditor Entries to Record Gain and Loss on Note Illustration G-12 shows the entries to record the gain and loss on the debtor s and creditor s books at the date of restructure, December 31, Resorts Development Co. (Debtor) December 31, 2008 (date of restructure) Morgan National Bank (Creditor) Notes Payable 1,260,000 Bad Debt Expense 4,350,444 Gain on Restructuring of Allowance for Doubtful Accounts 4,350,444 Debt 1,260,000 For Resorts Development (debtor), because the new carrying value of the note ($10,500,000 $1,260,000 $9,240,000) equals the sum of the undiscounted cash flows ($9,240,000), the imputed interest rate is 0 percent. Consequently, all of the future cash flows reduce the principal balance, and the company recognizes no interest expense. Morgan National reports the interest revenue in the same fashion as the previous example that is, using the historical effective interest rate applied toward the newly discounted value of the note. Illustration G-13 shows interest computations. Illustration G-13 Schedule of Interest and Amortization after Debt Restructuring Morgan National Bank (Creditor) Cash Interest Increase in Carrying Received Revenue Carrying Amount of Date (8%) (12%) Amount Note 12/31/08 $6,149,556 12/31/09 $ 560,000 a $ 737,947 b $177,947 c 6,327,503 12/31/10 560, , ,300 6,526,803 12/31/11 560, , ,216 6,750,019 12/31/12 560, ,981 d 249,981 d 7,000,000 Total $2,240,000 $3,090,444 $850,444 a $560,000 $7,000, b $737,947 $6,149, c $177,947 $737,947 $560,000 d $21 adjustment to compensate for rounding. 15 Total interest payments are: $7,000, years $2,240,000.
10 Exercises 1117 The journal entries in Illustration G-14 demonstrate the accounting by debtor and creditor for periodic interest payments and final principal payment. Resorts Development Co. (Debtor) Morgan National Bank (Creditor) December 31, 2009 (date of first interest payment following restructure) Notes Payable 560,000 Cash 560,000 Cash 560,000 Allowance for Doubtful Accounts 177,947 Interest Revenue 737,947 December 31, 2010, 2011, and 2012 (dates of 2nd, 3rd, and last interest payments) (Debit and credit same accounts as 12/31/09 using applicable amounts from appropriate amortization schedules.) December 31, 2012 (date of principal payment) Notes Payable 7,000,000 Cash 7,000,000 Cash 7,000,000 Allowance for Doubtful Accounts 3,500,000 Notes Receivable 10,500,000 Concluding Remarks The accounting for troubled debt is complex because the accounting standards allow for use of different measurement standards to determine the loss or gain reported. In addition, the assets and liabilities reported are sometimes not stated at cost or fair value, but at amounts adjusted for certain events but not others. This cumbersome accounting demonstrates the need for adoption of a comprehensive fair-value model for financial instruments that is consistent with finance concepts for pricing these financial instruments. Illustration G-14 Debtor and Creditor Entries to Record Periodic Interest and Final Principal Payments Key Terms impairment, 1109 troubled-debt restructuring, 1111 Summary of Learning Objectives for Appendix G 1 Describe the accounting for a loan impairment. A creditor bases an impairment loan loss on the difference between the present value of the future cash flows (using the historical effective interest rate) and the carrying amount of the note. 2 Describe the accounting for a debt restructuring. There are two types of debt settlements: (1) transfer of noncash assets, and (2) granting of equity interest. Creditors and debtors record losses and gains on settlements based on fair values. For accounting purposes there are also two types of restructurings with continuation of debt with modified terms: (1) the carrying amount of debt is less than the future cash flows, and (2) the carrying amount of debt exceeds the total future cash flows. Creditors record losses on these restructurings based on the expected future cash flows discounted at the historical effective interest rate. The debtor determines its gain based on undiscounted cash flows. Exercises EG-1 (Settlement of Debt) Larisa Nieland Company owes $200,000 plus $18,000 of accrued interest to First State Bank. The debt is a 10-year, 10% note. During 2008, Larisa Nieland s business deteriorated due to a faltering regional economy. On December 31, 2008, First State Bank agrees to accept an old machine and cancel the entire debt. The machine has a cost of $390,000, accumulated depreciation of $221,000, and a fair market value of $190,000.
11 1118 Appendix G Accounting for Troubled Debt (a) Prepare journal entries for Larisa Nieland Company and First State Bank to record this debt settlement. (b) How should Larisa Nieland report the gain or loss on the disposition of machine and on restructuring of debt in its 2008 income statement? (c) Assume that, instead of transferring the machine, Larisa Nieland decides to grant 15,000 shares of its common stock ($10 par) which has a fair value of $190,000 in full settlement of the loan obligation. If First State Bank treats Larisa Nieland s stock as a trading investment, prepare the entries to record the transaction for both parties. EG-2 (Term Modification without Gain Debtor s Entries) On December 31, 2008, Firstar Bank enters into a debt restructuring agreement with Nicole Bradtke Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications. 1. Reducing the principal obligation from $2,000,000 to $1,600, Extending the maturity date from December 31, 2008, to December 31, Reducing the interest rate from 12% to 10%. Bradtke pays interest at the end of each year. On January 1, 2012, Bradtke Company pays $1,600,000 in cash to Firstar Bank. (a) Based on FASB Statement No. 114, will the gain recorded by Bradtke be equal to the loss recorded by Firstar Bank under the debt restructuring? (b) Can Bradtke Company record a gain under the term modification mentioned above? Explain. (c) Assuming that the interest rate Bradtke should use to compute interest expense in future periods is %, prepare the interest payment schedule of the note for Bradtke Company after the debt restructuring. (d) Prepare the interest payment entry for Bradtke Company on December 31, (e) What entry should Bradtke make on January 1, 2012? EG-3 (Term Modification without Gain Creditor s Entries) Using the same information as in EG-2 above, answer the following questions related to Firstar Bank (creditor). (a) What interest rate should Firstar Bank use to calculate the loss on the debt restructuring? (b) Compute the loss that Firstar Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss. (c) Prepare the interest receipt schedule for Firstar Bank after the debt restructuring. (d) Prepare the interest receipt entry for Firstar Bank on December 31, (e) What entry should Firstar Bank make on January 1, 2012? EG-4 (Debtor/Creditor Entries for Settlement of Troubled Debt) Petra Langrova Co. owes $199,800 to Mary Joe Fernandez Inc. The debt is a 10-year, 11% note. Because Petra Langrova Co. is in financial trouble, Mary Joe Fernandez Inc. agrees to accept some property and cancel the entire debt. The property has a book value of $80,000 and a fair value of $120,000. (a) Prepare the journal entry on Langrova s books for debt restructure. (b) Prepare the journal entry on Fernandez s books for debt restructure. EG-5 (Debtor/Creditor Entries for Modification of Troubled Debt) Steffi Graf Corp. owes $225,000 to First Trust. The debt is a 10-year, 12% note due December 31, Because Graf Corp. is in financial trouble, First Trust agrees to extend the maturity date to December 31, 2010, reduce the principal to $200,000, and reduce the interest rate to 5%, payable annually on December 31. (a) Prepare the journal entries on Graf s books on December 31, 2008, 2009, and (b) Prepare the journal entries on First Trust s books on December 31, 2008, 2009, and EG-6 (Impairments) On December 31, 2008, Iva Majoli Company borrowed $62,092 from Paris Bank, signing a 5-year, $100,000 non-interest-bearing note. The note was issued to yield 10% interest. Unfortunately, during 2010, Majoli began to experience financial difficulty. As a result, at December 31, 2010, Paris Bank determined that it was probable that it would receive back only $75,000 at maturity. The market rate of interest on loans of this nature is now 11%.
12 (a) Prepare the entry to record the issuance of the loan by Paris Bank on December 31, (b) Prepare the entry (if any) to record the impairment of the loan on December 31, 2010, by Paris Bank. (c) Prepare the entry (if any) to record the impairment of the loan on December 31, 2010, by Majoli Company. EG-7 (Impairments) On December 31, 2007, Conchita Martinez Company signed a $1,000,000 note to Sauk City Bank. The market interest rate at that time was 12%. The stated interest rate on the note was 10%, payable annually. The note matures in 5 years. Unfortunately, because of lower sales, Conchita Martinez s financial situation worsened. On December 31, 2009, Sauk City Bank determined that it was probable that the company would pay back only $600,000 of the principal at maturity. However, it was considered likely that interest would continue to be paid, based on the $1,000,000 loan. (a) Determine the amount of cash Conchita Martinez received from the loan on December 31, (b) Prepare a note amortization schedule for Sauk City Bank up to December 31, (c) Determine the loss on impairment that Sauk City Bank should recognize on December 31, Problems 1119 Problems PG-1 (Loan Impairment Entries) On January 1, 2008, Bostan Company issued a $1,200,000, 5-year, zerointerest-bearing note to National Organization Bank. The note was issued to yield 8% annual interest. Unfortunately, during 2009, Bostan fell into financial trouble due to increased competition. After reviewing all available evidence on December 31, 2009, National Organization Bank decided that the loan was impaired. Bostan will probably pay back only $800,000 of the principal at maturity. (a) Prepare journal entries for both Bostan Company and National Organization Bank to record the issuance of the note on January 1, (Round to the nearest $10.) (b) Assuming that both Bostan Company and National Organization Bank use the effective-interest method to amortize the discount, prepare the amortization schedule for the note. (c) Under what circumstances can National Organization Bank consider Bostan s note to be impaired? (d) Compute the loss National Organization Bank will suffer from Bostan s financial distress on December 31, What journal entries should be made to record this loss? PG-2 (Debtor/Creditor Entries for Continuation of Troubled Debt) Jeremy Hillary is the sole shareholder of Hillary Inc., which is currently under protection of the U.S. bankruptcy court. As a debtor in possession, he has negotiated the following revised loan agreement with Valley Bank. Hillary Inc. s $400,000, 12%, 10-year note was refinanced with a $400,000, 5%, 10-year note. (a) What is the accounting nature of this transaction? (b) Prepare the journal entry to record this refinancing: (1) On the books of Hillary Inc. (2) On the books of Valley Bank. (c) Discuss whether generally accepted accounting principles provide the proper information useful to managers and investors in this situation. PG-3 (Restructure of Note under Different Circumstances) Sandro Corporation is having financial difficulty and therefore has asked Botticelli National Bank to restructure its $3 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. Presented below are four independent situations. Prepare the journal entry that Sandro and Botticelli National Bank would make for each of the following restructurings.
13 1120 Appendix G Accounting for Troubled Debt (a) Botticelli National Bank agrees to take an equity interest in Sandro by accepting common stock valued at $2,200,000 in exchange for relinquishing its claim on this note. The common stock has a par value of $1,000,000. (b) Botticelli National Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of $1,950,000 and a fair value of $2,400,000. (c) Botticelli National Bank agrees to modify the terms of the note, indicating that Sandro does not have to pay any interest on the note over the 3-year period. (d) Botticelli National Bank agrees to reduce the principal balance due to $2,500,000 and require interest only in the second and third year at a rate of 10%. PG-4 (Debtor/Creditor Entries for Continuation of Troubled Debt with New Effective Interest) Mildred Corp. owes D. Taylor Corp. a 10-year, 10% note in the amount of $110,000 plus $11,000 of accrued interest. The note is due today, December 31, Because Mildred Corp. is in financial trouble, D. Taylor Corp. agrees to forgive the accrued interest, $10,000 of the principal, and to extend the maturity date to December 31, Interest at 10% of revised principal will continue to be due on 12/31 each year. Assume the following present value factors for 3 periods % 2 3 8% 2 1 2% 2 5 8% 2 3 4% 3% Single sum Ordinary annuity of (a) Compute the new effective-interest rate for Mildred Corp. following restructure. (Hint: Find the interest rate that establishes approximately $121,000 as the present value of the total future cash flows.) (b) Prepare a schedule of debt reduction and interest expense for the years 2008 through (c) Compute the gain or loss for D. Taylor Corp. and prepare a schedule of receivable reduction and interest revenue for the years 2008 through (d) Prepare all the necessary journal entries on the books of Mildred Corp. for the years 2008, 2009, and (e) Prepare all the necessary journal entries on the books of D. Taylor Corp. for the years 2008, 2009, and 2010.
C H A P T E R 17 ELECTRONIC SUPPLEMENT TO CHAPTER 17 TROUBLED DEBT RESTRUCTURINGS Accounting requirements for troubled debt restructuring fall under the jurisdiction of two different FASB statements. The
Unit 6 Receivables 7-1 Receivables - Claims resulting from credit sales to customers and others goods or services for money,. Oral promises of the purchaser to pay for goods and services sold (credit sale;
Accounting for Certain Loans or Debt Securities 21,131 Section 10,880 Statement of Position 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer December 12, 2003 NOTE Statements
BDO KNOWS: TROUBLED DEBT RESTRUCTURING, DEBT MODIFICATION AND EXTINGUISHMENT A Practice Aid From BDO s National Assurance Practice December 2013 CONTACT: TABLE OF CONTENTS ADAM BROWN 214-665-0673 email@example.com
PROPOSED FASB STAFF POSITION No. SOP 94-6-a Title: Nontraditional Loan Products Comment Deadline: November 11, 2005 Introduction 1. This FASB Staff Position (FSP) is in response to inquiries from constituents
This white paper is not authoritative and users are urged to refer directly to applicable authoritative pronouncements for the text of the technical literature. This document does not purport to be applicable
Considerations for Troubled Debt Restructuring Identification of Loans August 2011 Introduction This document is intended to provide examiners with a general overview of the judgments required by an institution
Chapter 9 Reporting and Interpreting Liabilities Business Background The acquisition of assets is financed from two sources: Debt - funds from creditors Equity - funds from owners Business Background The
NOTES on business education Published by the De La Salle University - College of Business and Economics (CHED Center of Development for Business and Management Education) Center for Business and Economics
128 SU 3: Financial Accounting I 3.5 FINANCIAL ASSETS AND LIABILITIES Definitions 1. Financial assets include cash, equity instruments of other entities (e.g., preference shares), contract rights to receive
Page 1 ACC 255 FINAL EXAM REVIEW PACKET (NEW MATERIAL) Complete these sample exam problems/objective questions and check your answers with the solutions at the end of the review file and identify where
THE CONTENT AND VALUE OF THE STATEMENT OF CASH FLOWS The cash flow statement reconciles beginning and ending cash by presenting the cash receipts and cash disbursements of an enterprise for an accounting
Statement of Financial Accounting Standards No. 15 FAS15 Status Page FAS15 Summary Accounting by Debtors and Creditors for Troubled Debt Restructurings June 1977 Financial Accounting Standards Board of
Present Value Concepts Present value concepts are widely used by accountants in the preparation of financial statements. In fact, under International Financial Reporting Standards (IFRS), these concepts
Consolidated Financial Statements (Expressed in thousands of United States (U.S.) dollars) (Prepared in accordance with generally accepted accounting principles used in the United States of America (U.S.
Impairment of Notes Receivables US GAAP requires entities to assess whether financial assets are impaired and recognize the impairment. If a note receivable is impaired, the loss is measured by the creditor
FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin-534/fin-534-week-4-quiz-3- str/ For more course tutorials visit www.tutorialoutlet.com Which of the following
Sample Examination Questions CHAPTER 6 ACCOUNTING AND THE TIME VALUE OF MONEY MULTIPLE CHOICE Conceptual Answer No. Description d 1. Definition of present value. c 2. Understanding compound interest tables.
9. Short-Term Liquidity Analysis. Operating Cash Conversion Cycle 9.1 Current Assets and 9.1.1 Cash A firm should maintain as little cash as possible, because cash is a nonproductive asset. It earns no
Yosemite Farm Credit Quarterly Financial Report June 2015 TABLE OF CONTENTS Message to Members 1 Statements of Condition 2 Statements of Comprehensive Income 3 Statements of Changes in Shareholders Equity
6-1 Chapter 6 Time Value of Money Concepts 6-2 Time Value of Money Interest is the rent paid for the use of money over time. That s right! A dollar today is more valuable than a dollar to be received in
Objectives: Long-Term Debt! Extend our understanding of valuation methods beyond simple present value calculations. Understand the terminology of long-term debt Par value Discount vs. Premium Mortgages!
Accounting Fundamentals Lesson 8 8.0 Liabilities Current liabilities - Obligations that are due within one year. Obligations due beyond that period of time are classified as long-term liabilities. Current
Learning Objectives Cash and Receivables No substantial departures from the text, Chapter 7. Chapter 7 7-1 UCSB, Anderson 7-2 UCSB, Anderson Nature and Composition of Cash Cash is classified as a... Current
FREEDOM INVESTMENTS, INC. STATEMENT OF FINANCIAL CONDITION AS OF JUNE 30, 2015 (UNAUDITED) ****** Index Page(s) Statement of Financial Condition. 2 Notes to Statement of Financial Condition. 3-5 Statement
The Depository Trust Company Unaudited Condensed Consolidated Financial Statements as of March 31, 2016 and December 31, 2015 and for the three months ended March 31, 2016 and 2015 THE DEPOSITORY TRUST
C H 2 3, P a g e 1 CH 23 STATEMENT OF CASH FLOWS SELF-STUDY QUESTIONS (note from Dr. N: I have deleted questions for you to omit, but did not renumber the remaining questions) 1. The primary purpose of
human/istock/360/getty Images C H A P T E R 9 Receivables Financial Accounting 14e Warren Reeve Duchac Classification of Receivables The term receivables includes all money claims against other entities,
Consolidated Financial Report with Additional Information December 31, 2014 Contents Report Letter 1-2 Consolidated Financial Statements Statement of Financial Condition 3 Statement of Income 4 Statement
No. 2011-02 April 2011 Receivables (Topic 310) A Creditor s Determination of Whether a Restructuring Is a Troubled Debt Restructuring The FASB Accounting Standards Codification is the source of authoritative
Sample Test Questions CHAPTER 7 CASH AND RECEIVABLES Answer No. Description MULTIPLE CHOICE Conceptual d 1. Identification of cash items. b 2. Identification of cash items. d 3. Classification of travel
Chapter 6 The Time Value of Money: Annuities and Other Topics Chapter 6 Contents Learning Objectives 1. Distinguish between an ordinary annuity and an annuity due, and calculate present and future values
Dealing with Problem Debts Page 314-1 DEALING WITH PROBLEM DEBTS Introduction 1. The management of a banking corporation shall establish procedures for dealing with problem debts, as regards both the administrative
Accounting for Troubled Debt Restructurings Kyle Lyskawa Introduction It is widely accepted that the mortgage-lending standards during the 2000s contributed to the 2008-9 financial crisis. As borrowers
INDUSTRIAL-ALLIANCE LIFE INSURANCE COMPANY FIRST QUARTER 2000 Consolidated Financial Statements (Non audited) March 31,2000 TABLE OF CONTENTS CONSOLIDATED INCOME 2 CONSOLIDATED CONTINUITY OF EQUITY 3 CONSOLIDATED
B Exercises E4-1B (Balance Sheet Classifications) Presented below are a number of balance sheet accounts of Castillo Inc. (a) Trading Securities. (h) Warehouse in Process of Construction. (b) Work in Process.
"! 1. Policy and Procedures of the Debt-to-Equity Conversion Scheme, Rationale, Advantages and Disadvantages, and Benefits which the Company will obtain from the Debt-to-Equity Conversion Scheme 1.1 Policy
CHAPTER 10 Reporting and Analyzing Liabilities Accounting for Notes Payable Obligations in the form of written notes are recorded as notes payable. Notes payable usually require the borrower to pay interest
CHAPTER 6 Accounting and the Time Value of Money ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems 1. Present value concepts. 1, 2, 3, 4, 5, 9, 17 2. Use of
C- 1 Time Value of Money C- 2 Financial Accounting, Fifth Edition Study Objectives 1. Distinguish between simple and compound interest. 2. Solve for future value of a single amount. 3. Solve for future
Accounting for Loans Held- For-Investment (HFI) September 15, 2008 Purpose and Content Purpose To provide an overview of the accounting pronouncements related to loans Held-for-Investment with an emphasis
INTEGRATING FINANCE AND ACCOUNTING CONCEPTS: AN EXAMPLE USING TROUBLED DEBT RESTRUCTURING WITH MODIFICATION OF TERMS ABSTRACT In a troubled debt restructuring arrangement where future payments under the
This week its Accounting and Beyond Monday Morning Session Introduction/Accounting Cycle Afternoon Session Tuesday The Balance Sheet Wednesday The Income Statement The Cash Flow Statement Thursday Tools
CHAPTER15 Long-Term Liabilities Acct202 15-1 15-2 PreviewofCHAPTER15 Bond Basics Bonds are a form of interest-bearing notes payable. Three advantages over common stock: 1. Stockholder control is not affected.
(A CALIFORNIA LIMITED PARTNERSHIP) INDEPENDENT AUDITORS' REPORT AND FINANCIAL STATEMENTS DECEMBER 31, 1999 (A CALIFORNIA LIMITED PARTNERSHIP) TABLE OF CONTENTS PAGE INDEPENDENT AUDITORS' REPORT 1 FINANCIAL
Troubled Debt Restructuring Example 1 1. Viola Vacations signed a note to Empire Airways in the amount of $50,000. The terms specified annual 10% interest payments on the unpaid balance. The note is due
CURRENT RECEIVABLES Receivables are the amount owed to the organization by its customers and/or others. Current receivables will be collected within one year or the current operating cycle which ever is
INDEX TO FINANCIAL STATEMENTS Page Financial Statements Balance Sheets as of and December 31, 2014 (Unaudited) F-2 Statements of Operations for the three months ended and 2014 (Unaudited) F-3 Statements
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q È QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended
Adjusting Entries Prepaid Expenses Second Bullet Example - Assuming office supplies are charged to the Office Supplies inventory account when purchased: Office supplies expense 7,800 Office supplies 7,800
Chapter 14 1 Identify the purposes of the statement of cash flows Distinguish among operating, investing, and financing cash flows Prepare the statement of cash flows by the indirect method Identify noncash
NAU ACCOUNTING SKILLS ASSESSMENT PRACTICE EXAM & KEY 1. A company received cash and issued common stock. What was the effect on the accounting equation? Assets Liabilities Stockholders Equity A. + NE +
FINANCIAL STATEMENT AND SUPPLENTARY INFORMANTION For the Year Ended December 31, 2011 The financial statement, prepared by an independent Certified Public Accountant, is essential for bonding purposes.
CHAPTER 6 Accounting and the Time Value of Money ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems 1. Present value concepts. 1, 2, 3, 4, 5, 9, 17 2. Use of
7 Accounting for and Presentation of Liabilities Liabilities are obligations of the entity or, as defined by the FASB, probable future sacrifices of economic benefits arising from present obligations of
Tax Issues In Acquiring Debt Charles R. Beaudrot Partner, Tax and Real Estate Capital Markets Practices 404.504.7753 firstname.lastname@example.org Timothy S. Pollock Partner, Tax, Real Estate and Real Estate Capital
FASB STAFF POSITION No. APB 14-1 Title: Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) Date Posted: May 9, 2008 Introduction
ASPE AT A GLANCE Section 3856 Financial Instruments December 2014 Section 3856 Financial Instruments Effective Date Fiscal years beginning on or after January 1, 2011 1 SCOPE Applies to all financial instruments
PREPARING THE STATEMENT OF CASH FLOWS: THE INDIRECT METHOD OF REPORTING CASH FLOWS FROM OPERATING ACTIVITIES The work sheet method described in the text book is not the recommended approach. We will provide
Consolidated Statement of Financial Condition Period Ended Consolidated Statement of Financial Condition Year Ended TABLE OF CONTENTS Page(s) Consolidated Statement of Financial Condition 1 2-10 Consolidated
Shin Kong Investment Trust Co., Ltd. Financial Statements for the Years Ended, 2014 and 2013 and Independent Auditors Report INDEPENDENT AUDITORS REPORT The Board of Directors and stockholder Shin Kong
Finance 3130 Sample Exam 1B Spring 2012 True/False Indicate whether the statement is true or false. 1. A firm s income statement provides information as of a point in time, and represents how management
INSTRUCTIONS FOR COMPLETING INSURANCE COMPANY "DRAFT VERSION FOR FIRST REVIEW ONLY" Submitted to: Minstry of Finance and Economy Head of Insurance Department Republic of Armenia Submitted by: BearingPoint
GE Capital Second quarter supplement Results are unaudited. This document contains forward-looking statements that is, statements related to future, not past, events. In this context, forward-looking statements
Unaudited Financial Statements of WESTFIELD REAL ESTATE INVESTMENT TRUST Period from January 1, 2005 to March 31, 2005 BALANCE SHEET Assets March 31 2005 (unaudited) December 31 2004 (audited) Income-producing
Appendix 16: Chart of Accounts for Small Business Investment Companies 10 06 A A. Account Numbering System. This system provides for two-digit number designations for major categories under which accounts
C Time Value of Money C- 1 Financial Accounting, IFRS Edition Weygandt Kimmel Kieso C- 2 Study Objectives 1. Distinguish between simple and compound interest. 2. Solve for future value of a single amount.
Statement of Financial Condition unaudited June 30, 2015 Vanguard Marketing Corporation (a wholly owned subsidiary of The Vanguard Group, Inc.) Vanguard Marketing Corporation (a wholly owned subsidiary