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Chapter 14: Q12P (page 762)

(Debtor/Creditor Entries for Continuation of Troubled Debt) Daniel Perkins is the sole shareholder of Perkins Inc., which is currently under protection of the U.S. bankruptcy court. As a 鈥渄ebtor in possession,鈥� he has negotiated the following revised loan agreement with United Bank. Perkins Inc.鈥檚 \(600,000, 12%, 10-year note was refinanced with a \)600,000, 5%, 10-year note.

Instructions

(a) What is the accounting nature of this transaction?

(b) Prepare the journal entry to record this refinancing:

(1) On the books of Perkins Inc.

(2) On the books of United Bank.

(c) Discuss whether generally accepted accounting principles provide the proper information useful to managers and investors in this situation.

Short Answer

Expert verified
  1. The transaction of refinancing is classified as trouble debt restructuring.
  2. Creditor will lose$237,300.
  3. The GAAP principle in the above situation does not provide fair information to the investors and the managers.

Step by step solution

01

Definition of Shareholder

A shareholder can be defined as an individual interested in the company鈥檚 ownership. Such an individual becomes the owner of the company by purchasing the equity security issued by the company.

02

Accounting Nature of the transaction

The transaction will be classified as trouble debt restructuring because, under this type of transaction, the creditor refinances the loan because of the financial and economic difficulties faced by the business entity. Under this transaction, the debtor is provided with the concession.

03

Journal entry to record refinancing

Date

Accounts and Explanation

Debit $

Credit $

In the books of Perkins

No journal entry will be made by the Perkins Inc.

In the books of United bank

Bad debt expenses

237,300

Allowance for doubtful accounts

237,300

Working note:

Calculation creditor鈥檚 loss due to restructuring

Particular

Amount $

Carrying cost before restructuring

$600,000

Less: Present value of debt of $600,000 due after 10 years @ 12% (0.322)

(193,200)

Less: PVOAF of annual interest of $30,000 @ 12% for 10 years (5.65)

(169,500)

Creditor鈥檚 loss due to restructuring

$237,300

04

Information provided by the GAAP principles in the above situation to the managers and the investors

The GAAP principle in the above situation does not provide useful information because the loss faced by the creditor is calculated using the discounted value of the future cash flow (present value of the future cash flow). At the same time, the gains generated by the debtors are not calculated using the discounted present value. Therefore, it will not provide fair information relating to the benefits generated by the debtor due to refinancing.

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Most popular questions from this chapter

What are the two methods of amortizing discount and premium on bonds payable? Explain each.

On June 30, 2009, County Company issued 12% bonds with a par value of \(800,000 due in 20 years. They were issued at 98 and were callable at 104 at any date after June 30, 2017. Because of lower interest rates and a significant change in the company鈥檚 credit rating, it was decided to call the entire issue on June 30, 2018, and to issue new bonds. New 10% bonds were sold in the amount of \)1,000,000 at 102; they mature in 20 years. County Company uses straight-line amortization. Interest payment dates are December 31 and June 30.

Instructions

  1. Prepare journal entries to record the redemption of the old issue and the sale of the new issue on June 30, 2018.
  2. Prepare the entry required on December 31, 2018, to record the payment of the first 6 months鈥� interest and the amortization of premium on the bonds.

In each of the following independent cases, the company closes its books on December 31.

1. Sanford Co. sells \(500,000 of 10% bonds on March 1, 2017. The bonds pay interest on September 1 and March 1. The due date of the bonds is September 1, 2020. The bonds yield 12%. Give entries through December 31, 2018.

2. Titania Co. sells \)400,000 of 12% bonds on June 1, 2017. The bonds pay interest on December 1 and June 1. The due date of the bonds is June 1, 2021. The bonds yield 10%. On October 1, 2018, Titania buys back \(120,000 worth of bonds for \)126,000 (includes accrued interest). Give entries through December 1, 2019.

Instructions

For the two cases prepare all of the relevant journal entries from the time of sale until the date indicated. Use the effective-interest method for discount and premium amortization (construct amortization tables where applicable). Amortize premium or discount on interest dates and at year-end. (Assume that no reversing entries were made.)

(Issuance and Redemption of Bonds) Venezuela Co. is building a new hockey arena at a cost of \(2,500,000. It received a downpayment of \)500,000 from local businesses to support the project, and now needs to borrow \(2,000,000 to complete the project. It therefore decides to issue \)2,000,000 of 10.5%, 10-year bonds. These bonds were issued on January 1, 2016, and pay interest annually on each January 1. The bonds yield 10%.

Instructions

(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2016.

(b) Prepare a bond amortization schedule up to and including January 1, 2020, using the effective-interest method.

(c) Assume that on July 1, 2019, Venezuela Co. redeems half of the bonds at a cost of $1,065,000 plus accrued interest. Prepare the journal entry to record this redemption.

Foreman Company issued $800,000 of 10%, 20-year bonds on January 1, 2017, at 119.792 to yield 8%. Interest is payable semi-annually on July 1 and January 1. Prepare the journal entries to record (a) the issuance of the bonds, (b) the payment of interest and the related amortization on July 1, 2017, and (c) the accrual of interest and the related amortization on December 31, 2017. (Round to the nearest dollar.)
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