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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

Strickland Company owes \(200,000 plus \)18,000 of accrued interest to Moran State Bank. The debt is a 10-year, 10% note. During 2017, Strickland鈥檚 business deteriorated due to a faltering regional economy. On December 31, 2017, Moran 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 value of \(180,000.

Instructions

  1. Prepare journal entries for Strickland Company and Moran State Bank to record this debt settlement.
  2. How should Strickland report the gain or loss on the disposition of machine and on restructuring of debt in its 2017 income statement?
  3. Assume that, instead of transferring the machine, Strickland decides to grant 15,000 shares of its common stock (\)10 par) which has a fair value of $180,000 in full settlement of the loan obligation. If Moran State Bank treats Strickland鈥檚 stock as a trading investment, prepare the entries to record the transaction for both parties.

(L01) Assume the bonds in BE14-2 were issued at 98. Prepare the journal entries for (a) January 1, (b) July 1, and (c) December 31. Assume The Colson Company records straight-line amortization semiannually.

On January 1, 2017, Nichols Company issued for \(1,085,800 its 20-year, 11% bonds that have a maturity value of \)1,000,000 and pay interest semiannually on January 1 and July 1. The following are three presentations of the long-term liability section of the balance sheet that might be used for these bonds at the issue date.

1

Bonds payable (maturing January 1, 2037)

\(1,000,000

Unamortized premium on bonds payable

85,800

Total bond liability

\)1,085,800

2

Bonds payable鈥攑rincipal (face value \(1,000,000 maturing January 1, 2037)

\) 142,050a

Bonds payable鈥攊nterest (semiannual payment \(55,000)

943,750b

Total bond liability

\)1,085,800

3

Bonds payable鈥攑rincipal (maturing January 1, 2037)

\(1,000,000

Bonds payable鈥攊nterest (\)55,000 per period for 40 periods)

2,200,000

Total bond liability

\(3,200,000

aThe present value of \)1,000,000 due at the end of 40 (6-month) periods at the yield rate of 5% per period

bThe present value of \(55,000 per period for 40 (6-month) periods at the yield rate of 5% per period.

Instructions

(a) Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds.

(b) Explain why investors would pay \)1,085,800 for bonds that have a maturity value of only $1,000,000.

(c)Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose: (1) The coupon or nominal rate. (2) The effective or yield rate at date of issue.

(d)If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of the issue be affected by an increase or a decrease in the market rate of interest?

The following article appeared in the Wall Street Journal.

Bond Markets

Giant Commonwealth Edison Issue Hits Resale Market With \(70 Million Left Over

New york鈥擟ommonwealth Edison Co.鈥檚 slow-selling new 91 /4% bonds were tossed onto the resale market at a reduced price with about \)70 million still available from the \(200 million offered Thursday, dealers said.

The Chicago utility鈥檚 bonds, rated double-A by Moody鈥檚 and double-A-minus by Standard & Poor鈥檚, originally had been priced at 99.803, to yield 9.3% in 5 years. They were marked down yesterday the equivalent of about \)5.50 for each $1,000 face amount, to about 99.25, where their yield jumped to 9.45%.

Instructions

  1. How will the development above affect the accounting for Commonwealth Edison鈥檚 bond issue?
  2. Provide several possible explanations for the markdown and the slow sale of Commonwealth Edison鈥檚 bonds.

On April 1, 2017, Seminole Company sold 15,000 of its 11%, 15-year, \(1,000 face value bonds at 97. Interest payment dates are April 1 and October 1, and the company uses the straight-line method of bond discount amortization. On March 1, 2018, Seminole took advantage of favorable prices of its stock to extinguish 6,000 of the bonds by issuing 200,000 shares of its \)10 par value common stock. At this time, the accrued interest was paid in cash. The company鈥檚 stock was selling for $31 per share on March 1, 2018.

Instructions

Prepare the journal entries needed on the books of Seminole Company to record the following.

(a) April 1, 2017: issuance of the bonds.

(b) October 1, 2017: payment of semi-annual interest.

(c) December 31, 2017: accrual of interest expense.

(d) March 1, 2018: extinguishment of 6,000 bonds. (No reversing entries made.)
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