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Chapter 14: Q13P (page 763)

Question: (Restructure of Note under Different Circumstances) Halvor Corporation is having financial difficulty and therefore has asked Frontenac National Bank to restructure its \(5 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.

Instructions

The following are four independent situations. Prepare the journal entry that Halvor and Frontenac National Bank would make for each of these restructurings.

(a) Frontenac National Bank agrees to take an equity interest in Halvor by accepting common stock valued at \)3,700,000 in exchange for relinquishing its claim on this note. The common stock has a par value of \(1,700,000.

(b) Frontenac National Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of \)3,250,000 and a fair value of \(4,000,000.

(c) Frontenac National Bank agrees to modify the terms of the note, indicating that Halvor does not have to pay any interest on the note over the 3-year period.

(d) Frontenac National Bank agrees to reduce the principal balance due to \)4,166,667 and require interest only in the second and third year at a rate of 10%.

Short Answer

Expert verified

Answer

  1. Halvor corporation generates a gain of$1,300,000 on restructuring.
  2. Halvor corporation generates a gain of disposal of$750,000 and gains on the restructuring of$1,000,000.
  3. Modification in terms of the loan does not require any entry to be made in the books of Halvor, because there is no difference between the aggregate cash flow and the carrying amount.
  4. Frontenac national bank will report$1,212,083 as bad debt expenses.

Step by step solution

01

Definition of Restructuring Loan

The process adopted by the corporates and the government to avoid default over loans by generating new terms of loans is known as restructuring of loans. Under this process, they negotiate upon the interest charged on the loan.

02

Journal entries when Frontenac national bank takes an equity interest in Halvor

Date

Accounts and Explanation

Debit ($)

Credit ($)

In the books of Halvor corporation

Note payable

5,000,000

Common stock

1,700,000

Gain on restructuring

1,300,000

Paid-in-capital in excess of par 鈥� common stock

2,000,000

In the books of Frontenac national bank

Equity investment 鈥� Halvor corporation

3,700,000

Allowance for bad debts

1,300,000

Note receivable

5,000,000

Working note:

Calculation of gain on restructuring:

Particular

Amount $

Carrying amount of debt

$5,000,000

Less: Fair value of the equity exchanged

(3,700,000)

Gain on restructuring

$1,300,000

03

Journal entries when the Frontenac national bank agrees to accept land

Date

Accounts and Explanation

Debit ($)

Credit ($)

In the books of Halvor corporation

Note payable

5,000,000

Land

3,250,000

Gain on disposal of land

750,000

Gain on restructuring

1,000,000

In the books of Frontenac national bank

Land

4,000,000

Allowance for bad debts

1,000,000

Note receivable

5,000,000

Working note:

Calculation of gain on disposal of land:

Particular

Amount $

Fair value of land

$4,000,000

Less: book value of land

(3,250,000)

Gain on disposal of land

$750,000

Calculation of gain on restructuring:

Particular

Amount $

Note payable

$5,000,000

Less: fair value of land

(4,000,000)

Gain on restructuring debt

$1,000,000

04

Journal entries when the Frontenac national bank agrees to modify the term of note

Date

Accounts and Explanation

Debit ($)

Credit ($0

On the book of Halvor

No journal entry is required for Halvor Corporation because the aggregate cash flow is same as the carrying amount of the note payable.

In the books of Frontenac national bank

Bad debt expenses

1,245,000

Allowance for doubtful accounts

1,245,000

Working note:

Calculation of bad debt expenses:

Particular

Amount $

Carrying amount of loan before restricting

$5,000,000

Less: Present value of the restructured cash flow $5,000,000 (n=3, r=10%) (0.751)

(3,755,000)

Loss on restructuring debt

$1,245,000

05

Journal entries when the Frontenac national bank agrees to reduce the principal balance

Date

Accounts and Explanation

Debit ($)

Credit ($)

In the books of Halvor

No journal entry is required because the aggregate cash flow is same as the carrying amount of the note payable

In the books of Frontenac national bank

Bad debt expenses

1,212,083

Allowance for doubtful accounts

1,212,083

Working note:

Calculation of aggregate cash flow and carrying amount:

Particular

Amount $

Principal

$4,166,667

Add: Interest

833,333

Aggregate cash flow

$5,000,000

Calculation of creditor loss on restructuring:

Particular

Amount $

Carrying amount before restructuring

$5,000,000

Less: Present value of restructured loan

Present value of $4,166,667 (n=3, r=10%) (0.751)

(3,129,167)

Present value of interest payable annually $416,667 (n=3, r=10%) (PVOAF: 2.49)

(1,037,500)

Present value of interest due in first year (n=3, r=10%) (0.909)

378,750

Loss due to restructuring

$1,212,083

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Most popular questions from this chapter

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.)

E14-3 (L01) (Entries for Bond Transactions) Presented below are two independent situations.

1. On January 1, 2017, Simon Company issued \(200,000 of 9%, 10-year bonds at par. Interest is payable quarterly on April 1, July 1, October 1, andJanuary 1.

2. On June 1, 2017, Garfunkel Company issued \)100,000 of 12%, 10-year bonds dated January 1 at par plus accrued interest. Interest is payable semi-annually on July 1 and January 1.

Instructions

For each of these two independent situations, prepare journal entries to record the following.

(a) The issuance of the bonds.

(b) The payment of interest on July 1.

(c) The accrual of interest on December 31.

(Issuance and Redemption of Bonds; Income Statement Presentation) Holiday Company issued its 9%, 25-year mortgage bonds in the principal amount of \(3,000,000 on January 2, 2003, at a discount of \)150,000, which it proceeded to amortize by charges to expense over the life of the issue on a straight-line basis. The indenture securing the issue provided that the bonds could be called for redemption in total but not in part at any time before maturity at 104% of the principal amount, but it did not provide for any sinking fund.

On December 18, 2017, the company issued its 11%, 20-year debenture bonds in the principal amount of $4,000,000 at 102, and the proceeds were used to redeem the 9%, 25-year mortgage bonds on January 2, 2018. The indenture securing the new issue did not provide for any sinking fund or for redemption before maturity.

Instructions

(a) Prepare journal entries to record the issuance of the 11% bonds and the redemption of the 9% bonds.

(b) Indicate the income statement treatment of the gain or loss from redemption and the note disclosure required.

(b) What type of concessions might a creditor grant the debtor in a troubled-debt situation?

(a) In a troubled-debt situation, why might the creditor grant concessions to the debtor?
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