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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

Good-Deal Inc. developed a new sales gimmick to help sell its inventory of new automobiles. Because many new car buyers need financing, Good-Deal offered a low down payment and low car payments for the first year after purchase. It believes that this promotion will bring in some new buyers.

On January 1, 2017, a customer purchased a new \(33,000 automobile, making a down payment of \)1,000. The customer signed a note indicating that the annual rate of interest would be 8% and that quarterly payments would be made over 3 years. For the first year, Good-Deal required a $400 quarterly payment to be made on April 1, July 1, October 1, and January 1, 2018. After this one-year period, the customer was required to make regular quarterly payments that would pay off the loan as of January 1, 2020.

Instructions

(a) Prepare a note amortization schedule for the first year.

(b) Indicate the amount the customer owes on the contract at the end of the first year.

(c) Compute the amount of the new quarterly payments.

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Instructions

(Round answers to the nearest cent.)

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(2) The payment of interest and the amortization of the premium on December 31, 2017.

(3) The payment of interest and the amortization of the premium on June 30, 2018.

(4) The payment of interest and the amortization of the premium on December 31, 2018.

(b) Show the proper balance sheet presentation for the liability for bonds payable on the December 31, 2018, balance sheet.

(c) Provide the answers to the following questions.

(1) What amount of interest expense is reported for 2018?

(2) Will the bond interest expense reported in 2018 be the same as, greater than, or less than the amount that would be reported if the straight-line method of amortization were used?

(3) Determine the total cost of borrowing over the life of the bond.

(4) Will the total bond interest expense for the life of the bond be greater than, the same as, or less than the total interest expense if the straight-line method of amortization were used?

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.

On January 1, 2017, JWS Corporation issued \(600,000 of 7% bonds, due in 10 years. The bonds were issued for \)559,224, and pay interest each July 1 and January 1. JWS uses the effective-interest method. Prepare the company鈥檚 journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry. Assume an effective-interest rate of 8%

E14-1 (L01) (Classification of Liabilities) Presented below are various account balances of K.D. Lang Inc.

(a) Unamortized premium on bonds payable, of which \(3,000 will be amortized during the next year.

(b) Bank loans payable of a winery, due March 10, 2021. (The product requires aging for 5 years before sale.)

(c) Serial bonds payable, \)1,000,000, of which \(200,000 are due each July 31.

(d) Amounts withheld from employees鈥� wages for income taxes.

(e) Notes payable due January 15, 2020.

(f) Credit balances in customers鈥� accounts arising from returns and allowances after collection in full of account.

(g) Bonds payable of \)2,000,000 maturing June 30, 2018.

(h) Overdraft of $1,000 in a bank account. (No other balances are carried at this bank.)

(i) Deposits made by customers who have ordered goods.

Instructions

Indicate whether each of the items above should be classified on December 31, 2017, as a current liability, a long-term liability, or under some other classification. Consider each one independently from all others; that is, do not assume that all of them relate to one particular business. If the classification of some of the items is doubtful, explain why in each case.
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