Chapter 14, Problem 14.26P

Troubled debt restructuring

• Appendix B

At January 1, 2018, Rothschild Chair Company, Inc., was indebted to First Lincoln Bank under a $20 million, 10% unsecured note. The note was signed January 1, 2015, and was due December 31, 2021. Annual interest was last paid on December 31, 2016. Rothschild Chair Company was experiencing severe financial difficulties and negotiated a restructuring of the terms of the debt agreement.

Required:

Prepare all journal entries by Rothschild Chair Company, Inc., to record the restructuring and any remaining transactions relating to the debt under each of the independent circumstances below:

1. First Lincoln Bank agreed to settle the debt in exchange for land having a fair value of $16 million but carried on Rothschild Chair Company’s books at $13 million.

2. First Lincoln Bank agreed to (a) forgive the interest accrued from last year, (b) reduce the remaining four interest payments to $1 million each, and (c) reduce the principal to $15 million.

3. First Lincoln Bank agreed to defer all payments (including accrued interest) until the maturity date and accept $27,775,000 at that time in settlement of the debt.

To determine

Troubled debt restructuring

When the unique terms of a debt agreement is encouraged by the financial complications

by the debtor (borrower), the new agreement is referred to as a troubled debt restructuring. It includes some allowances on the part of the creditors (issuer).

To Prepare: The journal entry to record the gain on disposal of the assets.

Explanation of Solution

Prepare journal entry for gain on disposal of land.

Date		Account Title and Explanation			Debit ($)	Credit ($)
		Land			3,000,000
			Gain on Disposal of Assets			3,000,000
				(To record gain on disposition of assets)

Table (1)

Working notes:

Calculate the amount of gain on disposition.

$\begin{array}{c}\text{Gain on disposal of assets = Fair value –}\text{Book value}\\ \text{=\$16,000,000 –\$13,000,000}\\ \text{= \$3,000,000}\end{array}$

Hence, gain on disposal of assets amount is $3,000,000.

(1)

• Land is a non – current asset, and it is increased. Therefore, debit land account for $3,000,000.
• Gain on disposal of asset is a component of stockholders’ equity, and it is increased. Therefore, credit gain on disposal of asset amount is $3,000,000.

To Prepare: The journal entry to record the restructuring of the debt.

Date		Account Title and Explanation	Debit ($)	Credit ($)
	Notes Payable		20,000,000
	Interest Payable (2)		2,000,000
	Gain on Troubled Debt Restructuring (3)			6,000,000
	Land			16,000,000
	(To record restructuring of the debt)

Table (2)

Working notes:

Calculate the amount of interest payable.

$\begin{array}{c}\text{Interest}\text{payable}=10\%\times \$20,000,000\\ =\$2,000,000\end{array}$

Hence, interest payable amount is $2,000,000.

(2)

Calculate the amount of gain on troubled debt restructuring.

$\begin{array}{c}\text{Gain on troubled debt restructuring = \$22,000,000 –\$16,000,000}\\ \text{= \$6,000,000}\end{array}$

Hence, gain on troubled debt restructuring amount is $6,000,000.

(3)

• Notes payable is a long term liability, and it is decreased. Therefore, debit notes payable account for $20,000,000.
• Interest payable is a current liability, and it is decreased. Therefore, debit interest payable account for $2,000,000.
• Gain on troubled debt restructuring is a component of stockholders’ equity, and it is increased. Therefore, credit gain on troubled debt restructuring account for $6,000,000.
• Land is a non – current asset, and it is decreased. Therefore, credit land account for $16,000,000.

To determine

To Prepare: The journal entries to record forgive the interest accrued from last year.

Explanation of Solution

Prepare the journal entry to record forgive the interest accrued from last year of Bank FL.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2018		Notes Payable			1,000,000
January	1
		Interest Payable (4)			2,000,000
			Gain on Debt Restructuring(5)			3,000,000
				(To record restructuring of the debt)

Table (3)

Working notes:

Calculate the amount of interest payable.

$\begin{array}{c}\text{Interest}\text{payable}=10\%\times \$20,000,000\\ =\$2,000,000\end{array}$

Hence, interest payable amount is $2,000,000.

(4)

Calculate the amount of gain on troubled debt restructuring.

$\begin{array}{c}\text{Gain on debt restructuring = Book value – Future Payments}\\ \text{\$22,000,000 –}\left[\left(\$1,000,000\times 4\right)+\$15,000,0000\right]\\ \text{= \$22,000,000 –}\text{\$19,000,000}\\ \text{=}\text{\$3,000,000}\end{array}$

Hence, gain on debt restructuring amount is $3,000,000.

(5)

• Notes payable is a long term liability, and it is decreased. Therefore, debit notes payable account for $2,000,000.
• Interest payable is a current liability, and it is decreased. Therefore, interest payable account for $2,000,000.
• Gain on debt restructuring is a component of stockholders’ equity, and it is increased. Therefore, credit gain on debt restructuring account for $3,000,000.

To determine

To Prepare: The journal entry to revise interest payment on December 31, 2018, 2019, 2020 and 2021.

Explanation of Solution

Prepare the journal entry to record revise interest payment on December 31, 2018, 2019, 2020 and 2021.

Date	Account Title and Explanation	Debit ($)	Credit ($)
	Notes Payable	1,000,000
	Cash		1,000,000
	(To record restructuring of the debt to revise interest payment)

Table (4)

• Notes payable is a long term liabilities, and it is decreased. Therefore, debit notes payable account for $1,000,000.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $1,000,000.

To determine

To Prepare: The journal entry to revise principal payment.

Explanation of Solution

Prepare the journal entry to revise the principal payment as on 31^st December 2021.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2021		Notes Payable(L–)	15,000,000
December	31
		Cash (A–)		15,000,000
	(To record restructuring of the debt to revise principal payment)

Table (5)

• Notes payable is a long term liability, and it is decreased. Therefore, debit notes payable account for $15,000,000.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $15,000,000.

To determine

To Prepare: The journal entry to record the restructuring of the debt at January 1, 2018.

Explanation of Solution

The future payment of debt $27,775,000 is more than the present value of debt $22,000,000 $\left[\$20,000,000+\left(10\%\times \$20,000,000\right)\right]$. Hence, no reduction of the existing debt is required. Therefore, no journal entry is required at the time of restructuring of the debtat January 1, 2018.

Working note:

Figure (1)

The following is journal entry for restructuring of the debt at December 31, 2018:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2018		Interest Expense			1,320,000
December	31
			Interest Payable			1,320,000
				(To record interest expense)

Table (6)

Working notes:

Calculate the present value factor.

$\begin{array}{c}\text{Present value factor =}\frac{\text{Present value of debt}}{\text{Future value of debt}}\\ =\frac{\$240,000+\left(10\%\times \$240,000\right)}{\$27,775,000}\\ =\frac{\$22,000,000}{\$27,775,000}\\ =0.79208\end{array}$

Hence, present value factor is 0.79208.

Find the interest rate from Table 2 (present value $1) in Appendix.

In row 4 of Table 2, the value of 0.79208 is in 6% column.

Hence, the effective rate of interest is 6%.

Calculate the amount of interest expense.

$\begin{array}{c}\text{Interest expense = Present value of debt }\times \text{ 6\%}\\ \text{= \$22,000,000}\times 6\text{\%}\\ \text{= \$1,320,000}\end{array}$

Hence, interest expense amount is $1,320,000.

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $1,320,000.
• Interest payable is a current liability, and it is increased. Therefore, credit interest payable account for $1,320,000.

The following is journal entry for restructuring of the debt at December 31, 2019:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2019		Interest Expense			1,399,200
December	31
			Interest Payable			1,399,200
				(To record interest expense)

Table (7)

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $1,399,200.
• Interest payable is a current liability, and it is increased. Therefore, credit interest payable account for $1,399,200.

The following is journal entry for restructuring of the debt at December 31, 2020:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2020		Interest Expense			1,483,152
December	31
			Interest Payable			1,483,152
				(To record interest expense)

Table (8)

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $1,483,152.
• Interest payable is a current liability, and it is increased. Therefore, credit interest payable account for $1,483,152.

The following is journal entry for restructuring of the debt at December 31, 2021:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2021		Interest Expense			1,572,648
December	31
			Interest Payable			1,572,648
				(To record interest expense)

Table (9)

• Interest expense is a component of stockholders’ equity, and it is decreased. Therefore, debit interest expense account for $1,572,648.
• Interest payable is a current liability, and it is increased. Therefore, credit interest payable account for $1,572,648.

The following is journal entry for restructuring of the debt at December 31, 2021:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2021		Notes Payable (L–)			20,000,000
December	31
		Interest Payable (6)			7,775,000
			Cash (A–)			27,775,000
				(To record restructuring of the debt to revise interest amount)

Table (9)

Working note:

Calculate the amount of interest payable.

$\begin{array}{c}\text{Interest payable = }\left(\begin{array}{l}\text{\$2,000,000 +\$1,320,000 +\$1,399,200 }\\ \text{+\$1,483,152 +\$1,572,648}\end{array}\right)\\ =\$7,775,000\end{array}$

Hence, interest payable amount is $7,775,000.

(6)

• Notes payable is a long term liability, and it is decreased. Therefore, debit notes payable account for $2,000,000.
• Interest payable is a current liability, and it is decreased. Therefore, interest payable account for $7,775,000.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $27,775,000