Chapter 14, Problem 14P

Restructuring (Debtor) Oakwood Corporation is delinquent on a $2,400,000, 10% note to Second National Bank that was due January 1, 2019. At that time, Oakwood owed the principal amount plus $34,031.82 of accrued interest. Oakwood enters into a debt restructuring agreement with the bank on January 2, 2019.

Required:

Prepare the journal entries for Oakwood to record the debt restructuring agreement and all subsequent interest payments assuming the following independent alternatives:

1. 1. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 8%.
2. 2. The bank extends the repayment date to December 31, 2022, forgives the accrued interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%.
3. 3. The bank accepts 160,000 shares of Oakwood’s 55 par value common stock, which is currently selling for $14.50 per share, in full settlement of the debt.
4. 4. The bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Oakwood’s books at a cost of $2,200,000.

To determine

Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date as on 31^st December 2022, forgives the accrued interest owed, reduces the principal by $200,000 and reduces the interest to 8%.

Explanation of Solution

Troubled Debt Restructuring: A troubled debt restructuring happens if a creditor, for legal or economic reasons associated to a debtor’s financial complications, grants a concession to a debtor that would not be otherwise considered.

Calculate carrying value of note:

$\begin{array}{c}\text{Carrying value of note as on 1}\text{.1}\text{.2019}\text{=}\text{Notes payable + Interest payable}\\ \text{=}\text{\$2,400,000}+\$34,031.82\\ =\$2,434,031.82\end{array}$

Calculate total amount to be repaid of notes payable.

$\begin{array}{c}\text{Amount to be repaid =}\text{Principal + Interest}\\ \text{=}\left(\$2,400,000-\$200,000\right)+\left(\$2,200,000\times 8\%\times 4\right)\\ =\$2,200,000+\$704,000\\ =\$2,904,000\end{array}$

Therefore, no gain recognized by the debtor, because the repaid amount of notes is exceeds the current carrying value of the note and interest.

Calculate amount of restructuring agreement using effective interest rate method.

Particulars	Amount (A)	Present value factor (B)	Value of the Bonds (A × B)
Present value of principal	$2,200,000	0.822702	$1,809,944.44
Add: Present value of interest	$176,000	3.545951	$624,087.38
Restructuring agreement			$2,434,031.82

Table (1)

Note: The Present value of an ordinary annuity of $1 for 4 periods at 5% is 3.545951 (refer Table 4 in TVM Module). And the present value of $1 for 4 periods at 5% is 0.822702 (refer Table 3 in TVM Module).

Working note:

(1)Calculate present value interest amount.

$\begin{array}{c}\text{Present value interest =}\text{Face value of bonds}\times \text{Stated interest rate}\times \text{Time period}\\ =\$2,200,000\times 8\%\times \frac{12}{12}\\ =\$176,000\end{array}$

Calculate interest expense and principal reduction using amortization schedule.

AMORTIZATION SCHEDULE - NOTES PAYABLE
Date	Cash (A)	Interest expense ( B = Prior period D × 5%)	Notes payable (C = A –B)	Carrying Value of Note (D = Prior period D –C)
1/2/2019				$2,434,031.82
12/31/2019	$176,000	$121,701.59	$54,298.41	$2,379,733.41
12/31/2020	$176,000	$118,986.67	$57,013.33	$2,322,720.08
12/31/2021	$176,000	$116,136.00	$59,864.00	$2,262,857.08
12/31/2022	$2,376,000	$113,142.92	$2,262,857.08	$0.00

Table (2)

Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date as on 31^st December 2022, forgives the accrued interest owed, reduces the principal by $200,000 and reduces the interest to 8%.

Date	Account titles and Explanation	Debit	Credit
January 2, 2019	Interest payable	$34,031.82
	Notes payable		$34,031.82
	(To record transfer of accrued interest payable to notes payable)
December 31, 2019	Interest expense	$121,71.59
	Notes payable	$54,298.41
	Cash		$176,000.00
	(To record payment of interest expense and interest payable)
December 31, 2020	Interest expense	$118,986.67
	Notes payable	$57,013.33
	Cash		$176,000.00
	(To record payment of interest expense and interest payable)
December 31, 2021	Interest expense	$116,136.00
	Notes payable	$59,864.00
	Cash		$176,000.00
	(To record payment of interest expense and interest payable)
December 31, 2022	Interest expense	$113,142.92
	Notes payable	$2,262,857.08
	Cash		$2,376,000.00
	(To record payment of interest expense and interest payable)

Table (3)

To determine

Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date to December 31, 2022, forgives the interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%.

Explanation of Solution

Calculate carrying value of note:

$\begin{array}{c}\text{Carrying value of note as on 1}\text{.1}\text{.2019}\text{=}\text{Notes payable + Interest payable}\\ \text{=}\text{\$2,400,000}+\$34,031.82\\ =\$2,434,031.82\end{array}$

Calculate total amount to be repaid of notes payable.

$\begin{array}{c}\text{Amount to be repaid =}\text{Principal + Interest}\\ \text{=}\left(\$2,400,000-\$200,000\right)+\left(\$2,200,000\times 1\%\times 4\right)\\ =\$2,200,000+\$88,000\\ =\$2,288,000\end{array}$

Calculate gain recognized by the debtor.

$\begin{array}{c}\text{Gain recognized by the debtor}\text{=}\text{Carrying value of note}-\text{Repaid amount of notes payable}\\ \text{=}\text{\$2,434,031}\text{.82}-\$2,228,000\\ =\$146,031.82\end{array}$

Therefore, gain recognized by the debtor is $146,031.82. Because the repaid amount of notes is lesser than the current carrying value of the note and interest.

Prepare journal entries to record the debt restructuring agreement and all subsequent interest payments assuming the bank extends the repayment date to December 31, 2022, forgives the interest owed, reduces the principal by $200,000, and reduces the interest rate to 1%.

Date	Account titles and Explanation	Debit	Credit
January 2, 2019	Interest payable	$34,031.82
	Notes payable		$34,031.82
	(To record transfer of accrued interest payable to notes payable)
January 2, 2019	Notes payable	$146,031.82
	Gain on debt restructure		$146,031.82
	(To record gain on debt restructuring)
December 31, 2019	Notes payable	$22,000
	Cash		$22,000
	(To record payment of notes payable)
December 31, 2020	Notes payable	$22,000
	Cash		$22,000
	(To record payment of notes payable)
December 31, 2021	Notes payable	$22,000
	Cash		$22,000
	(To record payment of notes payable)
December 31, 2022	Notes payable	$22,000
	Cash		$22,000
	(To record payment of notes payable)

Table (4)

To determine

Prepare journal entries to record the debt restructuring agreement assuming the bank accepts 160,000 shares of Corporation O, par value of common stock, which is currently selling for $14.50 per share, in full settlement of the debt.

Explanation of Solution

Calculate gain recognized by the debtor.

$\begin{array}{c}\text{Gain recognized by the debtor =}\text{Carrying value of note}-\text{Fair value of stock}\\ \text{=\$2,434,031}\text{.82}-\left(160,000\text{shares}\times \text{\$14}\text{.50}\right)\\ =\$2,434,031.82-\$2,320,000.00\\ =\$114,031.82\end{array}$

Prepare journal entries to record the debt restructuring agreement assuming the bank accepts 160,000 shares of Corporation O, par value of common stock, which is currently selling for $14.50 per share, in full settlement of the debt.

Date	Account titles and Explanation	Debit	Credit
January 2, 2019	Notes payable	$2,400,000
	Interest payable	$34,031.82
	Gain on Debt restructure		$114,031.82
	Common stock		$800,000
	Additional paid in capital on common stock (balancing figure)		$1,520,000.00
	(To record payment of debt restructuring)

Table (5)

Working note:

(2)Calculate common stock.

$\begin{array}{c}\text{Common stock =}\text{Number of shares}\times \text{Par value of common stock}\\ \text{=}\text{160,000 shares}\times \text{\$5}\\ \text{=}\text{\$800,000}\end{array}$

To determine

Prepare journal entries to record the debt restructuring agreement assuming the bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Corporation O’s books at a cost of $2,200,000.

Explanation of Solution

Prepare journal entries to record the debt restructuring agreement assuming the bank accepts land with a fair value of $2,300,000 in full settlement of the debt. The land is being carried on Corporation O’s books at a cost of $2,200,000.

Date	Account titles and Explanation	Debit	Credit
January 2, 2019	Notes payable	$2,400,000
	Interest payable	$34,031.82
	Gain on debt restructure		$134,031.82
	Gain on disposal of land		$100,000
	Land		$2,200,000.00
	(To record payment of debt restructuring)

Table (6)

Working notes:

(3)Calculate gain on debt restructure.

$\begin{array}{c}\text{Gain on debt restructure}\text{=}\text{Fair value of land}-\text{Cost of land}\\ \text{=}\text{\$2,300,000}-\$2,200,000\\ =\$100,000\end{array}$

(4)Calculate gain recognized by the debtor.

$\begin{array}{c}\begin{array}{l}\text{Gain recognized by the }\\ \text{debtor}\text{(transfer of land)}\end{array})\text{=}\text{Carrying value of note }-\text{Fair value of land}\\ \text{=}\text{\$2,434,031}\text{.82}-\$2,300,000\\ =\$134,031.82\end{array}$