Chapter 14, Problem 16P

Tenth National Bank has a $200,000, 12% note receivable from Priday Company that is due on December 31, 2022. On December 31, 2019, Priday misses the interest payment due on that date. The bank expects that the company will also miss the next payment, but will pay the principal on the maturity date. On December 31, 2020, Priday misses the interest payment due on that date. On December 31, 2021, Priday pays half the interest payment due on that date and is not expected to pay the other half.

In early January 2022, the bank and the company agree to a loan restructuring because of the financial condition of the company. The bank forgives the unpaid interest, extends the loan to December 31, 2024, and reduces the interest rate to 6%. The market rate for the loan is estimated to be 10% at this time.

Required:

1. 1. Compute the value of the impaired loan on December 31, 2019.
2. 2. Prepare the journal entries from 2019 to 2024 for the bank to record the above events. Assume that Priday makes all required payments under the modified agreement.

To determine

Prepare the value of impaired loan on December 31, 2019.

Explanation of Solution

Compute the value of impaired loan as on December 31, 2019.

Particulars	Amount (A)	Present value factor (B)	Present value factor (C)		Value of the Bonds (A × B × C)
Present value of principal	$200,000	0.711780			$142,356.00
Add: Present value of interest	$24,000	1.690051	0.892857		$36,215.37
The value of impaired loan					$178,571.37

Table (1)

Note: The Present value of an ordinary annuity of $1 for 3 periods at 12% is 1.690051 (refer Table 4 in TVM Module). And the present value of $1 for 3 periods at 6% is 0.711780, and the present value of $1 for 1 periods at 12% is 0.892857 (refer Table 3 in TVM Module).

Working note:

(1)Calculate present value interest amount.

$\begin{array}{c}\text{Present value interest =}\text{Face value of bonds}\times \text{Stated interest rate}\times \text{Time period}\\ =\$200,000\times 12\%\times \frac{12}{12}\\ =\$24,000\end{array}$

Therefore, the value of impaired loan amount is $178,571.37.

To determine

Prepare journal entries to record 2019 to 2024 for the bank to record the given events, assume Company P makes all required payments under the modified agreement.

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.

Prepare journal entries to record 2019 to 2024 for the bank to record the given events, assume Company P makes all required payments under the modified agreement.

Date	Account titles and Explanation	Debit	Credit
December 31, 2019	Interest receivable	$24,000
	Interest revenue		$24,000
	(To record adjusting entry to record interest receivable)
December 31, 2019	Bad debt expense (1)	$45,428.63
	Interest receivable		$24,000
	Allowance for doubtful notes		$21,428.63
	(To record adjusting entry to record bad debts expense)
December 31, 2020	Allowance for doubtful notes (2)	$21,428.63
	Interest revenue		$21,428.63
	(To record adjustment entry to record allowance for doubtful notes)
December 31, 2021	Interest receivable	$24,000
	Interest revenue		$24,000
	(To record adjusting entry to record interest receivable)
December 31, 2021	Bad debt expense (3)	$12,000
	Cash	$12,000
	Interest receivable		$24,000
	(To record adjustment entry to record bad debts expense)
January 2, 2022	Loss on restructured loan (4)	$28,822.03
	Notes receivable		$28,822.03
	(To record loss on restructured loan)
December 31, 2022	Cash	$12,000
	Notes receivable	$8,541.36
	Interest revenue (6)		$20,541.36
	(To record bank recognizes interest revenue)
December 31, 2023	Cash	$12,000
	Notes receivable	$9,566.32
	Interest revenue (7)		$21,566.32
	(To record bank recognizes interest revenue)
December 31, 2024	Cash	$12,000
	Notes receivable	$10,714.35
	Interest revenue (8)		$22,714.35
	(To record bank recognizes interest revenue)
December 31, 2024	Cash	$200,000
	Notes receivable		$2,000,000
	(To record cash received for issuing notes receivable)

Table (2)

Working notes:

(1)Calculate bad debts expense.

$\begin{array}{c}\text{Bad debts expense =}\left(\begin{array}{l}\text{Face value of notes }\\ \text{+ Interest revenue}\end{array}\right)-\text{Carrying value of notes}\\ =\$200,000+\$24,000-\$178,571.37\\ =\$45,428.63\end{array}$

 (2)Calculate allowance for doubtful notes.

$\begin{array}{c}\text{Allowance for doubtful notes =}\text{Carrying value of notes }\times \text{Interest rate}\\ \text{=}\text{\$178,571}\text{.37}\times \text{12\%}\\ \text{=}\text{\$21,428}\text{.63}\text{(Rounded off)}\end{array}$

(3)Calculate bad debts expense.

$\begin{array}{c}\text{Bad debts expense =}\left(\begin{array}{l}\text{Carrying value of notes + Interest revenue }\\ -\text{Book value of note as on 1}\text{.1}\text{.2019}\end{array}\right)\\ \text{=}\left(\text{\$200,000 +\$24,000}\right)-\left(\left(\$224,000\times 0.892857\right)\text{+\$12,000}\right)\\ \text{=}\text{\$224,000}-\$212,000\\ =\$12,000\end{array}$

(4)Calculate loss on restructured loan.

$\begin{array}{c}\text{Loss on restructured loan =}\text{Face value of notes }-\text{Value of restructured loan}\\ \text{=}\text{\$200,000}-\$171,177.97\\ =\$28,822.03\end{array}$

(5)Calculate value of restructured loan.

Particulars	Amount (A)	Present value factor (B)	Value of the Bonds (A × B)
Present value of principal	$200,000	0.711780	$142,356.00
Add: Present value of interest ($200,000 × 12%)	$12,000	2.401831	$28,821.97
Value of restructured loan			$171,177.97

Table (1)

Note: The Present value of an ordinary annuity of $1 for 3 periods at 12% is 2.401831 (refer Table 4 in TVM Module). And the present value of $1 for 3 periods at 12% is 0.711780 (refer Table 3 in TVM Module).

(6)Calculate interest revenue.

$\begin{array}{c}\text{Interest revenue =}\text{Value of restructured loan }\times \text{ Interest rate}\\ \text{=}\text{\$171,177}\text{.97}\times \text{12\%}\\ \text{=}\text{\$20,541}\text{.36}\end{array}$

(7)Calculate interest revenue.

$\begin{array}{c}\text{Interest revenue =}\text{Value of restructured loan }\times \text{ Interest rate}\\ \text{=}\left(\text{\$171,177}\text{.97 +\$8,541}\text{.36}\right)\times \text{12\%}\\ \text{=}\text{\$21,566}\text{.32}\end{array}$

(8)Calculate interest revenue.

$\begin{array}{c}\text{Interest revenue =}\text{Value of restructured loan }\times \text{ Interest rate}\\ \text{=}\left(\text{\$171,177}\text{.97 +\$9,566}\text{.32}\right)\times \text{12\%}\\ \text{=}\text{\$22,714}\text{.35}\end{array}$