appendix g-1. appendix g-2 appendix f accounting for troubled debt intermediate accounting...
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Appendix G-1
Appendix G-2
APPENDIX F
ACCOUNTING FOR TROUBLED DEBT
INTERMEDIATE ACCOUNTING
Principles and Analysis
2nd Edition
Warfield Wyegandt
Kieso
Appendix G-3
Troubled DebtTroubled DebtTroubled DebtTroubled Debt
Two situations result with troubled debt:
1. Impairments.
2. Restructurings:
a. Settlements.
b. Modification of termsIllustration G-1Usual Progression
Appendix G-4
Impairments
Troubled DebtTroubled DebtTroubled DebtTroubled Debt
O 1 Describe the accounting for a loan impairment.O 1 Describe the accounting for a loan impairment.
A loan is impaired when it is probable the creditor will not collect all amounts due (both principal and interest).
Appendix G-5
Impairments
Troubled DebtTroubled DebtTroubled DebtTroubled Debt
O 1 Describe the accounting for a loan impairment.O 1 Describe the accounting for a loan impairment.
If considering a loan impaired, the creditor should If considering a loan impaired, the creditor should measure the loss due to the impairment as the measure the loss due to the impairment as the difference between the investment in the loan difference between the investment in the loan (generally the principal plus accrued interest) and the (generally the principal plus accrued interest) and the expected future cash flows discounted at the loan’s expected future cash flows discounted at the loan’s historical effective interest rate.historical effective interest rate.
Appendix G-6
Example of Loss on Impairment
O 1 Describe the accounting for a loan impairment.O 1 Describe the accounting for a loan impairment.
On December 31, 2008, Prospect Inc. issued a $500,000, five-year, zero-interest-bearing note to Community Bank. Prospect issued the note to yield 10% annual interest. As a result, Prospect received, and Community Bank paid, $310,460 ($500,000 x .62092) on December 31, 2008. Illustration G-2
Troubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - Impairments
Appendix G-7 O 1 Describe the accounting for a loan impairment.O 1 Describe the accounting for a loan impairment.
Show how Community Bank (creditor) and Prospect (debtor) record these transactions on December 31, 2008
Illustration G-3
Troubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - Impairments
Appendix G-8 O 1 Describe the accounting for a loan impairment.O 1 Describe the accounting for a loan impairment.
Schedule of Interest and Discount Amortization (Before Impairment)
Illustration G-3
Illustration G-4
Troubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - Impairments
Appendix G-9 O 1 Describe the accounting for a loan impairment.O 1 Describe the accounting for a loan impairment.
Assume Community Bank determines that Prospect will probably pay back only $300,000 of the principal at maturity. Community Bank declares the loan impaired.
Determine the loss due to impairment.Illustration G-5
Troubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - Impairments
Appendix G-10 O 1 Describe the accounting for a loan impairment.O 1 Describe the accounting for a loan impairment.
The loss due to impairment is the difference between the present value of the expected future cash flows and the recorded carrying amount of the investment in the loan. Illustration G-6
Illustration G-7
Troubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - ImpairmentsTroubled Debt - Impairments
Appendix G-11
Restructurings
Troubled DebtTroubled DebtTroubled DebtTroubled Debt
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
A troubled-debt restructuring occurs when a creditor “for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it wouldnot otherwise consider.”Two basic types of transactions:
1. Settlement of debt at less than its carrying amount.
2. Continuation of debt with a modification of terms.
Appendix G-12
Settlement of Debt
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
Involve either a:
Transfer of noncash assets (real estate, receivables, or other assets) or
Issuance of the debtor’s stock.
Creditor should account for noncash assets or equity interest received at their fair value.
Appendix G-13
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-1 (Settlement of Debt) Larisa Nieland Company owes $200,000 plus $18,000 of accrued interest to First State Bank. The debt is a 10-year, 10% note. During 2008, Larisa Nieland’s business deteriorated due to a faltering regional economy. On December 31, 2008, First 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 market value of $190,000.
Appendix G-14
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-1 Prepare journal entries for Larisa Nieland Company and First State Bank to record this debt settlement.
Larisa Nieland Company (Debtor):
Notes Payable 200,000
Interest Payable 18,000
Accumulated Depreciation 221,000
Machine 390,000
Gain on Disposition of Machine 21,000
Gain on Debt Restructuring 28,000
a $190,000 – ($390,000 – $221,000) = $21,000. b ($200,000 + $18,000) – $190,000 = $28,000.
a
b
Appendix G-15
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-1 Prepare journal entries for Larisa Nieland Company and First State Bank to record this debt settlement.
First State Bank (Creditor):
Machine 190,000
Allowance for Doubtful Accounts 28,000
Notes Receivable 200,000
Interest Receivable 18,000
Appendix G-16
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-1 Assume instead that Larisa Nieland decides to grant 15,000 shares of its common stock ($10 par) which has a fair value of $190,000 in full settlement of the loan obligation. If First State Bank treats Larisa Nieland’s stock as a trading investment, prepare the entries to record the transaction for both parties.
Larisa Nieland Company (Debtor):
Notes Payable 200,000
Interest Payable 18,000
Common Stock 150,000
Additional Paid-in Capital 40,000
Gain on Debt Restructuring 28,000
Appendix G-17
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-1 Assume instead that Larisa Nieland decides to grant 15,000 shares of its common stock ($10 par) which has a fair value of $190,000 in full settlement of the loan obligation. If First State Bank treats Larisa Nieland’s stock as a trading investment, prepare the entries to record the transaction for both parties.
First State Bank (Creditor):
Investment (Trading) 190,000
Allowance for Doubtful Accounts 28,000
Notes Receivable 200,000
Interest Receivable 18,000
Appendix G-18
Modification of Terms
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
1. Reduction of the interest rate.
2. Extension of maturity date of the face amount of debt.
3. Reduction of the face amount of the debt.
4. Reduction or deferral of any accrued interest.Two examples demonstrate troubled-debt restructuring by debtors and creditors:
1. No gain for debtor.
2. Gain for debtor.
Appendix G-19
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-2 (Term Modification without Gain — Debtor’s Entries) On December 31, 2008, Firstar Bank enters into a debt restructuring agreement with Nicole Bradtke Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications.
1. Reduce principal obligation from $2,000,000 to $1,600,000.
2. Extend the maturity date from December 31, 2008, to December 31, 2011.
3. Reduce the interest rate from 12% to 10%.
Bradtke pays interest at the end of each year. On January 1, 2012, Bradtke Company pays $1,600,000 in cash to Firstar.
DebtorNo Gain
Appendix G-20
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-2 Can Bradtke Company record a gain under the term modification mentioned above? Explain.
No. Total future cash flows after restructuring exceed total pre-restructuring carrying amount of the note (principal):
Total future cash flows after restructuring:Principal $1,600,000Interest ($1,600,000 X 10% X 3) 480,000
$2,080,000
Total pre-restructuring carrying amount of note (principal): $2,000,000
DebtorNo Gain
Appendix G-21
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
EG-2 Assuming the interest rate Bradtke should use to compute interest expense is 1.4276%, prepare the interest payment schedule of the note after the debt restructuring.
a. $1,600,000 x 10% = $160,000. b. $2,000,000 x 1.4276% = $28,552. c. $160,000–$28,552 = $131,448. d. Adjusts $1 due to rounding.
DebtorNo Gain
Appendix G-22
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
EG-2 Prepare the interest payment entry for Bradtke Company on December 31, 2010.
Note Payable 133,325
Interest Expense 26,675
Cash 160,000
EG-2 What entry should Bradtke make on January 1, 2012?
Note Payable 1,600,000
Cash 1,600,000
DebtorNo Gain
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
Appendix G-23
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-3 (Term Modification without Gain — Creditor’s Entries) On December 31, 2008, Firstar Bank enters into a debt restructuring agreement with Nicole Bradtke Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications.
1. Reduce principal obligation from $2,000,000 to $1,600,000.
2. Extend the maturity date from December 31, 2008, to December 31, 2011.
3. Reduce the interest rate from 12% to 10%.
Bradtke pays interest at the end of each year. On January 1, 2012, Bradtke Company pays $1,600,000 in cash to Firstar.
Creditor No Gain
Appendix G-24
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-3 Compute the loss that Firstar Bank will suffer from the debt restructuring. Prepare the journal entry to recordthe loss.
a$1,600,000 X .71178 = $1,138,848. b$160,000 X 2.40183 = $384,293.
Bad Debt Expense 476,859
Allowance for Doubtful Accounts 476,859
Creditor No Gain
Appendix G-25
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-3 Prepare the interest receipt schedule for Firstar Bank after the debt restructuring.
Creditor No Gain
Appendix G-26
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
EG-3 Prepare the interest receipt entry for Firstar Bank on December 31, 2010.
Cash 160,000
Allowance for Doubtful Accounts 25,510
Interest Revenue 185,510
EG-3 What entry should Firstar make on Jan. 1, 2012?
Cash 1,600,000
Allowance for Doubtful Accounts400,000
Note Receivable 2,000,000
Creditor No Gain
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
Appendix G-27
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-2 - Modified (Term Modification with Gain — Debtor’s Entries) On December 31, 2008, Firstar Bank enters into a debt restructuring agreement with Nicole Bradtke Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications.
1. Reduce principal obligation from $2,000,000 to $1,300,000.
2. Extend the maturity date from December 31, 2008, to December 31, 2011.
3. Reduce the interest rate from 12% to 10%.
Bradtke pays interest at the end of each year. On January 1, 2012, Bradtke Company pays $1,300,000 in cash to Firstar.
DebtorGain
Appendix G-28
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-2 – Modified Can Bradtke Company record a gain under the term modification mentioned above? If yes, record the gain.
Total future cash flows after restructuring:Principal $1,300,000Interest ($1,300,000 X 10% X 3) 390,000
$1,690,000
Total pre-restructuring carrying amount of note (principal): $2,000,000
Gain = $2,000,000 – $1,690,000 = $310,000
Journal December 31, 2008:
Note Payable 310,000
Gain on Debt Restructuring 310,000
DebtorGain
Appendix G-29
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
EG-2 - Modified Prepare the interest payment schedule of the note for Bradtke after the debt restructuring.
DebtorGain
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
Appendix G-30
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
EG-2 - Modified Prepare the interest payment entry for Bradtke Company on December 31, 2009, 2010, and 2011.
Note Payable 130,000
Cash 130,000
EG-2 What entry should Bradtke make on January 1, 2012?
Note Payable 1,300,000
Cash 1,300,000
DebtorGain
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
Appendix G-31
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-3 - Modified (Term Modification with Gain — Creditor’s Entries) On December 31, 2008, Firstar Bank enters into a debt restructuring agreement with Nicole Bradtke Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,000,000 note receivable by the following modifications.
1. Reduce principal obligation from $2,000,000 to $1,300,000.
2. Extend the maturity date from December 31, 2008, to December 31, 2011.
3. Reduce the interest rate from 12% to 10%.
Bradtke pays interest at the end of each year. On January 1, 2012, Bradtke Company pays $1,300,000 in cash to Firstar.
Creditor Gain
Appendix G-32
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-3 - Modified Compute the loss that Firstar Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss on Firstar’s books.
a$1,300,000 X .71178 = $925,314 b$130,000 X 2.40183 = $312,238
Creditor Gain
Bad Debt Expense 762,448
Allowance for Doubtful Accounts 762,448
Appendix G-33
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
EG-3 - Modified Prepare the interest receipt schedule for Firstar Bank after the debt restructuring.
Creditor Gain
Appendix G-34
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
EG-3 - Modified Prepare the interest receipt entry for Firstar Bank on December 31, 2009, 2010, and 2011.
Cash 130,000
Allowance for Doubtful Accounts 18,506
Interest Revenue 148,506
Creditor Gain
Cash 130,000
Allowance for Doubtful Accounts 20,727
Interest Revenue 150,727
Cash 130,000
Allowance for Doubtful Accounts 23,215
Interest Revenue 153,215
20092009
20102010
20112011
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
Appendix G-35
Troubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt RestructuringTroubled-Debt Restructuring
EG-3 - Modified What entry should Firstar make on Jan. 1, 2012?
Cash 1,300,000
Allowance for Doubtful Accounts700,000
Notes Receivable 2,000,000
Creditor Gain
O 2 Describe the accounting for debt restructuring.O 2 Describe the accounting for debt restructuring.
Appendix G-36
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