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ACCT 401 final review- debt example

# ACCT 401 final review- debt example - Megan debtor issued a...

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Megan( debtor) issued a \$1000, 10%, 5 year note to Rob (creditor), EIR=12% on 1/1/01., with interest payable annually on 12/31. Morgan's fiscal year ends on 12/31. It's easier to make the amortization table before you make journal entries. Also, to make life easier, we'll treat part 2, part 3, part 4 and part 5 independently. Creditor's amortization table 4)Carrying amount of note=previous 4)+s3) 1/1/2001 928 12/31/2001 100 111.36 11.36 939 12/31/2002 100 112.7232 12.7232 952 12/31/2003 100 114.249984 14.249984 966 12/31/2004 100 115.95998208 15.959982 982 12/31/2005 100 117.8751799296 17.87518 1000 * 5 N, 12 I/Y, 100 PMT, 1000 FV, CPT PV =-928 Dr: N/R 1000 Cr:discount on N/R 72 Cr: Cash 928 Debtor's amortization table 4)Carrying amount of note=previous 4)+3) 1/1/2001 928 12/31/2001 100 111.36 11.36 939 12/31/2002 100 112.7232 12.7232 952 12/31/2003 100 114.249984 14.249984 966 12/31/2004 100 115.95998208 15.959982 982 12/31/2005 100 117.8751799296 17.87518 1000 Dr: Cash 928 Dr:discount o 72 Cr: N/P 1000 Note: because the note is discounted, the carrying amount is increasing. 2)On 1/1/2003, Rob determined that it was probable Megan would only pay back \$700 at maturity. to compare the current carrying amount with PV of the expected future cash inflow discounted at the historical EIR Required: Prepare the journal entries to record the impairment. Creditor: Carrying amount: 952 PV of expected FCF (3 N, 12 I/Y 666 (principal=700, annual interest=700*0.1=70) Impairment loss 286 Dr: Bad Debt Expense: 286 Cr: Allowance for Doubtful Account 286 On 1/1/04, Megan asked Rob for a break due to her finanical difficulties. Rob agreed to change the interest rate from 10% to 8% and reduce the principal from \$1000 to \$600. Required: Prepare the amortization table and the journal entries for the debt restructuring. Creditor: Creditor's new amortization table 4)Carrying amount of note=previous 4) + 3) 1/1/2004 560 12/31/2004 48 67.2 19.2 579 12/31/2005 48 69.504 21.504 601 Pre-restructuring carrying amount 966 PV of restructured CF ( 2 N, 12 I/Y, 48 PMT, 600 FV, C 560 Loss for the creditor due to restructuring 406 1/1/2004 Dr: Bad Debt Expense: 406 Cr: Allowance for Doubtful Account 406 12/31/2004 Dr: Cash 48 Dr: Allowance for Doubtful Accou 19 Cr: Interest revenue 67 12/31/2005 Dr: Cash 48 Dr: Allowance for Doubtful Accou 22 Cr: Interest revenue 70 Dr: Cash 600 Dr: Allowance for Doubtful Accou 366 Dr: Discount 34 Cr: N/R 1000 Note: the sum of the debit to the allowance accounts should be equal to the amount credit to the allowance account. The loss was calculated based upon the expected future CF discounted at the historical effective rate of 12%. when the note was restructured. Debtor: Debtor's new amortization table 4)Carrying amount of note=previous 4) + 3) 1/1/2004 696 12/31/2004 48 0 48 648 12/31/2005 48 0 48 600 Current carrying amount 966 Total future CF after restructurin 696 Gain 270 1/1/2004 Dr: N/P 270 Cr: Gain on resstructuring 270 12/31/2004 Dr: N/P 48 Cr: Cash 48 12/31/2005 Dr: N/P 682 Cr: Cash 648 Cr: discount 34 Note: 1) because the pre-structure carrying amount (the amount the debtor was supposed to pay)exceeds the total future CF (the amount the debtor is now entitled to pay), the debtor recordes a gain. 2) For debtor because the new carrying amount (966-270=696) equals the sum of the undiscounted CFs(696), the imputed interest rate is 0%.

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