On December 31, 2010, the American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,000,000 note receivable by the following modifications: 1. Reducing the principal obligation from $3,000,000 to $2,400,000 2. Extending the maturity date from December 31, 2010, to January 31, 2014. 3. Reducing the interest rate from 12% to 10%. Barkley pays interest at the end of each year. On January 1, 2014, Barkley Company pays $2,400,000 in cash to American Bank. Instructions (a) Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring? No. The gain recorded by Barkley is not equal to the loss recorded by American Bank under the debt restructuring agreement. (You wil see why this happens in the following four exercises). In response to this "accounting assymmetry" treatment, GAAP did not address debtor accounting because the FASB was concerned that expansion of the scope of its pronouncement would delay issuance of GAAP for the creditor. (b) Can Barkley Company record a gain under the term modification mentioned above? Explain. No. There is no gain under the modified terms because the total future cash flows after restructuring exceed the total pre-restructuring carrying of the note (principal). Total future cash flows after restructuring are: Principal $2,400,000 Interest ($2,400,000 * 10% * 3) 720,000 Total $3,120,000 Total pre-restructuring carrying amount of note (principal) $3,000,000 © Assuming that the interest rate Barkley should use to compute interest expense in future periods is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt restructuring. BARKLEY COMPANY Interest Payment Schedule After Debt Restructuring Effective- Interest Rate of 1.4276% Cash Interest Reduction of Carrying Paid Expense Carrying Amount of Date 10% 1.4276% Amount Note 12/31/2007 $3,000,000 12/31/2008 $240,000 $42,828 $197,172 $2,802,828 12/31/2009 $240,000 $40,013 $199,987 $2,602,841 12/31/2010 $240,000 $37,159 $202,841 $2,400,000 Total $720,000 $120,000 $600,000 To determine cash paid: $2,400,000 (Principal) * 10% (stated interest rate) = $240,000 To determine the Interest Expense each period: CV of note at beginning of year * 1.4276 (effective interest rate); So: Year 1: $3,000,000 * 1.4276% = $42,828 Year 2: $2,802,828 * 1.4276% = $40,013 Year 3: $2,602,841 * 1.4276% = $37,159 Note: The above figures are all rounded. To determine the reduction of carrying amount: Cash paid - Interest expense each period: Year 1: $240,000 - $42,828 = $197,172 Year 2: $240,000- $40,013 = $199,987 Year 3: $240,000 - $37,159 = $202,841 To determine the carrying value of the note: CV of current year - reduction to CV. Year 1: $3,000,000 - $197,172 = $2,802,828 Year 2: $2,802,828 - $199,987= $2,602,841 Year 3: $2,602,841 - $202,841 = $2,400,000 (d) Prepare the interest payment entry for Barkley Company on December 31, 2012. 31-Dec-12 Note Payable 199,987 Interest Expense 40,013 Cash 240,000 (e) What entry should Barkley on January 1, 2014? 1-Jan-14 Note Payable 2,400,000 Cash 2,400,000
Exercise 14-22 (Term Modification without Gain - Creditor's Entries) Using the same information as in E14-21 above, answer the following questions ralted to American Bank (creditor). Info from E14-21 On December 31, 2010, the American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,000,000 note receivable by the following modifications: 1. Reducing the principal obligation from $3,000,000 to $2,400,000 2. Extending the maturity date from December 31, 2010, to January 31, 2014.
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