Chapter 11 - Solution Manual

# Calculated as follows 214 current book balances note

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calculated as follows:

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214 Current book balances: Note Payable \$100,000 Interest Payable 10,000 \$110,000 Total future cash flows under the new agreement 100,000 Gain on Troubled Debt Restructuring \$ 10,000 This requirement implies that the book value of the debt will be written down to equal the total future cash flows of \$100,000. Therefore, Whiley Company will report the restructured liability at 12/31/10 at \$100,000. Because the recorded value of the restructured debt is equal to the total future cash flows, there will be no interest expense recorded. That is, the debt will be treated as though the effective rate is zero. b. Current GAAP for the creditor, Security, is found at FASB ASC 310-40, previously SFAS No. 114. According to this guidance, Security may report the restructured receivable at \$75,815, the present value of the future cash flows. This value presumes that Security expects to receive all four payments. If Security believes that it is not probable that all of the \$100,000 will be received, the present value of the expected amounts discounted at 10% should be reported. As an alternative, GAAP allows restructured receivables to be recorded at the loan's observable market price. Since the Whiley note has no observable market price, Security may not use this alternative. In addition, GAAP also allows a collateralized receivable to be record at the fair value of the collateral. In this case, the note is secured by equipment having a fair value of \$80,000. As a practical matter, this amount would represent the minimum recoverable value of the receivable. Thus, theoretically, it represents the minimum value at which the creditor should report the restructured receivable. The effect on the income statement for 2010 would be that Security would recognize a loss for the difference between the recorded value of the restructured receivable and its book value immediately prior to restructure, as follows: 1. If the restructured receivable is recorded at its present value: Book value of receivable prior to restructuring \$110,000 Recorded value of restructured receivable 75,815 Loss on Restructured Receivable \$ 34,185 2. If the restructured receivable is recorded at the value of the collateral: Book value of receivable prior to restructuring \$110,000 Recorded value of restructured receivable 80,000 Loss on Restructured Receivable \$ 30,000 GAAP allows two alternatives for reporting income in the income statement.
215 1. Security may report changes in the present value due to the passage of time as interest revenue. When interest income is recognized, changes in the present value (or floor value) that are due to changes in expectations regarding future cash flows are reported as adjustments to bad debt expense. 2. All changes in the present value of expected future cash flows (or presumably the floor value) may be treated as adjustments to bad debt expense.

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