Chapter 11 - Solution Manual

C under fasb asc 470 60 previously sfas no 15 the

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c. Under FASB ASC 470-60 previously, SFAS No. 15 the creditor, Security, would not recognize any loss. It is clear that due to the time value of money and the risk inherent in collecting the future cash flows, Security has suffered a loss. Hence, the asset (the restructured receivable) would be overstated. It is also evident that to allow the debtor more time, implies that there is income associated with the receipt of the future cash flows, assuming they are collected. Hence, this treatment can be viewed as providing financial statements that are more representationally faithful and relevant. Recording the restructured receivable at the present value of the expected cash flows has merit. Balance sheet values for receivables should reflect expectations about future cash flows. The FASB proposed that these cash flows should be discounted at the interest rate on the original financial instrument. This position is defended on the basis that the restructuring represents an effort to recover an existing debt and is not a new financial instrument. Opponents of this view counter that the restructuring is replacing the expected cash flows under the prior, original agreement, hence the interest rate used to discount the original debt instrument is no longer relevant. Recording the restructured receivable at the fair value of the collateral has merit in that this value could presumably be recovered. However, it could be argued that this value should serve only as a floor. If the present value of the expected future cash flows exceeds the fair value of the collateral, it would provide a more relevant measure of the future service potential of the asset. d. If debtors were allowed to record the transaction in the same manner as creditors, Whiley would recognize a gain for the difference between the present value of the future cash flows and the prerestructure book value of the debt or for the difference between the fair value of the collateral and the prerestructure book value. These values would be equivalent to those reflected above in b. for Security. For example, under the assumption that Whiley will record the restructured debt at $75,815. Total debt would be less by $24,185 ($100,000 - 75,815) than it is under currentGAAP. This measurement would have a positive effect on Whiley's debt to equity ratio. At the same time the gain recognized in the income statement would be greater by $24,185 ($34,185 - 10,000). This would increase EPS. Also, because the gain would be closed to retained earnings, the debt to equity ratio would be further enhanced. A similar balance sheet effect would occur in 2011. The debt would again be lower. Debt balance under current GAAP (100,000 - 25,000) $75,000 Debt balance under creditor treatment
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216 Beginning balance $75,815 Interest at 10% 7,582 $83,397 Payment received 25,000 58,397 Difference $16,603 Retained earnings under current GAAP Beginning balance $10,000 Interest expense 0 $10,000 Retained earnings under creditor treatment Beginning balance $34,185 Interest expense ( 7,582) 26,603 Difference $ 16,603 However, the reported net income in future years would be less by the recognition of interest expense.
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