Question

• Discuss how debt restructuring, settlement, or modification works.
• Discuss the journal entries for debtor and creditor

Answer 1

Debt restructuring arises when the risk of existing debt is likely to be defaulted due to financial risk of the debtor and hence, the debtor and the creditor get together to negotiate such debts or the interests thereon by modifying, settling or restructuring. This can be in following ways:

1. Reduction of outstanding debts wherein the creditor agrees to waive off some portion of debt and interest thereon. (Restructuring)
2. Agree to compromise and settle for lesser payment than what actually is due (Settlement).
3. Modify debt obligation into equity. (settlement)
4. Agree to settle debt partially/wholly by transfer of asset.
5. Extend the due dates for payments (Modification of terms)
6. Agree to reduce the rates of interest, default fines (Modification)

The Journal entries for the above 5 ways of restructuring can be as following:

• In the books of debtor:

  	Old loan a/c Dr	xxx
  	Interest Payable a/c Dr	xxx
  	To New loan (1st Method)		xxx
  	To Bank a/c (2nd method)		xxx
  	To Asset (transferred) (3rd method)		xxx
  	To Equity Share capital (4th method)		xxx
  	To Gain on debt restructuring/settlement		xxx
  	By/To Gain/(loss) of transfer of asset

The 5th and 6th way are modification of terms hence won't impact journal entries. However if any interest portion of debt is waived off due to the modifications, it has to treated as 1 above.

• In the books of the creditor:

	New loans and advances made a/c (or Debtor's a/c) (1st method)	xxx
	Bank a/c Dr (1st method)	xxx
	Asset a/c Dr (@ taken over value) (3rd Method)	xxx
	Equity shares in debtor's company a/c Dr (4th method)	xxx
	To Old loan and advances made (Or debtor's a/c)		xxx
	To Interest receivables a/c		xxx
	To Loss on debt restructuring/settlement (or Bad debts) (or Allowance for Uncollectible Receivables)		xxx

Please comment in case of any query regarding the solution.