Question

On December 31, 2020, American Bank enters into a debt restructuring agreement with Grouper Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $2,720,000 note receivable by the following modifications: 1. 2. 3. Reducing the principal obligation from $2,720,000 to $2,176,000. Extending the maturity date from December 31, 2020, to January 1, 2024. Reducing the interest rate from 12% to 10%. Grouper pays interest at the end of each year. On January 1, 2024, Grouper Company pays $2,176,000 in cash to American Bank.

Answer 1

(a) What interest rate should American Bank use to calculate the loss on the debt restructuring?

Answer:

The American Bank should use the historical interest rate to calculate the loss.

Historical Interest Rate = 12%

(b) Compute the loss that American Bank will suffer from the debt restructuring. Prepare the journal entry to record the loss.

Solution:

Step 1: Computation of Loss:

                Pre-restructuring carrying amount of note                          = $2,720,000

                Less:

                Present value of restructured future cash flows:

                PV of principal*                                               =($1,548,833.28)

                PV of interest**                                                               = ($522,638.20)

                                                                                                                                = ($2,071,471.48)

                Loss on debt restructuring                                                          = $648,528.5

                * Present value of principal $2,176,000 due in 3 years at 12%

                $2,176,000 * 0.71178 = $1,548,833.28

                ** Present value of interest $217,600 paid annually for 3 years at 12%

                $217,600 * 2.40183 = $522,638.20

Step 2: Journal Entry:

                31-Dec

                Bad Debt Expense           Dr           $648,528.5

                                Allowance for Doubtful Accounts             Cr            $648,528.5

(c) Prepare the interest receipt schedule for American Bank after the debt restructing.

Solution:

               

AMERICAN BANK
Interest Payment Schedule After Debt Restructuring
Effective - Interest Rate of 1.4276%
Date	Cash Received 10%	Interest Revenue 12%	Increase Carrying Amount	Carrying Amount of Note
12/31/2020	-	-	-	$2,071,471.48
12/31/2021	$217,600	$248,576.57	$30,976.57	$2,102,448
12/31/2022	$217,600	$252,293.76	$34,694.76	$2,137,141.76
12/31/2023	$217,600	$256,457.	$ 38,857	$2,175,999
	$652,800	$757,327	$104,528

(d) Prepare the interest receipt entry for American Bank on December 31, 2022.

Answer:

                Journal Entry:

                31-12-2022

                Cash                                                         Dr           $217,600

                Allowance for Doubtful Accounts             Dr           $34,695

                                Notes Receivable                                             Cr            $252,295

(e) What entry should American Bank make on January 1, 2024?

Answer:

Journal Entry:

                1-01-2024

                Cash                                                      Dr           $2,176,000

                Allowance for Doubtful Accounts             Dr           $544,000

                                Notes Receivable                                             Cr            $2,720,000

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