On December 31, 2012, the American Bank enters into a debt restructuring agreeme

Question

On December 31, 2012, 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, $3,140,000 note receivable by the following modifications:

Reducing the principal obligation from $3,140,000 to $1,930,000.
Extending the maturity date from December 31, 2012, to December 31, 2016.
Reducing the interest rate from 12% to 10%.
Barkley pays interest at the end of each year. On January 1, 2016, Barkley Company pays $1,930,000 in cash to American Bank for the principal.


a) How much gain can Barkley Company record a under this term modification?


(b) Prepare the journal entries to record the gain on Barkley's books.



(c) What interest rate should Barkley use to compute its interest expense in future periods?



(d) Prepare the interest payment schedule of the note for Barkley Company after the debt restructuring. (If answer is zero, please enter 0, do not leave any fields blank.)





(e) Prepare the interest payment entries for Barkley Company on December 31, of 2013, 2014, and 2015.


(f) What entry should Barkley make on January 1, 2016?

Explanation / Answer

(a) No. The gain recorded by Barkley is not equal to the loss recorded by American Bank under the debt restructuring agreement. (You will see why this happens in the following four exercises.) In response to this “accounting asymmetry” treatment, GAAP did not address debtor ac¬counting because the FASB was concerned that expansion of the scope of its pronouncement would delay issuance of GAAP for the creditor. (b) No. There is no gain under the modified terms because the total future cash flows after restructuring exceed the total pre-restructuring carrying amount of the note (principal): Total future cash flows after restructuring are: Principal $2,400,000 Interest ($2,400,000 X 10% X 3) 720,000 $3,120,000 Total pre-restructuring carrying amount of note (principal): $3,000,000 (c) The interest payment schedule is prepared as follows: BARKLEY COMPANY Interest Payment Schedule After Debt Restructuring Effective-Interest Rate 1.4276% Date Cash Paid (10%) Interest Expense (1.4276%) Reduction of Carrying Amount Carrying Amount of Note 12/31/10 $3,000,000 12/31/11 $240,000a $ 42,828b $197,172c 2,802,828 12/31/12 240,000 40,013 199,987 2,602,841 12/31/13 240,000 37,159d 202,841 2,400,000 Total $720,000 $120,000 $600,000 a$2,400,000 X 10% = $240,000. b$3,000,000 X 1.4276% = $42,828. c$240,000 – $42,828 = $197,172. dAdjusts $1 due to rounding. (d) Interest payment entry for Barkley Company is: December 31, 2012 Note Payable 199,987 Interest Expense 40,013 Cash 240,000 (e) The payment entry at maturity is: January 1, 2014 Note Payable 2,400,000 Cash 2,400,000

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