On December 31, 2017, Federal Bank enters into a debt restructuring agreement wi
ID: 2539462 • Letter: O
Question
On December 31, 2017, Federal Bank enters into a debt restructuring agreement with Carson Company which is experiencing financial difficulties. The bank restructures a $6,000,000 note receivable by:
Reducing the principal obligation from $6,000,000 to $5,000,000.
Extending the maturity date from 12/31/17 to 12/31/20, and
Reducing the interest rate from 12% to 6%.
Interest has been paid up to date as of 12/31/17.
Instructions
Discuss the nature of this transaction, indicating whether any gain or loss is recognized by either party and preparing any 12/31/17 journal entries that may be required by the debtor (Carson).
**I have several questions very similar to this one, so it would be really helpful if you give some explanation with the answer so I can apply the concept to the other questions, thank you!
Explanation / Answer
The nature of this transaction is Debt Restructuring Agreement.
Discounting Factor at the end of 3rd year = 1/ (1+ 0.12) 3 = 0.711
Present Value of restructured Loan = 5,000,000 * Discounting Factor at the end of 3rd year
= 5,000,000 *0.711 = 3,558,901
Interest payable for year on restructured loan = 5,000,000*6% = 300,000
Cumulative discount factor for 3 years at 12% = 1/ (1+ 0.12) 1 + 1/ (1+ 0.12) 2 + 1/ (1+ 0.12) 3 = 2.401
Present Value of Interest Payable = 300,000 * 2.401 = 720,549
Total Present Value of Loan Receipts = 720,549+ 3,558,901 = 4,279,450
Bank's Gain/Loss on restructuring = Loan amount prior to restructure - Total Present Value of Loan Receipts
= 6,000,000 - 4,279,450
= 1,720,550
The loss to the bank is $ 1,720,550
The Debtor (Carson) will not recognize any loss on this transaction.
The Bank will recognize a loss of $1,720,550.
No journal entry will be recorded by the debtor to record the gain/loss as a result of this agreement since the GAAP does not provide for debtor accounting on debt restructuring agreements.
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