On December 31, 20x0, the American Bank enters into a debt restructuring agreement with Barkley...

Question:

On December 31, 20x0, the American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a {eq}12 \, \% {/eq}, issued at par, {eq}\$3,000,000 {/eq} note receivable by the following modifications:

(i) Reducing the principal obligation from {eq}\$3,000,000 {/eq} to {eq}\$2,400,000 {/eq}.

(ii) Extending the maturity date from December 31, 20x0, to January 1, 20x4.

(iii) Reducing interest rate from {eq}12 \, \% {/eq} to {eq}10 \, \% {/eq}.

Barkley pays interest at the end of each year. On January 1, 20x4, Barkley Company pays {eq}\$2,400,000 {/eq} in cash to Firstar Bank.

Required:

A) Will the gain be recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring?

B) Can Barkley Company record a gain under the term modification mentioned above? Why?

C) Assuming that the interest rate Barkley should use to compute the interest expense in future period is {eq}1.4276 \, \% {/eq}, prepare the interest payment schedule of the not for Barkley Company after the debt restructuring.

D) Prepare the interest payment entry for Barkley Company on December 31, 20x2.

E) What entry should Barkley make on January 1, 20x4?

IDebt Restructuring

Debt restructuring is a process whereby a creditor like banks or other companies modify the terms of a delinquent debt of a debtor that is experiencing financial difficulty to meet its obligations.

Answer and Explanation:

Answer A

Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt restructuring?

  • The gain recorded by Barkley will not be equal to the loss recorded by American Bank under the debt restructuring agreement. Debtor will recognize a gain from debt restructuring of the carrying amount of the debt exceeds the future cash flows to the creditor.

Answer B

Can Barkley Company record a gain under the term modification mentioned above? Explain.

  • Barkley will not recognize any gain from the new terms because the total future cash flows after the debt restructuring is more than the carrying amount of the note. (Refer to the calculations below)

Future cash flows after debt restructuring = Principal + Total Interests = $2,400,000 + ($2,400,000 x 10% x 3 years) = $3,120,000

Total pre-restructuring carrying amount of note = $3,000,000

Answer C

Assuming that the interest rate Barkley should use to compute interest expense in future periodsis 1.4276%, prepare the interest payment schedule of the note for Barkley Company after thedebt restructuring

Date Interest Payments (10% x $2,400,000) Interest Expense (1.4276% x CA) Deduction from CA (Payment - Expense) Carrying Amount (CA)
December 31, 2010 $3,000,000
December 31, 2011 $240,000 $42,828 $197,172 $2,802,828
December 31, 2012 $240,000 $40,013 $199,987 $2,602,841
December 31, 2013 $240,000 $37,159 $202,841 $2,400,000
TOTAL $720,000 $120,000 $600,000

Answer D

Prepare the interest payment entry for Barkley Company on December 31, 20X2.

(Refer to Answer C for figures)

December 31, 2012 Interest Expense 40,013
Note Payable 199,987
Cash 240,000

Answer E

What entry should Barkley on January 1, 20X4?

January 1, 20X4 Note Payable 2,400,000
Cash 2,400,000


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