Question

Strickland Company owes \(200,000 plus \)18,000 of accrued interest to Moran State Bank. The debt is a 10-year, 10% note. During 2017, Strickland’s business deteriorated due to a faltering regional economy. On December 31, 2017, Moran State Bank agrees to accept an old machine and cancel the entire debt. The machine has a cost of \(390,000, accumulated depreciation of \)221,000, and a fair value of \(180,000.

Instructions

1. Prepare journal entries for Strickland Company and Moran State Bank to record this debt settlement.
2. How should Strickland report the gain or loss on the disposition of machine and on restructuring of debt in its 2017 income statement?
3. Assume that, instead of transferring the machine, Strickland decides to grant 15,000 shares of its common stock (\)10 par) which has a fair value of $180,000 in full settlement of the loan obligation. If Moran State Bank treats Strickland’s stock as a trading investment, prepare the entries to record the transaction for both parties.

Short answer

1. Gain on disposal of machinery for Strickland Company is $11,000.
2. Recorded in the income statement as ordinary gains.
3. Paid-in-capital in excess of Par-common stock of Strickland Company is $30,000.

Step-by-step solution

Meaning of Journal Entry

A journal entry is a record of financial transactions kept in the books of accounts of an organization. There are debit and credit columns and narration of each transaction.

(a) Preparing journal entry

Transfer of property on December 31, 2017:

Strickland Company (Debtor):

Date	Particulars	Debit ($)	Credit ($)
	Notes payable	200,000
	Interest payable	18,000
	Accumulated depreciation-Machinery	221,000
	Machinery		390,000
	Gain on disposal of machinery		11,000
	Gain on the restructuring of debt		38,000

Working notes:

Calculation of gain on disposal of machinery

$\begin{array}{rcl}\mathbf{Gain}\mathbf{}\mathbf{on}\mathbf{}\mathbf{disposal}\mathbf{}\mathbf{of}\mathbf{}\mathbf{machinery}& \mathbf{=}& \mathbf{Fair}\mathbf{}\mathbf{value}\mathbf{-}\left(\mathrm{Cost}\mathrm{of}\mathrm{machine}-\mathrm{Accumulated}\mathrm{depriciation}\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{180}\mathbf{,}\mathbf{000}\mathbf{-}\left(\$390,000-\$221,000\right)\\ & \mathbf{=}& \mathbf{\$}\mathbf{11}\mathbf{,}\mathbf{000}\end{array}$

Calculation of gain on the restricting of debt

$\begin{array}{rcl}\mathbf{Gain}\mathbf{}\mathbf{on}\mathbf{}\mathbf{restructing}\mathbf{}\mathbf{of}\mathbf{}\mathbf{debt}& \mathbf{=}& \left(\mathrm{Company}\mathrm{owns}+\mathrm{Accured}\mathrm{interest}\right)\mathbf{-}\mathbf{Fair}\mathbf{}\mathbf{value}\\ & \mathbf{=}& \left(\$200,000+\$18,000\right)\mathbf{-}\mathbf{\$}\mathbf{180}\mathbf{,}\mathbf{000}\\ & \mathbf{=}& \mathbf{\$}\mathbf{38}\mathbf{,}\mathbf{000}\end{array}$

Moran State Bank (Creditor):

Date	Particulars	Debit ($)	Credit ($)
	Machinery	180,000
	Allowance for doubtful accounts	38,000
	Notes receivables		200,000
	Interest receivables		18,000

(b) Reporting of gain or loss on the machine's disposition and on restricting debt

The income statement should include "Profit on Disposal of Machinery" and "Profit on Restructuring of Debt" as ordinary gains.

(c) Preparing journal entry

Strickland Company (Debtor):

Date	Particulars	Debit ($)	Credit ($)
	Notes payable	200,000
	Interest payable	18,000
	Common stock		150,000
	Paid-in-capital in excess of Par-common stock		30,000
	Gain on restricting debt		38,000

Moran State Bank (Creditor):

Date	Particulars	Debit ($)	Credit ($)
	Equity investments	180,000
	Allowance for doubtful accounts	38,000
	Notes receivable		200,000
	Interest receivable		18,000